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The divergence dilemma: where next for UK insurance regulation?

The divergence dilemma: where next for UK insurance

At the end of this year, EU regulations will no longer apply to UK insurers.

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Matthew Francis is Director, Insurance at KPMG UK.

Director, Insurance

KPMG in the UK

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At the end of this year, EU regulations will no longer apply to UK insurers, even though the UK’s regulatory rulebook will look almost identical in substance at that point. Post-Brexit, the powers for shaping UK insurance regulation will be split between the UK Parliament, HM treasury and the regulators.

The UK faces a dilemma:

  • Should it seek to maximise divergence from Europe at the cost of losing preferential market access? 
  • Can it chart a path forward in close (or loose) alignment to Europe without foregoing an opportunity to enhance UK competitiveness?

It seems unlikely that the UK can have its cake and eat it!

Chicken or egg?

The UK’s commitment to align (or not) to EU rules will shape its future relationship with Europe. To secure market access, Europe expects a ‘level playing field’; the UK rejects becoming a ‘rule-taker’.

The Political Declaration puts regulatory autonomy and equivalence at the centre of future trade in financial services. Politicians and regulators recognise that this arrangement would permit divergence without tearing up the existing rulebook. However, the EU’s insistence that equivalence is at their sole discretion remains a stumbling block and in any case, equivalence will not give the same market access as current passporting rights.

Divergence and discretion

Divergence will allow the UK to tailor UK rules to better reflect the nuances of the UK market. For example, Solvency II’s risk margin is too sensitive to interest rates and has resulted in UK annuity providers holding more capital than seems appropriate. Europe has rigidly resisted calls to modify the risk margin’s design or fixed cost of capital assumption and it can be expected that UK changes will be closely monitored in Europe.

Reporting requirements and availability of the matching adjustment are further areas that the PRA could simplify. The PRA might also have greater latitude to exercise its discretion and issue waivers where there is justification to do so.

Divergence will not necessarily occur solely at the instigation of the UK however. The EU’s own rulebook will also evolve, raising the spectre of the UK aligning with rules it has been unable to influence. EIOPA and the European Commission are unlikely to take account of UK input as part of the Solvency II 2020 review. If the UK does not adopt similar changes, then it will be more challenging for pan-UK/EU insurance groups to manage compliance, capital, governance, operations and reporting.

Equivalence

The EU and the UK have committed to assessing equivalence by the end of June 2020, but this is restricted to areas of EU Directives that currently contain equivalence provisions. In the insurance sector, this is limited and equivalence will be no substitute for market access. It would however facilitate cross-border reinsurance, group supervision and using local solvency rules as a basis for inclusion in group solvency. Equivalence might therefore deliver some efficiencies to large UK insurance groups with material European activities, but it is generally less relevant to domestic carriers.

A key point to remember is that UK rules do not need to be identical – equivalence assessments are supposed to be outcomes focused. However, equivalence decisions can be rescinded unilaterally by the EU, making it difficult for business leaders to rely on it. The Prime Minister, Boris Johnson, acknowledged this when he called for a process of “structured withdrawal of equivalence findings”.

Horses for courses

There could be merit in exploring how the UK could differentiate its approach to international groups from that to domestic carriers, similar to its current directive/non-directive approach and Bermuda’s class system. This would enable groups that require equivalence to be subjected to rules more closely aligned to Europe, without imposing these on the rest of the UK market.

Competiveness of the UK regime

It would need to be ensured that such an approach would not introduce an element of anti-competitiveness within the UK. However divergence could enhance the UK market’s comparative attractiveness as a place to do business. This would likely reopen the debate about whether the PRA should have competitiveness written into its statutory objectives.

Fit for purpose

It is critical that the UK’s future regulatory regime is ‘fit for purpose’, being both capable of fostering growth and innovation and giving insurers support to respond to society’s challenges.

New technologies capable of enhancing customer experiences and transforming insurers’ product lines and operations are increasingly bringing new entrants to the market.

Regulators must be able to adapt regulatory approaches to safely test and monitor these developments, so that regulation does not become a barrier to entry.

Climate change, digitalised workforce, ageing populations, autonomous vehicles, cloud computing, sustainable finance, biotech, artificial intelligence, big data, cybersecurity all present material opportunities and threats to existing business models and regulation needs to be agile to respond to such fast-moving developments.

Where to next?

The UK benefits from its regulators’ established reputation, experience and credibility in international standards bodies such as the IAIS and UK regulators are committed to upholding international standards. A race-to-the-bottom approach is therefore highly unlikely.

Divergence presents opportunities for the UK to tailor its regulation and relieve business from overly-burdensome compliance, but much will depend on the terms of the future trade agreement negotiated with Europe. Until then, UK politicians, regulators and business cannot speak with certainty as to what changes might be made after 31 December 2020.

What changes to UK insurance regulation would you like to see? To discuss how the regulatory agenda might develop and affect your firm, please feel free to get in touch.

© 2020 KPMG LLP, a UK limited liability partnership, and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

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