Solvency 2 and Insurance (Amendment, etc.) (EU Exit) Regulations 2019

Motion to Approve

Moved by

To move that the draft Regulations laid before the House on 8 January 2019 be approved.

My Lords, as this instrument has been grouped, with the leave of the House I will speak also to the draft Financial Conglomerates and Other Financial Groups (Amendment) (EU Exit) Regulations 2019 and the draft Insurance Distribution (Amendment) (EU Exit) Regulations 2019.

The Treasury has been undertaking a programme of legislation to ensure that, if the UK leaves the EU without a deal or an implementation period, there continues to be a functioning legislative and regulatory regime for financial services in the UK. The Treasury is laying SIs under the European Union (Withdrawal) Act to deliver this, and a number of debates on these SIs have already been undertaken in this place and in the House of Commons. The SIs being debated today are part of that programme and have been debated and approved by the Commons.

These SIs will fix deficiencies in UK law on the prudential regulation of insurance firms, the distribution of insurance products, and financial conglomerates, in order to ensure that they continue to operate effectively post exit. The approach taken in this legislation aligns with that of other SIs being laid under the EU withdrawal Act, providing continuity by maintaining existing legislation at the point of exit but amending where necessary to ensure that it works effectively in a no-deal context.

Three SIs are being debated today: the financial conglomerates and other financial groups regulations, the insurance distribution regulations and the draft amendments to the Solvency II regulations. The financial conglomerates and other financial groups regulations set prudential requirements for financial conglomerates or for groups with activities in more than one other financial sector. The insurance distribution regulations set standards for insurance distributors regarding insurance product oversight and governance, and set information and conduct-of-business rules for the distribution of insurance-based investment products.

Solvency II sets out the prudential framework for insurance and reinsurance firms in the EU. Prudential regulation is aimed at ensuring that financial services firms are well managed and able to withstand financial shocks so that the services they provide to businesses and consumers are safe and reliable. Solvency II is designed to provide a high level of policyholder protection by requiring insurance and reinsurance firms to provide a market-consistent valuation of their assets and liabilities, understand the risks that they are exposed to and hold capital that is sufficient to absorb shocks. Solvency II is a risk-sensitive regime, in that the capital that a firm must hold is dependent on the nature and level of risk that a firm is exposed to. In a no-deal scenario, the UK would be outside the EEA and outside the EU’s legal, supervisory and financial regulatory framework. The Solvency II and insurance regulations, the financial conglomerates and other financial groups regulations and the insurance distribution regulations therefore need to be updated to reflect that, and ensure that the provisions work properly in a no-deal scenario.

As is the case for the statutory instrument that amends the Solvency II regulations, which I will discuss later, this instrument removes obligations for the EU competent authorities to share information. If the UK leaves the EU without a deal, it will no longer be appropriate to require UK regulators to share information with EU regulators. However, the UK regulators will continue to be able to use their discretionary powers to share information where this might be necessary to ensure that supervisory responsibilities are carried out effectively.

I turn now to the amendments to the insurance distribution regulations. Again, this is an instrument which fixes deficiencies in the regulations, which mostly relate to removing inappropriate cross-references to EU bodies and legislation. This instrument transfers to the Financial Conduct Authority the power to make technical standards regarding a template for presenting information about general insurance policies. This is a standardised document to help consumers compare policies and make informed decisions. This power is required, as it enables the Financial Conduct Authority to update this document in the future to ensure that it continues to deliver useful information for consumers. This instrument also transfers relevant legislative functions to HM Treasury. These give HM Treasury the powers to make regulations about conflicts of interest, inducements, assessments of suitability, appropriateness and reporting to customers, and specifying principles for product oversight and governance.

Finally, let me turn to the amendments to the Solvency II regulations. These first remove references to the European Union and EU legislation and replace them with references to the UK and UK legislation. It is important to stress that the high prudential standards of Solvency II are not being altered. Changes are being made to ensure that the Solvency II regime continues to operate as originally intended, once the UK is outside of the EU. Secondly, preferential risk-charges for certain assets and exposures that originate from within the EEA, and which are held by UK insurance and reinsurance firms, will be removed. A UK firm’s exposures from the EEA will now be treated in the same way as exposures from any third country. The EU has confirmed that it will treat UK exposures as third country exposures if we leave the EU without an agreement.

Thirdly, this statutory instrument alters the arrangements for the regulation of cross-border EEA groups of insurance and reinsurance firms that provide services in the UK. As in other areas of EU regulation, insurers and reinsurers are currently subjected to the EU’s joint supervisory framework. This enables the requirements of Solvency II for a cross-border EEA insurance or reinsurance group to be applied to the group, with one EEA supervisor allocated lead responsibility for supervision of the group in addition to supervision of solo firms by their respective EEA supervisors. Supervisory co-operation takes place through a “college” of supervisors in which all interested EEA supervisors take part. After exit, in a no-deal scenario, the EU has confirmed that it will treat the UK as a third country and that the UK will be outside the joint supervisory mechanisms which are part of the basis for the current treatment of groups in the EEA. Therefore, cross-border groups may become subject to group supervision by both UK and EEA supervisory authorities in the absence of equivalence decisions.

Fourthly, this statutory instrument removes obligations for EU competent authorities to share information with each other. If the UK leaves the EU without a deal, it will no longer be appropriate to require UK regulators to share information with EU regulators. However, the UK regulators will continue to be able to use their discretionary powers to share information where this might be necessary to ensure that supervisory responsibilities are carried out effectively.

Fifthly, this statutory instrument will transfer responsibility for a number of important technical functions from the EU authorities to the UK. Most significantly, responsibility for setting the risk-free rate—the rate that insurance and reinsurance firms must use to value their liabilities—will be transferred from the European Insurance and Occupational Pensions Authority to the Prudential Regulation Authority. The Prudential Regulation Authority is the most suitable UK body to undertake the technical function of compiling the risk-free rate. It will also take on responsibility to publish this rate. In addition, responsibility for making binding technical standards, which are currently developed and drafted by the EU supervisory agencies, will be transferred to the Prudential Regulation Authority, in a manner consistent with the approach taken in the other statutory instruments that we are laying under the European Union (Withdrawal) Act 2018.

Finally, this statutory instrument will transfer responsibility for making equivalence decisions in relation to third-country regimes. Currently, a third country’s regulatory and supervisory regime may be deemed by the European Commission to be equivalent to the approach set out in Solvency II. After the UK leaves the EU, HM Treasury will make equivalence decisions for third-country regimes.

The Treasury has been working closely with the Prudential Regulation Authority and the Financial Conduct Authority in drafting these instruments. It has also engaged the financial services industry on these and will continue to do so going forward. In late 2018, the Treasury published these instruments in draft, along with explanatory policy notes, to maximise transparency to Parliament and industry.

In summary, this Government believe that the proposed legislation is necessary to ensure that insurance and reinsurance firms, insurance distributors and financial conglomerates continue to operate effectively in the UK and that the legislation will continue to function appropriately if the UK leaves the EU without a deal or an implementation period. I hope noble Lords will find that explanation helpful. I commend these regulations to the House.

My Lords, I declare my interests as set out in the register, especially those in respect of the insurance and reinsurance industries. I will speak briefly to two of the three statutory instruments: the Solvency II and insurance regulations and the insurance distribution regulations.

Turning to the Solvency II and insurance regulations, and thinking about the near term, I congratulate the drafters of the statutory instrument; I know the ABI has been sitting with Treasury and PRA officials. First, it gives great comfort to the board of an insurer or reinsurer in the near term—I was thinking about how I would analyse it. It gives certainty on capital required, rollover for capital models and the ability to use reinsurance as temporary capital, and the asset values in an insurer’s balance sheet are unaffected. Secondly, I think the mutual equivalence regime is clever. It would have been possible to put equivalence for EU countries in the statutory instrument, but instead it is left to the Treasury to decide what to do. I think that is important because otherwise it would be possible for us to grant equivalence and then find that our Lloyd’s market had no equivalence granted back to it in the EU, which would be quite wrong. Mutuality of interest is preserved by that. Finally, I think the selection of measures designed to reduce that horror for all insurers, multiple regulation of the same action, is as good as can be done in the circumstances, so I congratulate the drafters on that.

However, thinking about the longer term, I put a question to the Minister. Solvency II—which came into force on 1 January 2016, for those who did not know, and is a regulation dating from 2009—is very much a one-size-fits-all solution to the problem of having the right amount of capital in your insurance market. Accordingly, it was not designed for the British situation. If you look at equivalent regimes in other jurisdictions—I am particularly familiar with the Bermuda jurisdiction, which is equivalent to the EU, but there are others such as Japan, Australia, Canada and the US, which is of course 50 jurisdictions in insurance terms—it seems that some changes could be made.

My Lords, I too thank the Minister for his introduction. When I was involved in legislation in Europe, Solvency II was perhaps the first time that I discovered that I could be right while the Treasury was wrong. When I chaired the committee that gave me the confidence to trust my own judgment and to have few, if any, disagreements with the Treasury.

As it was originally done, Solvency II did not manage to cater for everything that the UK needed. In particular, we forgot about annuities; so did the ABI and the Treasury. I have to tell your Lordships that Parliament did not forget about annuities, but we were not strong enough to work out what to do about that because there was a big row going on, particularly between the UK and France, on equities and volatility. When I came back and discovered that I was to chair the committee, one of the first things on my agenda was Omnibus II, which aimed to sort things these out. We had the volatility adjustment for France; we had extrapolation for bonds in the eurozone, which were desperately needed by Germany; we also had the so-called matching adjustment, which we needed because otherwise the fact that insurance companies naturally tried to match the term of the assets that they collected to their liabilities would have been forbidden. They were supposed to account for their assets separately from assessing their liabilities, which in the business of annuities is a pretty stupid thing to do. Because we were having to box and cox with three other things, that meant that the solutions were probably less than perfect in the end, so in the fullness of time it might perhaps be made a little more perfect.