Insurers across the country would remain well capitalised under the UK Treasury’s proposed post-Brexit regulatory reforms as the overhaul could allow firms to release surplus capital, which they could either return to shareholders or use to take on more risks, according to Moody’s.
In a new report, the rating agency explained how both options would reduce total capitalisation – a credit negative – but added that the overall impact for most insurers was expected to be modest.
“In their current form, the proposals would reduce UK insurers’ risk margin, a layer of capital designed to fund the transfer of liabilities if the insurer fails, allowing for a capital release,” Moody’s wrote. “This reduction would be partly offset by changes to the matching adjustment (MA) calculation. The MA allows insurers to apply a higher discount rate to their liabilities, with a corresponding reduction in their capital requirement.”
The proposals, which are subject to consultation until July 21, seek to amend the European Union’s Solvency II insurance capital rules to better reflect UK insurers’ risk profiles. According to the Treasury office, these reforms could allow firms to release as much as 15% of their capital.
Moody’s, however, expects the overall impact on capital to be “relatively modest” and “potentially neutral” for insurance companies that are significant MA beneficiaries such as annuity specialists.
“The redeployment of released capital towards new business opportunities, including investments in illiquid assets, is credit negative,” the agency added. “But the reforms will ensure that insurers’ remaining capital is more closely matched to their risk profiles, and, therefore, resilient in a range of scenarios. Channelling capital into new business should also strengthen insurers’ future capital generation capacity.”
According to the report, some insurance companies are expected to use surplus capital to write more bulk purchase annuities (BPAs), which will allow them to “assume UK corporates’ defined benefit (DB) pension liabilities in return for a premium.”
Moody’s pointed out, however, that the supply of BPAs would fall short of booming demand.
“Increased BPA activity will support demand for illiquid assets, which BPA writers use to match their annuity obligations,” the agency wrote. “As the reforms also aim to broaden the range of assets insurers use to match annuity liabilities, some BPA writers could expand and diversify their illiquid asset holdings. However, we foresee no significant change in the sector’s overall asset allocation. Illiquid assets’ superior yield and liability matching characteristics relative to bonds or equities outweigh their higher risk.”