Solvency UK: changes for small firms
Insurer Update - Summer 2024
Read time: 31 mins
What do the revised thresholds for Solvency II mean for firms? And what are the benefits of becoming a non-directive firm (NDF)?
In November last year, we looked at the potential impact on Solvency UK of the PRA’s consultation paper 12/23. This was most likely to affect smaller insurers, as the PRA continues its drive to have a more proportionate approach to the regulation of small firms.
Across the industry, there were 36 responses to CP 12/23. Having considered these, the PRA released a policy statement in February (PS2/24 – Review of Solvency II: Adapting to the UK insurance market | Bank of England). There were a number of changes to the original consultation paper, most notably:
- Capital add-ons (CAOs) – firms won’t have to disclose residual model limitation (RML) CAOs in their solvency and financial condition report (SFCR), and safeguards (including RML CAOs) have been removed from the PRA’s regular aggregate report on CAOs
- CAO flexibility – allows for the possibility of setting a CAO which moves dynamically in line with certain outputs calculated by a firm, to show how the underlying risk deviation varies over time
- Calculating the group SCR – allows an insurance group up to six months after an acquisition to create a clear and realistic plan to integrate any internal models (rather than requiring this immediately on acquisition), and a two-year period thereafter to implement the plan
- TMTP financial resource requirement (FRR) test – the PRA no longer expects firms to carry out the FRR test when recalculating the TMTP. This is subject to case-by-case assessments for some firms. The change has been made a year earlier than proposed in the consultation paper
- Solvency II thresholds – increases the threshold for gross written premiums, above which a firm enters Solvency II, to £25m. This is an increase of £10m compared with the original proposals.
Significance of new thresholds
It is the last change, a further increase in the Solvency II thresholds, which is the most interesting for insurers at the smaller end of the industry. The original proposal to increase the thresholds to £15m for gross written premiums and to £50m for technical provisions was expected to affect nine firms currently required to comply with Solvency II.
Combined with the confirmed switch in currency to pounds sterling from euros, the PRA estimates the GWP threshold extension to £25m will now give roughly 15 firms an option to move out of Solvency UK. This would account for around £187m in annual gross written premiums for life and non-life business at year end 2021 and £86m in technical provisions across the UK market.
These firms would be excluded from the Solvency UK regime based on their premium income and technical provisions, and have the option to become a non-directive firm (NDF). So let’s take a closer look at the potential choices and several of the implications for those considering becoming an NDF.
Initial application
A firm that falls under the new Solvency UK thresholds will not automatically be subject to the prudential regime for NDFs. It must assess whether the threshold increases and currency change will impact its status as a UK Solvency II firm at 31 December 2024.
If a firm concludes it will no longer meet the Solvency UK thresholds and doesn’t want to voluntarily become a Solvency UK firm, it should tell the PRA the date on which it will become subject to the NDF section of the PRA Rulebook. Firms can still volunteer to operate under the UK Solvency II regime by applying for a Voluntary Requirement (VREQ) with the PRA.
It’s important to consider your organisation’s future business plans and projections before taking this decision. The PRA has made clear that firms will only be exempted from Solvency UK at the point of implementation if they have not exceeded any of the revised thresholds for three consecutive years and don’t expect to exceed any in the following five years. So forward planning is key to avoiding the risk of constant process changes if your business were to ‘bounce’ between regulatory regimes.
Reporting requirements
Becoming an NDF is likely to mean less regulatory reporting.
Whilst the requirement for Solvency UK firms to submit a regular supervisory report (RSR) has already been removed with effect from 31 December 2023, the Solvency & Financial Condition Report (SFCR) is still compulsory.
There is no equivalent narrative report necessary for NDF firms. But several quantitative templates are still required, which can be viewed on the PRA website.
Regulatory oversight and audit requirements
It’s worth noting that even if a firm falls under the new thresholds and chooses not to comply with the Solvency UK regime, the PRA has said it would still be considered a public interest entity (PIE). This is because PIE is defined under the Companies Act 2006 and cannot be amended by the PRA.
But the FRC’s definition of a PIE only includes insurers which are subject to Solvency UK. Some industry participants are therefore seeking to clarify this matter with the PRA. It is the FRC’s definition which drives additional regulations for audit firms. Our view is that NDF firms should have a greater choice of external auditor, as they’ll no longer be restricted to those on the PIE auditor register.
This has potential benefits for firms. However, most firms that qualify for NDF status will already be exempt from the regulatory audit of their SFCR. In contrast, all NDF firms’ regulatory reporting must still be subject to external audit in accordance with the PRA Rulebook. Many in the industry are questioning whether this is proportionate.
Other considerations
As you would expect, NDF firms benefit from a simpler, more proportionate prudential regulatory framework, with generally lower capital standards than are applicable under Solvency UK.
Additional benefits include the freeing up of smaller firms from the qualitative requirements of Pillar 2. For example, they would no longer have to produce an ORSA, and risk and governance requirements would become less onerous.
Some other factors for NDFs to consider include the requirements for senior management functions (which are, again, simpler than those for Solvency UK reporters), the actuarial requirements and other rules relating to conduct and fitness and propriety. We’ve included some links below for further information.
Whilst it is unlikely that any smaller insurance groups will be writing business outside of the UK, any requirements of overseas regulators should also be considered before changing your regulatory regime.
The implementation date of PS2/24 is 31 December 2024, so firms that fall under these revised thresholds should consider the points in this article, and decide the best option to suit their needs.
If you’d like to discuss these issues in more detail, please contact James Randall.