On Monday, the economic secretary to the Treasury outlined some more details of the government’s proposed reforms to the Solvency II regime after the UK’s exit from the EU. Will the reforms change anything for pension funds? 

 

The UK leaving the EU has meant it is able to define its own solvency rules for insurance companies, although the pace at which this is being done has been criticised recently. 

 

On Monday, economic secretary to the Treasury John Glen gave some indications around the magnitude of the changes, which had already been anticipated and had been lobbied for by the insurance industry. 

 

The reforms are set to contain a reduction in the risk margin, including a cut of around 60-70% for long-term life insurers, more sensitive treatment of credit risk in the matching adjustment, an increase in flexibility to invest in long-term assets such as infrastructure, and “a meaningful reduction in the current reporting and administrative burden”. 

 

The Treasury claims this could create “an opportunity worth in the region of tens of billions of pounds for insurance firms to invest in long-term capital to unlock growth, unleashing greater investment in UK infrastructure”. 

 

But what does it mean for pension funds that are looking to transfer their liabilities – and that invest in the same kinds of assets as insurers? 

 

 

Insurance companies already have some exposure to infrastructure and housing, noted Tiziana Perrella, a professional trustee at Dalriada Trustees, who said that  “insurers still seem to be sourcing the right assets”, but added that how this develops will depend on the speed and impact of any changes to Solvency II.  

 

“It’s certainly not going to be a negative; it may even be a positive,” provided there is no major upheaval in capital markets - given current uncertainties - said Perrella. 

 

"A less restrictive portfolio that delivers a better yield and is also good for the economy would be a win-win,” she said, adding: “The messaging is good, we just have to see what comes of it.” 

 

Adam Davis, managing director of risk transfer specialists K3 Advisory, said the changes to the regime had been anticipated. “A number of insurers have previously commented to me that their pricing allows for some level of reduction in capital. So it’s not necessarily the case that confirmation of such changes would lead to massive changes in insurer pricing,” he said.  

 

However, the extra detail given in the minister’s speech and the extent of the changes “would lead me to believe that this ought to be beneficial to the pricing of long-term insurance products such as bulk annuities”, he added. 

 

  

Davis is also hopeful that relaxing the requirements on investments will mean insurers will be more able to accept assets in specie from pension schemes, in particular illiquids.   

 

“The current market has this bizarre ‘liquidity kink’ whereby pension schemes and insurers both see the benefits of holding illiquid assets either side of a transaction, but when it comes to trading with each other, the scheme has to liquidate such assets to pay the premium, which although there are ways to manage it, is far from ideal,” he said. 

 

The proposed changes to the matching adjustment eligibility could help with this, he believes, but agreed that “the devil will be in the detail”. 

 

If insurers start to invest in infrastructure more, this is “good news for those holding assets now but maybe not so good for those looking to enter the market”, said Andrew Singh, head of real assets research at consultancy Isio. 

 

Pension funds that are nearing buyout tend not to hold illiquid assets because regulation has meant that insurance companies have tended not to accept in-specie transfers of these assets. “If that changed for insurance companies, I’m sure more pension funds would hold infrastructure in the view they will be able to transfer the assets to an insurer at buyout,” he agreed. 

 

However, this would push up demand for these assets – which would already be increased if insurers invest more. “There are already concerns that the demand from pension funds and other institutional investors is pushing up prices and reducing returns. If you add extra demand from insurance companies to this, then presumably this will be exacerbated,” Singh warned. 

The proposals for reform should "unlock significant fresh investment in the UK", enabling insurers to invest more in "the colleges, hospitals, transport and renewable energy which are critical to our future”, said Amanda Blanc, group chief executive of Aviva.

Andrew Kail, chief executive of Legal & General Retirement Institutional, said he was encouraged by the government's announcement. 

"We have invested more than £30bn, targeted at the areas of the UK that need it most. But, this is just the start. An overhaul of pension sector regulations will enable us to accelerate further investment around the country, delivering our purpose of ‘inclusive capitalism’ to all our communities," he said.

Kail added: “It is now key that these reforms are implemented in good time. Pension Risk Transfer is one of the fastest growing sources of UK investment with immense potential for future growth and we want to see that unlocked as soon as possible. We must not lose this opportunity to transform our economy for the better by unleashing the full power of pensions.”