Calibrating the Solvency II risk-based regime to address emerging liquidity and sustainability risks

Eight Key trends in insurance regulation in EMEA   

The risk-based regime of Solvency II, which outlines regulatory requirements for insurance firms across Europe and the UK, continues to evolve in response to emerging risks that affect the industry. In a recent webinar hosted by Clearwater Analytics, Russell Lee, Head of Insurance Solutions at M&G, and Bob Warren, Senior Policy Adviser at the Association of British Insurers (ABI), engaged in a discussion on the regulatory landscape for insurance.  

While the conversation initially focused on Solvency II, it naturally expanded to encompass other significant topics such as technological advancements, the transition towards green energy, and both foreign and domestic investment. 

Here are eight key highlights from the discussion: 

1. There is a growing trend towards global alignment in insurance regulation 

The movement towards greater global regulatory alignment within the insurance sector has been met with enthusiasm. Since the Solvency II regime was introduced nearly a decade ago, it has emerged as a benchmark for the industry, establishing a framework that many other jurisdictions aspire to emulate. The International Association of Insurance Supervisors has recently finalised the Insurance Capital Standard, which will be implemented by major insurance groups worldwide, underscoring its recognition as a significant achievement. This trajectory is viewed positively.

2. Risk-based regimes continue to be calibrated and adapted internationally to ensure a level playing field. 

The evolution in Solvency II and other risk-based frameworks reflects a dynamic balance between financial resilience and market competitiveness. In each jurisdiction, the respective supervisors are taking steps to refine and calibrate the risk-based capital (RBC) regime, ensuring it remains fit for purpose. Both the EU and the UK have recently embraced smarter regulation, making their insurance regulations more agile and robust in response to shifts in risk profiles. Meanwhile, in the APAC region, Hong Kong and Singapore have implemented calibrated measures that will benefit their onshore businesses while maintaining an internationally-level playing field. There is a general trend towards principle-based regulation, which serves not as direct regulation but rather as a rulebook for regulators. 

3. There is an ever-growing focus on liquidity risk management. 

The Financial Stability Board (FSB) has published a working paper and recommendations for its members, highlighting that liquidity risk is a critical concern that can rapidly materialise if not properly monitored and managed. This can have a ripple effect on the stability and resilience of the global financial system. The Bank of England has taken steps to refine and enhance its liquidity risk management framework since the publication of SS5/19 nearly six years ago, specifically for the insurance sector. As part of this initiative, the Bank is conducting a Phase 3 review of the Solvency UK regime, with a particular emphasis on liquidity risk management, liquidity risk reporting, and liquidity stress testing. This aims to bolster its supervisory capabilities in addressing these risks, particularly given events such as the Liability Driven Investment (LDI) and the Dash-for-Cash crisis.  

A similar narrative is unfolding in Europe, where the eurozone is undertaking liquidity risk stress tests, including a recent industry-wide stress test for pension funds. The overarching goal of maintaining financial stability through effective liquidity risk management extends beyond safeguarding policyholders and the financial system; it also fosters a stable environment for firms operating within it, ultimately enhancing international competitiveness and growth of the industry. We have observed an evolution in regulatory frameworks and reforms aimed at freeing up capital for investment, refining risk management practices, and encouraging market growth. 

4. The UK BPA market: growth amid global volatility 

The Bulk Process Annuity (BPA) market in the UK has witnessed remarkable growth over the past few years, with projections estimating it will reach £1 trillion ($1.33 trillion) by 2030. While investments are currently favouring dollar-denominated assets, there is a significant political push to redirect this focus towards domestic long-term assets, particularly in the areas of green and infrastructure investments.   

By engaging in cross-jurisdictional investments, the exposure to risk is broadened to encompass both domestic and global macroeconomic events. Recent developments in the US markets, such as trade tariffs, have underscored the necessity of evaluating cross-currency and swaps stress, as well as dollar and counterparty risks. Consequently, this situation highlights the critical importance of stress testing and liquidity risk considerations, which should not be narrowly focused.  

5. Regulating for growth 

Regulation extends beyond mere compliance; it acts as a catalyst for stability, innovation, and growth. Striking the right balance is essential to ensure that regulation achieves its intended goals of protection and stability without stifling growth. For instance, the Bank of England now has a statutory obligation to consider competitive factors and growth during its consultation processes. Likewise, Europe has reiterated its commitment to growth initiatives, evidenced by two recent waves of consultations aimed at simplifying rules, processes, and reporting for firms. This effort is designed to bolster the economic vitality of the Eurozone.  

6. Approaches to addressing sustainability risks through regulation still vary 

Sustainability risk is, and will remain, a significant topic in the debate surrounding insurance regulation. Various global supervisory bodies and associations, such as the FSB, the European Supervisory Authorities (ESA), and the Bank of England, have highlighted this area of concern. Notably, the Bank of England was the first supervisory authority to establish comprehensive expectations for managing financial risks linked to climate change. The European Insurance and Occupational Pensions Authority (EIOPA) was the first to provide guidance on integrating sustainability risks into insurers’ capital management frameworks, including additional stress tests for fossil fuel industries (e.g., NACE B.9).  

As time progresses, these approaches are expected to evolve leading to closer alignment. We anticipate further consultations in both the EU and the UK during 2025, leading to further refinement and definition of these regulations.  

7. The interpretative nature of ESG and sustainability reporting 

Although ESG and sustainability regulations focus mainly on risk management, challenges persist. Reporting in this domain tends to be largely subjective, which is a complication for insurers. A major concern is the lack of clear and consistent definitions; for example, how can regulators accurately define a “green” or “brown” asset class to integrate these distinctions into a regulatory framework? Despite these challenges, there is hope that standardized measures will eventually emerge, allowing the industry to advance collectively. 

8. The Importance of technology in driving transformation for supervisory and industry communities 

Both the supervisory body (the regulator) and the industry (the regulated) place a high priority on transformations in data, operations, and reporting. This is exemplified in the UK through the Transforming Data Collection (TDC) programme while Europe is making strides through the ESA harmonisation initiative in reporting. Digitization is established as key priority on the supervisory agendas of both the Eurozone and the UK, with the industry rapidly evolving to adopt new technologies that meet the emerging demands of the market and regulatory landscape. Many organisations have already begun to reap the benefits of technology, which is poised to play a crucial role in facilitating these transformations and enhancing overall competitiveness. 

If you would like to hear this conversation in full, click here to watch the webinar on demand.