This question is often posed to Brexiteers, usually by those who believe Eurosceptics lack detailed arguments or, worse still, didn’t know precisely what they were voting for. Though this may be true in some cases, EU-friendly commentators are also, at times, guilty of a myopia of their own – assuming that the current regulatory status quo automatically equates to ‘best practice.’
In reality, the European Union has been responsible for a raft of regulations which have caused great harm to businesses and consumers. While much is made of the compliance cost of certain regulations, less attention is generally paid to the anti-competitive harm they cause. Increasing costs for certain firms, and forcing some (especially smaller, firms) to exit the market can have the effect of raising prices for consumers and diminishing capacity. Anti-competitive regulations make it difficult for new competitors to enter the market, thereby entrenching existing companies and leading to the formation of oligopolies.
This blog series examines a number of regulations, with anti-competitive effects, to illustrate how they work and the distortions they cause.
Solvency II Capital Requirements Regulation
Solvency II is an EU regulation which harmonises existing insurance regulation (replacing 14 EU insurance directives). Besides setting capital ratios and reserve requirements, Solvency II also covers the harmonisation of asset valuations, regulatory authorisation, corporate governance, supervisory reporting, public disclosure, risk assessment and risk management. Under Solvency II insurers are obliged to publish details of their risk portfolio, capital adequacy and risk management.
What was the goal of the regulation?
The fundamental goal of Solvency II was to increase transparency around the financial position of insurers, and their ability to absorb loss. It was hoped this would improve consumer choice, ensure uniform consumer protection across the EU, and allow market forces to prevent insurers taking excessive risks.
Was this regulation ever necessary?
Yes – the harmonisation of EU insurance directives and the push for more transparency and exposure to market forces was intended to help policyholders and shift supervisory focus towards an insurer’s risk profile, risk management and governance.
Why is Solvency II anti-competitive?
Solvency II was designed primarily for life and property insurance, the predominant type of insurance bought by retail policyholders throughout the EU. However, Solvency II also applies to insurers covering less frequent events, e.g. catastrophe insurance, aircraft insurance, and cargo insurance – as well as more complex insurance like oil platforms and nuclear power plants, even construction contract overruns or errors and omissions insurance for consultancy contracts.
Solvency II’s capital requirements are overly reliant on data samples which are often small and of limited value in assessing the risk of rare or complex events. It is overly cautious in its capital requirements, allowable asset classes and durations, which impacts the competitiveness of UK insurers with non-EU based insurance companies.
Post Brexit, the UK regulators should review Solvency II’s prescriptive capital requirements, especially for insurance that is outside the regular life, car or house insurance. UK authorities should also review the illegality of using gender as a risk factor in driving insurance and life insurance if statistically women have fewer driving accidents or live longer than men. The Treasury should also consider removing the taxation of loss equalisation reserves and catastrophe reserves.
Any divergence from Solvency II should enhance the competitiveness and efficiency of the UK insurance market without eroding the fundamental goal of ensuring that an insurance provider is able to meet its obligations and absorb any losses. However, regulation designed to ensure good governance within an insurance company is more likely to protect consumers than prescriptive regulation of that company’s capital.