According to the Bank of England (BoE), new rules for insurance could force UK taxpayers to bail out policyholders. This is similar to events that occurred around 20 years ago.
The government announced in November that it would continue reforms to the insurance industry, which are expected to release billions of dollars of investment into the economy.
The UK will add the Solvency II changes, which it inherited from EU, to its Financial Services and Markets Bill. They will reduce the capital buffer or risk margin of insurers by 65% for life insurance and 30% for general insurance.
This decision was against the Prudential Regulation Authority’s advice and led to further cautionary words from the central bank yesterday.
Is there another Equitable Life?
The BoE raised concerns that the changes could lead to a repeat of Equitable Life’s near collapse.
Andrew Bailey, Bank of England Governor, stated that while it was unlikely that there would be any risk to financial stability, it was a risk for policyholders.
Bailey said, “I will mention Equitable life…it can happen.”
Equitable Life was established in 1762 and closed its doors to new customers in 2000. It almost collapsed after providing unsustainable guarantees for policyholders.
Sam Woods, BoE deputy governor, pointed out that this case shows how risks can “come hometo roost” if there isn’t enough capital backing pensions.
“Now, you can look back at the past to see what’s likely to happen if it does. Woods stated that it was highly probable that the public purse would be returned to the government if this happens.
In compensation for Equitable policyholders, the government paid out PS1.1bn.
Woods last year warned that reducing the capital held by insurers would not be a free lunch, as it could reduce firms’ ability to pay out on policies in a crisis.
No trading between Bank and Chancellor
Woods stated that the government had already made its decision regarding insurance reform, and it was time to move on.
He said that the BoE would not seek to use new powers to allow regulators to “reverse engineer,” changes to insurance rules that go against the spirit and intent of the government’s proposals.
Bailey stated that there was no trading between the Bank of England and the government. Some suggested that the insurance proposals had been accepted by the government in exchange for it withdrawing its plans to grant itself the power to veto financial regulators’ decisions.
Bailey stated that he would not be open to this type of “trade.”
Jeremy Hunt, the Chancellor, proposed a series of financial market changes collectively known as the Edinburgh Reforms to increase the City of London’s global competitiveness.
These reforms include a review and relaxation of the requirements for banks to wrap retail deposits with a capital cushion.
Woods stated that the BoE was keen to be “very closely involved” in detail reforms.