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UK insurers hit out at regulator's 'stringent' proposal on capital

The Association of British Insurers has hit out at the U.K. Prudential Regulation Authority's proposed changes to rules for insurers investing in equity release mortgages, calling them "unnecessarily stringent."

The PRA has said itself that the changes, which could require insurers that invest in the mortgages to hold more capital, could have a "significant impact" on some insurers. And pensions consulting firm Hymans Robertson warned in a July 5 report that the proposals, made July 2, could have a "potentially significant impact on solvency levels for insurers" that have a "material proportion" of their total portfolios invested in equity-release mortgages.

The consultancy also said the new rules could raise the price pension funds pay for bulk annuity deals, on which the responsibility for paying retirees with defined benefit pensions is transferred to insurers, because insurers have been investing in equity-release mortgages to back their bulk-annuity liabilities.

Insurers and other interested parties have until Sept. 30, 2018, to voice their opinions about the proposed new rules, which the PRA expects to be implemented Dec. 31, 2018.

A favored asset

Equity-release mortgages, or ERMs, allow homeowners to borrow money against the value of their home without making regular interest payments. The loan, plus interest, is repaid by selling the house when the homeowner dies or enters long-term care.

Insurers' interest in ERMs has been driven by the burgeoning market for bulk annuity transfers, which is fueling insurers' search for high-yielding, long-term, illiquid assets in general to match the liabilities they take on in the deals. David Rule, executive director of insurance supervision at the PRA, said in a speech to the Association of British Insurers (ABI) in July 2017 that life insurers take on "almost all" of the flow of new equity release mortgages in the U.K.

Hymans Robertson said in its July 5 report that the long-term nature of ERMs means they "can form a helpful component of an insurer's asset portfolio used to back annuity liabilities." It added that the yield so far on ERMs "has compared very favorably with other long-term alternatives."

The benefit of ERMs and other long-term, illiquid assets is their treatment under the so-called matching adjustment, part of the Solvency II European insurance capital rules. The matching adjustment allows insurers to hold less capital if assets closely match liabilities.

The PRA is concerned, however, that U.K. insurers are giving themselves too much credit under the matching adjustment for ERMs in particular in some cases, and so not holding enough capital. The main worry is that ERMs contain a so-called no negative equity guarantee, which limits the loan repayment to the sale proceeds from the property. Insurers exposed to ERMs therefore run the risk that the proceeds from the house sale will not cover the loan plus interest if, for example, interest rates rise faster than house values.

'Unnecessarily stringent'

In its original July 5, 2017, supervisory statement on illiquid assets, the PRA set out a test to determine whether companies were giving themselves too much credit under the matching adjustment for ERMs, but did not specify the calibration that companies should use for the test. The new proposals would require insurers to adopt a minimum calibration for risk associated with no negative equity guarantees.

The regulator acknowledged that the consequences of applying the new calibrations "may be significant for some firms" and has proposed a short phase-in period based on firms' circumstances, which it said is unlikely to exceed three years in any event.

The ABI believes that the PRA is being heavy-handed. Steven Findlay, head of prudential regulation at the ABI, said in an emailed statement: "The Treasury Select Committee agreed with us last year that the PRA had erred on the side of caution when implementing Solvency II in a range of areas, including equity release. Equity release is an invaluable tool for some customers when it comes to finding a way to fund their later life, and it doesn't seem right that unnecessarily stringent regulations could be preventing them from getting a better deal."

Findlay added that the ABI would respond to the PRA's consultation and that the association hoped "that it does not end up as a missed opportunity for the PRA to adjust its approach and establish a more proportionate way forwards, for it is the customer that will end up having to pay too high a price for this prudence."