In a shot across the bows of the regulators and politicians in UK and Europe, Prudential (PRU) has announced it is reviewing its domicile as a possible response to “unintended consequences” of Solvency II regulations.
The UK-based insurer’s statement said:
“Prudential regularly reviews its range of options to maximize the strategic flexibility of the group. This includes consideration of optimizing the group’s domicile, including as a possible response to an adverse outcome on Solvency II.”
The company notes that “certain versions” of Solvency II will give it problems investing in corporate bonds, infrastructure and some bank assets. It is also concerned about becoming uncompetitive in the US via its Jackson Life subsidiary due to Solvency II applying higher capital rules than local regulation.
The problems it identifies relate to the high charges applied to different asset classes under the current drafts of the standard Solvency II capital calculation and issues around equivalence with other regulatory regimes.
It is very likely that Prudential will operate an approved internal model to calculate its capital requirements, giving it more flexibility to model its assets in a way that it feels is appropriate, as long as it can justify its approach.
There is still a requirement for all insurers to complete the standard capital formula and concern that it will, explicitly or implicitly, be used to compare companies and influence model approval decisions. Specifically, the standard formula is harsh on longer duration corporate bonds, equities (particularly unlisted) and property assets. This complicates matching of assets and liabilities of a longer tailed book of business, particularly a life book with a large “traditional” with profits element or with return guarantees.
Equivalence as a Motive
The equivalence point is an interesting one. The Pru talks of potentially relocating to Hong Kong. Its failed takeover of AIG’s Asian Life business shows Pru’s interest in the Asian region, source of 45% of the company’s sales, but an attraction of Hong Kong may be that it is one of the regimes that the European Commission has confirmed to be in the next wave of equivalence applicants.
Equivalent regimes do not need to be identical to Solvency II, rather exhibit similar controls, mechanism and capital standards. Being based in an equivalent regime will allow that regime’s capital requirements to be used for non-European based operations, potentially alleviating their US problem assuming that the Hong Kong regulator allows a greater flexibility or, from an insurer’s point of view, more realism in its capital charge for investment risk .
My money though is on a way being found for the US to be deemed equivalent, at least for a transition period, which would fix the US problem even if Pru stays based in London. The European Commission has already indicated that a “different approach” is required for US equivalence, which seems to be an invitation for a fix of some kind.
There is still some way to go in Solvency II, regardless of potential further delays and transitions. The Pru is showing how regulators and policy makers need to balance protection of the consumer with creation of a healthy business environment. It’s a tough nut to crack and it will be interesting to see how the Pru’s intervention changes this dynamic.