Insuring the Future of the UK Insurance Industry

UK Insurance Industry

Key takeaways

Reforming the risk margin

Reform package includes three interrelated parts.

Adjusting the matching adjustment

Taken together, the package of reforms is expected to release 10-15% of capital from the life insurance sector.

Increasing investment flexibility

The package will also increase flexibility to invest in long-term illiquid assets.

The UK Treasury is consulting on a package of measures that Ministers have said will usher in a new “investment big bang” for the insurance industry. The planned reforms would include:


  • a substantial reduction in the risk margin of around 60-70% for long-term life insurers;
  • a reassessment of the fundamental spread used in the calculation of the matching adjustment;
  • the introduction of a significant increase in flexibility to allow more investment in long-term assets; and
  • a major reduction in the EU-derived regulations which make up the current reporting and administrative burden.

Reforming the risk margin

As at year-end 2021, the risk margin for life business was in excess of £32bn, while for non-life business the risk margin was in excess of £7bn (source Bank of England, 31 March 2022). The UK Government and Prudential Regulation Authority (PRA) are proposing a substantial reduction in the risk marking, including a cut of around 60-70% for long-term life insurers.


The size and volatility of the risk margin could be reduced using either a modified cost of capital methodology or the Margin over Current Estimate model used in the Insurance Capital Standard set by the International Association of Insurance Supervisors. However, the modified cost of capital approach is seen as the preferred option because it would be less disruptive to firms as only slight adaptions would be needed and there would be greater comparability with the revised risk margin methodology being proposed in the EU, which would benefit insurers operating in both markets.  This could be accompanied by a tapering parameter but only for life insurance business.


The PRA considers that a reduction in risk margin of 60% or just over for long-term life business could be consistent with observed transfer values, but only if accompanied by a significant strengthening of the fundamental spread in the matching adjustment.

Adjusting the matching adjustment

At year-end 2020 insurer balance sheets benefited by £81 billion from the matching adjustment. The UK Government recognises that there is not yet consensus on how the fundamental spread should be reformed demonstrates how important it is and how difficult it is to get right. The higher the fundamental spread, the lower the matching adjustment benefit.


However, the PRA has set out the significant risks that the fundamental spread is underestimating the risks retained by life insurers and therefore giving rise to an overly generous matching adjustment, in particular since the fundamental spread is currently heavily driven by the floor. The fundamental spread is also insensitive to different credit risk spread, incentivising insurance firms to seek out assets with the highest spread within each rating category. These risks may be heightened given the steady increase in the proportion of assets in matching adjustment portfolios that are illiquid. The proportion of assets invested in less liquid asset classes has increased from around 31% in 2018 to around 41% in 2021.1


The UK Government is therefore considering the merits of a fundamental spread methodology that incorporates market measures of credit risk by integrated the credit risk premium into the calculation of the fundamental spread.


The PRA considers a credit risk premium calibrated to be equivalent to at least 35% of credit spreads on average and over time to be consistent with its statutory objectives. However, the UK Government is open to a lower calibration if it could be demonstrated that such a calibration would support investment in the economy without undermining policyholder protection. As stated above, the PRA considers that a lower calibration of 25% would increase the capital release by 5%-10%.

Increasing investment flexibility

Reforming the fundamental spread so that it better measures credit risk would increase confidence in a wider variety of assets being suitable for inclusion in matching adjustment portfolios. It would also justify increased flexibility in how such investments are treated when there is a matching adjustment application or breach


The Government proposes to ease in a targeted way the restrictions on which assets insurers can include in matching adjustment portfolios. This includes three key areas:


  1. Insurers will be able to include assets with prepayment risk for which the issuer has the option to repay the asset at an earlier date, such as callable bonds, commercial real estate lending, housing association bonds and loans, infrastructure assets and local authority loan portfolios.
  2. With-profits annuities and deferred annuities in with profit funds will also become eligible for matching adjustment portfolios, on the basis that part of these annuities are benefits that are contractually guaranteed and may be matched with bond assets. Life insurers currently hold reserves of over £20 billion against with-profits annuities and deferred annuities in with profit funds.
  3. Introducing a more credit risk sensitive fundamental spread removes the need for a cap on the matching adjustment benefit for sub-investment grade assets. Insurers currently invest very little in assets rated below BBB. Around £3.3 billion (or 1%) of matching adjustment assets are rated BB or below. A further £83 billion (or 25%) of matching adjustment assets are rated BBB10. Removing the disproportionately severe treatment of assets for which the rating is below BBB will encourage insurers to diversify into a wider range of assets.

The bottom line

The precise impact will vary as proposed calibrations are finalized, but the PRA currently assesses that a package of a 60% risk margin reduction (for life business) and a fundamental spread calibrated to include a credit risk premium equivalent to 35% of credit spreads over the cycle would release between 10% and 15% of capital from the life sector in current economic conditions. A package which has a CRP of 25% (significantly below the level the PRA considers appropriate) would be likely to release between 15% and 20% of capital, and a package with a CRP of 45% would be likely to release between 5% and 10% of capital. Cutting the Risk Margin by around 70%, as opposed to around 60%, would release 2%-3% more capital.



1Bank of England, 31 March 2022


Investment risks:


The value of investments and any income will fluctuate. This may partly be the result of exchange rate fluctuations. Investors may not get back the full amount invested.


Important information:


This document is marketing material and is not intended as a recommendation to invest in any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. The information provided is for illustrative purposes only, it should not be relied upon as recommendations to buy or sell securities.


Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals, they are subject to change without notice and are not to be construed as investment advice

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