When Insurers Have Discretion: Lessons for Regulators from UK Insurers' Response to the Global Financial Crisis

Abstract

This paper examines the steps taken by life insurers writing participating business in the UK to protect their solvency during the global financial crisis of 2008. It highlights two areas where the insurers had discretion and the interest that regulators have in controlling that discretion. The first is that the regulations then in force allowed discretion to insurers in the discount rate they used to calculate their liabilities in the calculations of solvency that were required. This paper finds that one of the main responses of the insurers to the global financial crisis was to reduce the margin of prudence in the discount rate they used to value their liabilities, meaning that their liabilities were given a lower value than otherwise, with a consequent increase in their reported solvency. Insurers also used their discretion to increase their charges to and reduce the payouts to policyholders, while they also reduced risks by adopting a more conservative investment strategy. This paper then considers the effect of Solvency II regulation introduced in the European Union (EU) in 2016 and the implications for regulators generally. Regulators need to be wary of rules that offer insurers discretion in calculating their liabilities; they may use it to enhance their reported financial position in a way that is essentially artificial. Solvency II removes the discretion in choice of discount rate, implying that insurers need to review how they manage solvency in adverse circumstances. It is also suggested that European regulators review their rules to ensure that policyholders are fairly protected when insurers have discretion on charges and payouts.