In the UK, we have a strong flow of defined benefit pension liabilities to insurers, which provides a further incentive to ensure the regulatory regime can facilitate productive investments within the bounds of appropriate risk management of those funds. But what is ‘productive investment’? If we completed a survey here today, I expect we could easily receive a different answer from each attendee in the room, and I won’t claim to have the best. However, here’s one prepared earlier: ‘investment(s)… that have the potential to expand the productive capacity of the economy, while also generating marginal returns to society that exceed  Page 4  the marginal cost of that investment to society’[6]. This was the definition used in the terms of reference of the Productive Finance Working Group, which comprised representatives of industry, HM Treasury, the Bank of England, and the Financial Conduct Authority (FCA). Examples given in those terms of reference include: plant and equipment; research and development; technologies and infrastructure. That working group’s report focussed on the role that Defined Contribution pension funds could play. But long-term and illiquid productive investments could be a natural match to life insurers’ long term, predictable liabilities - in particular pension annuities, which commonly reside in matching adjustment (MA) portfolios. Given the long-term guaranteed nature of these liabilities, and the cost of shareholder capital to support this business, it is natural that insurers’ investment risk appetite will be reasonably low in these portfolios – and this indeed has long been the case for annuity books.

The PRA agrees with longstanding and justified concerns raised by the industry on the sensitivity of the risk margin to interest rates, and its overall quantum when interest rates are low. The Government’s April Consultation Document[9] lays out reform proposals. The potential impact of these reforms can be significant. For general insurers, we believe that a roughly 30% cut in risk margin can be justified, similar to the impact on EU firms of reform proposals made by the European Commission. This outcome would therefore ensure no disadvantage on competitiveness grounds for GI firms. For life insurers, given the longer term nature of the insurance risks and the presence of closely matched assets, we believe that a greater reduction of around 60% is possible – but only if the FS is also reformed to better reflect credit risk retained by life insurers. Simultaneous reform of both risk margin and MA can also correct a potential distortion in the current framework that has become apparent over time. Namely that, broadly speaking, under the Solvency II regulatory regime, some long term insurance risks – in particular, longevity risk – appears to have been highly-capitalised, relative to credit risk. This has created an environment where life insurers have been retaining less and less insurance risk, but acquiring additional credit risk, including counterparty credit risk. This trend has become more evident since Solvency II came into force, and raises questions about the effectiveness of the regime, in terms of both competitiveness and in mitigating risks to our statutory objectives.