Risk margin (Solvency II)

Category: Capital management · Reviewed by Matt Bartlett, Director · Founder · Last reviewed

Risk margin (Solvency II)

The risk margin is the component of Solvency II technical provisions designed to bring the total to the amount a hypothetical third party would require to take over the obligations. It compensates that hypothetical taker for the cost of holding capital against the non-hedgeable risks until run-off.

Formula

Risk margin = CoC rate × Σ_t [ SCR_RU(t) / (1 + r(t+1))^(t+1) ]

where:

• CoC rate = Cost of Capital rate set by regulation.
• SCR_RU(t) = projected SCR of the reference undertaking for year t.
• r(t+1) = risk-free rate at maturity t+1.

CoC rate history

• EU under EIOPA: 6% (Article 39 of Delegated Regulation 2015/35).
• UK post-Brexit reforms: cost-of-capital rate reduced from 6% to 4% and a tapering factor introduced from end-2023 under HMT’s Solvency II reform programme, materially reducing UK life insurer risk margins (particularly annuity writers).

Why the UK reform

Pre-reform UK life insurer risk margins were criticised as excessively volatile and conservative, particularly for annuity portfolios. The Treasury’s reform, announced in 2022 and implemented from 31 December 2023, was expected to release £40–60 billion of capital across the UK life sector, supporting productive investment.

References

• Solvency II Directive 2009/138/EC, Article 77.
• Delegated Regulation 2015/35, Article 39.
• HMT (November 2022). Review of Solvency II: Consultation Response.
• PRA PS2/24 — Review of Solvency II.

Cross-references

• Technical provisions Solvency II
• Solvency capital requirement
• Insurance capital

Maintained by Matt Bartlett, Director, Apex Insurance Brokers Limited. FCA FRN 724952. Companies House 07014570.