UK taxpayers could be forced to bail out policyholders under planned new rules for insurers according to the Bank of England (BoE) echoing events of around 20 years ago.
In November last year, the government confirmed it would push forward with reforms to the insurance sector aimed at releasing billions of pounds of investment into the economy.
The changes to Solvency II, which the UK inherited from the EU, will be added to the UK’s Financial Services and Markets Bill and will cut insurers’ capital buffer, or risk margin, by 65% for life insurers and 30% for general insurers.
The decision went against the advice of the Prudential Regulation Authority and prompted further words of caution from the central bank yesterday.
Could there be another Equitable Life?
Indeed, the BoE raised the spectre that the changes could spark a repeat of the near collapse of life assurance company, Equitable Life.
"I don't think that it's likely, all things equal, that it's a risk to financial stability, but it is a risk to policyholders," Bank of England governor Andrew Bailey told parliament's Treasury Select Committee.
"I will mention Equitable Life ... it can happen," Bailey added.
Equitable Life, established in 1762, closed to new customers in 2000 and almost collapsed after making unsustainable guarantees to policyholders.
BoE deputy governor Sam Woods pointed out this case showed how risks could "come home to roost if there is not enough capital backing pensions".
"Now you can look at history for guidance as to what is likely to happen if that occurs. I would say it is highly likely that comes back to the public purse, if that occurs," Woods said.
The government ended up paying out £1.1bn in compensation to Equitable policyholders.
Woods warned last year that reducing how much capital insurers held would not be a "free lunch", as it could make firms less able to make payouts on policies during a crisis.
No trading on rules between Bank and Chancellor
The government, however, had made its decision on insurance reform and there was a need to move forward now, Woods said.
The BoE would not use proposed new powers for regulators to "reverse engineer" changes to insurance rules that went against the spirit of the government proposals, he added.
Bailey also said there had been no trading between the Bank and the government with some suggesting that the proposals on insurance had been accepted in return for the government withdrawing plans to give itself powers to veto decisions by financial regulators.
Bailey said he would not consider that sort of "trade".
Chancellor, Jeremy Hunt, has proposed a raft of financial market changes, known collectively as the Edinburgh Reforms, to boost the City of London's global competitiveness.
The reforms include a review of rules on the direct accountability of bankers for their decisions, known as the senior managers regime, and ease a requirement on some banks to wrap their retail deposits with a bespoke capital cushion.
The BoE wanted to be "very closely engaged" on the detail of those reforms, Woods said.