The Bank of England said it was carefully monitoring falling capital levels at insurers that use their own computer models for calculating capital requirements.
David Rule, executive director of insurance supervision at the Bank of England’s Prudential Regulation Authority, also warned insurers that ending use of the tarnished Libor interest rate benchmark was a top priority.
Large insurers are allowed to use their own models, while smaller firms must use the so-called standard approach set out by regulators.
Rule said he has not seen a general fall in standards.
“Nonetheless, the significant reduction in internal model capital compared to the standard formula is not a trend we would expect to continue over time. We will be watching it carefully,” Rule told a conference held by the Association of British Insurers on Tuesday.
Models are authorised by the PRA under European Union rules known as Solvency II, introduced in 2018. The PRA has allowed 24 insurers to use their own models, the highest number in any EU state.
Rule said the PRA has conducted an intensive review to check for model “drift” or misuse of models in order to hold less capital.
“There is an issue with model drift,” he later said in response to questions. Unacceptable reductions in capital will be tackled when the PRA reviews changes to models.
“The more that insurers can disclose about the models in a simple way that users can understand the better… They can do better, but I understand that it’s not easy.”
The BoE and the Financial Conduct Authority have written to the chief executives of insurers and banks, asking them to spell out their preparations for effectively ditching the use of Libor by the end of 2021.
The BoE wants insurers to reference its overnight rate SONIA in contracts and balance sheet assessments after banks were fined billions of pounds for trying to rig Libor.
“We, and the FCA, have been clear that this is a significant change and achieving an orderly transition is a high priority for us,” Rule said.
The PRA and FCA will shortly publish findings from a “Dear CEO” letter sent last September.