FinregE RIG Insights: Proposed Reforms to Matching Adjustment (MA) under Solvency II

PRA, Solvency II, RIG, Compliance AI, Legal AI

Publication Date: 2024-06-06 | Regulator: Bank of England (BOE)

Title: PS10/24 – Review of Solvency II: Reform of the Matching Adjustment

RIG, PRA, Solvency II, Legal AI, Compliance AI, Insights


The document is structured into several sections and chapters, each addressing specific aspects of the proposed reforms to the Matching Adjustment (MA) under the Solvency II framework. The chapters cover topics such as investment flexibility, liability eligibility, credit ratings, MA permissions, assumptions underlying the MA, and more.

The document begins with an overview section that provides background information on the reforms and highlights the developments since the consultation paper (CP19/23). It also includes a summary of responses received from stakeholders and outlines the changes made to the draft policy based on the feedback received.

The accountability framework section explains the legal obligations of the PRA in making proposed rules and considering responses to consultations. It emphasizes the PRA’s duty to have regard to representations made to it and to publish an explanation of its reasons for making the proposed rules.

The structure of the document is then outlined, indicating the chapters that correspond to the chapters in the consultation paper. The implementation section is mentioned, but specific details are not provided in the document.

Following the overview and structure, the document delves into each chapter, providing details on the changes made to the draft policy, feedback received from stakeholders, and the PRA’s response to that feedback.

The document concludes with a chapter on general points raised by respondents, which covers additional feedback that does not fit into the specific chapters. Appendices are also included, although their content is not specified in the document.

Overall, the document serves as a policy statement that outlines the PRA’s final rules, near-final rules, and final policy regarding the reform of the Matching Adjustment under Solvency II. It provides a comprehensive overview of the proposed changes, feedback received, and the PRA’s responses to that feedback.

What information does the PRA expect firms to include in MA applications?

The PRA expects firms to include the following information in their MA (Matching Adjustment) applications:

  1. Comprehensive assessment of surrender option risks: Firms should provide a thorough evaluation of the risks associated with the exercise of surrender options. This assessment should consider the potential impact on the firm’s financial position and the ability to meet policyholder liabilities.
  2. Breakdown of insurance contracts: Firms should provide a breakdown of the number and value of each type of insurance contract included in the MA application. This information helps the PRA understand the composition and characteristics of the firm’s insurance portfolio.
  3. Assessment of market risks: Firms should assess the market risks arising from any cash flow mismatch. This evaluation should consider the potential impact of market fluctuations on the firm’s ability to match its liabilities with its assets.
  4. Exclusion of excess assets: Firms should provide details regarding the exclusion of excess assets from the MA calculation. Excess assets are those that are not required to demonstrate matching and should be clearly identified and explained.
  5. Results of matching tests and cashflow data: Firms should include the results of the matching tests as outlined in Appendix 1 of SS7/18. These tests evaluate the quality of matching in the MA portfolio. Additionally, firms should provide asset and liability cashflow data to support their application.
  6. Proposed methodology for determining best estimate cash flows: Firms should outline their proposed methodology for determining the best estimate cash flows, except in cases where assets with higher-probability (HP) cash flows are included and the standard approach is not used to calculate any FS (Fluctuations Spread) addition.

It is important for firms to ensure that their MA applications contain appropriate evidence to enable the PRA’s review. The PRA has also published supplementary information forms on its website, which firms are encouraged to submit alongside the required application form to facilitate the review process.

What reports will the PRA publish on the MA framework?

The PRA will publish regular reports on the MA (Matching Adjustment) framework alongside the PRA Annual Report. These reports will provide valuable insights into the MA application review process and decision rates. The specific information covered in these reports includes:

  1. Application review timelines: The reports will include information on the timelines associated with the review of MA applications. This will help firms understand the expected duration of the review process and provide transparency on the PRA’s performance in reviewing applications.
  2. Decision rates: The reports will also include data on the decision rates for MA applications. This information will indicate the proportion of applications that are approved or declined by the PRA. It provides firms with an understanding of the likelihood of their application being successful.

By publishing these reports, the PRA aims to enhance transparency and accountability in the MA framework. Firms can use this information to assess the efficiency and effectiveness of the application review process and make informed decisions regarding their MA applications.

What is the Application Readiness Assessment Process (ARAP)?

The Application Readiness Assessment Process (ARAP) is a process developed by the PRA (Prudential Regulation Authority) to facilitate a more consistent and efficient engagement with firms prior to the submission of an MA (Matching Adjustment) application. The ARAP aims to ensure that firms are adequately prepared and ready to submit a formal MA application.

The key features of the ARAP are as follows:

  1. Early engagement: The PRA encourages firms to engage in the ARAP at an early stage when they are considering submitting an MA application. This allows for proactive communication and collaboration between the firm and the PRA.
  2. Assessment of readiness: The ARAP assists the PRA in assessing the firm’s readiness to submit a formal MA application. It helps determine whether the firm has the necessary information, documentation, and understanding of the requirements to proceed with the application.
  3. Resourcing needs: The ARAP also helps the PRA determine the resourcing needs for reviewing the firm’s MA application. By assessing the firm’s readiness, the PRA can allocate appropriate resources and plan the review process effectively.
  4. Level of review required: The ARAP aids in determining the likely level of review required for the firm’s MA application. It helps the PRA understand the complexity and scope of the application, enabling them to allocate resources accordingly.

Engaging in the ARAP is not a mandatory requirement for submitting an MA application. However, firms are strongly encouraged to participate in the process as it can streamline the application review and decision-making process. The ARAP promotes a more efficient and consistent approach to engagement between firms and the PRA, ultimately facilitating a smoother MA application process.

What is the proposed deadline for the Matching Adjustment Liability Information Return (MALIR) submission?

The proposed deadline for the Matching Adjustment Liability Information Return (MALIR) submission is not explicitly mentioned in the provided documents. However, it is stated that the proposed deadline has been deliberately set after the deadline for other regular reporting. The purpose of this decision is to alleviate the operational burden on firms while still ensuring the relevance and timeliness of the data.

While the specific deadline is not mentioned, it is important to note that the PRA (Prudential Regulation Authority) considers the proposed deadline to be reasonable and has taken into account the potential impact on firms’ resources and reporting obligations. The intention is to strike a balance between providing firms with sufficient time to complete the MALIR and ensuring that the data received remains up-to-date and relevant.

To obtain the exact deadline for the MALIR submission, it is advisable to refer to the final policy and instructions provided by the PRA, which should outline the specific timeline for the submission. Firms should also stay in communication with their supervisory contacts at the PRA for any updates or clarifications regarding the deadline.

What is the target timeline for decisions on MA applications?

According to the provided documents, the Prudential Regulation Authority (PRA) has set a target timeline of six months for decisions on Matching Adjustment (MA) applications. This means that the PRA aims to reach a decision on an MA application no later than six months from the date of receipt.

It is important to note that this target timeline represents an expected maximum timeframe rather than a minimum. The PRA acknowledges the importance of efficient MA application review processes and aims to make decisions within this timeframe to facilitate timely investment decisions by firms.

Additionally, the PRA intends to develop a specific target timeline for the completion of streamlined reviews. This timeline will be determined after the implementation of the current reforms, taking into account the experience gained from the new MA regime.

It is advisable for firms to consider these target timelines when planning their MA application submissions and engage in the Application Readiness Assessment Process (ARAP) provided by the PRA to ensure a more consistent and efficient approach to engagement and readiness for the formal MA application submission.

Please note that the target timelines mentioned are based on the information provided in the documents and may be subject to change. It is recommended to refer to the latest guidance and updates from the PRA for the most accurate and up-to-date information regarding MA application timelines.

Key Requirements

Investment Flexibility
  1. Amendments to the Glossary Part of the PRA Rulebook: The document proposes introducing amendments to the Glossary Part of the PRA Rulebook to incorporate new definitions and terms related to investment flexibility.
  2. Introduction of elements in the Matching Adjustment Part of the PRA Rulebook: The document proposes introducing specific elements in the Matching Adjustment Part of the PRA Rulebook. These elements are aimed at expanding the asset eligibility criteria for firms’ Matching Adjustment (MA) portfolios.
  3. Updates to SS3/17 – Solvency II: Illiquid unrated assets: The document outlines updates to SS3/17, which provides guidance on the treatment of illiquid unrated assets under Solvency II. These updates are intended to align with the proposed reforms and the expanded asset eligibility criteria.
  4. Updates to SS7/18 – Solvency II: Matching adjustment: The document includes updates to SS7/18, which focuses on the treatment of the matching adjustment. The updates reflect the proposed changes to the MA framework and the expanded asset eligibility criteria.
  5. Updates to SS8/18 – Solvency II: Internal models – modelling of the matching adjustment: The document proposes updates to SS8/18, which provides guidance on the modeling of the matching adjustment under internal models. These updates align with the proposed reforms and the expanded asset eligibility criteria.
  6. Updates to SS1/20 – Solvency II: Prudent Person Principle: The document outlines updates to SS1/20, which relates to the prudent person principle under Solvency II. The updates are intended to align with the proposed reforms and the expanded asset eligibility criteria.
  1. Expansion of liability eligibility criteria: The document proposes amendments to the liability eligibility criteria for inclusion in Matching Adjustment (MA) portfolios. The amendments aim to widen the scope of eligible liabilities that can be included in MA portfolios.
  2. Inclusion of in-payment income protection liabilities: The document introduces changes to allow for the inclusion of in-payment income protection liabilities in MA portfolios. This expansion is intended to provide greater flexibility and align with the business models of UK firms.
  3. Inclusion of guaranteed benefits component of with-profits annuities: The document proposes permitting the inclusion of the guaranteed benefits component of with-profits annuities in MA portfolios. This inclusion is subject to certain conditions, such as the guaranteed element being legally established and identifiable within the insurance contract.
  4. Clarification on liability eligibility for group income protection policies: The document addresses concerns raised by respondents regarding the eligibility of group income protection policies. It clarifies that the proposed rules allow for the inclusion of in-payment parts of group income protection policies in MA portfolios, even if future premiums are still payable for other parts of the policy.
  5. Expectations for separate identification of liability parts: The document sets out expectations for the separate identification of liability parts within MA portfolios. This includes the requirement that in-payment parts of liabilities should be separately identifiable and not require payment of future premiums while in claim.
  1. Independence and integrity of internal credit assessment function: Firms are expected to ensure the independence of the internal credit assessment function and have effective controls in place to manage any potential conflicts of interest. The nature, scale, and complexity of assets held by the firm should be considered when designating an individual responsible for the internal credit assessment.
  2. Consideration of materiality in assessing weaknesses or issues: Firms should take into account the materiality of any risk arising from weaknesses or issues identified in the internal credit assessment. Although individual weaknesses or issues may not be material on their own, they could be when considered together.
  3. Relevance of credit ratings in prudential regulation: The Prudential Regulation Authority (PRA) considers credit ratings to provide a relevant assessment of risk for usage in prudential regulation. The proposals in the document have been developed to be consistent with the legislative framework for the Matching Adjustment (MA) and the Fundamental Spread (FS).
  4. Attestation process and consideration of retained risks: Firms are required to consider the extent to which the FS is sufficient compensation for all retained risks, including potential risks not captured in ratings, as part of the proposed attestation process.
  5. Assurance on internal credit assessments: Internal credit assessments must be subject to proportionate independent external assurance to ensure that the outcomes of the assessments lie within a plausible range of issue ratings that could have resulted from a Credit Rating Agency (CRA).
  1. MA Permissions: The document outlines the process for firms to apply for permission to include assets and liabilities in MA portfolios based on the expanded asset and liability eligibility criteria. Firms are required to submit MA applications and provide the necessary documentation to support their eligibility for MA permissions.
  2. Breaches of MA Eligibility Conditions: The document sets out the consequences for firms in the event of breaches of MA eligibility conditions. Firms are given a two-month window to restore compliance with the conditions. If compliance is not restored within this timeframe, firms are required to reduce the amount of MA in a staggered fashion. The reduction starts at a minimum of 10% of the unadjusted MA and increases by an additional 10% for each further month of non-compliance. If the MA is reduced to zero, the PRA may revoke the permission to apply the MA.
  3. Variations of MA Permissions: The document clarifies the expectations for variations of MA permissions. It states that firms should comply with the expectations set out in the PRA’s supervisory statement regarding variations of MA permissions. Failure to comply with these expectations may be considered a breach of MA compliance.
  4. Application Documentation: The document provides guidance on the documentation requirements for MA applications. It specifies the expectations for firms submitting MA applications, including a reduced scope of required documentation. The aim is to streamline the application process and provide clarity on the information that needs to be provided.
  1. Standardized Attestation Wording: Firms are required to make an MA attestation to the Prudential Regulation Authority (PRA) using standardized wording that is set out in the PRA Rulebook. This ensures consistency and clarity in the attestation process.
  2. Frequency of Attestation: An attestation must be given annually for each MA portfolio within the firm. Additionally, an attestation must be provided upon any material change in the firm’s risk profile. This ensures regular assessment and accountability for the level of MA benefit being taken.
  3. Responsibility of Senior Management Function Holder: The PRA senior management function holder (SMF) who holds the prescribed responsibility for the production and integrity of the firm’s financial information and regulatory reporting (PR Q) is responsible for the attestation. This ensures accountability at a senior management level.
  4. Attestation Policy and Internal Processes: Firms are required to put in place and maintain a policy on providing the attestation. They must also establish appropriate internal processes, systems, and controls to allow for the analysis and justification of the use of the Fundamental Spread (FS) in accordance with the attestation. This ensures a structured and controlled approach to the attestation process.
  5. Attestation Document and Report: Firms must provide an attestation document to the PRA, which includes the attestation itself alongside a supporting attestation report. The report should provide the necessary evidence and analysis to support the attestation. This ensures transparency and provides the PRA with the information needed to assess the appropriateness of the MA benefit being taken.
  1. Conceptual and Technical Assumptions: The document outlines the key conceptual and technical assumptions that underpin the MA framework. These assumptions provide the basis for determining the eligibility and calculation of the MA benefit.
  2. Consideration of Assumptions: Firms are expected to consider the conceptual and technical assumptions when assessing the consistency of their risk profile with the assumptions underlying the MA. This assessment should be part of the attestation process and should be documented accordingly.
  3. Compliance with Assumptions: Firms are required to comply with the assumptions underlying the MA. If a firm’s risk profile deviates significantly from these assumptions, it may result in a capital add-on. Firms should review their risk profile and assess any deviations from the assumptions to ensure compliance.
  4. Application of Assumptions in Practice: The document provides guidance on the application of the assumptions in practice. It clarifies how firms should use and consider the assumptions when determining the eligibility and calculation of the MA benefit.
  5. Capital Add-Ons: The document highlights that the PRA may impose capital add-ons if a firm’s risk profile deviates significantly from the assumptions underlying the MA. This serves as a mechanism to ensure that firms maintain appropriate capital levels in line with their risk profile.
  1. Annual Reporting Requirement: Firms are required to provide an annual MA asset and liability information return (MALIR) to the Prudential Regulation Authority (PRA). This return includes detailed information on the assets and liabilities held in their MA portfolios.
  2. Portfolio Metrics: The MALIR should include portfolio metrics that provide an overview of the MA portfolios held by the firm. These metrics help the PRA understand the nature and composition of the portfolios and assess their impact on the MA benefit.
  3. Detailed Asset and Liability Information: Firms are required to provide detailed information on the assets and liabilities held in their MA portfolios. This includes information such as asset type, rating, notional value, whether the asset involves lending to small or medium enterprises, and whether it contributes to climate targets or UK economic growth.
  4. Cash Flow Reporting: Firms are expected to report detailed cash flows for assets extending up to 50 years. Cash flows beyond the 50-year period should be discounted and reported at the last month of the 50th year. This requirement ensures that the PRA has visibility into the cash flow projections for the MA portfolios.
  5. Data Fields and Definitions: The document provides definitions for various asset types and data fields to ensure consistency in reporting across firms. Firms are expected to accurately report the relevant information in the specified data fields as per the defined definitions.
  6. Overlapping Data with Other Reporting Requirements: The document acknowledges that there may be overlapping data fields between the MALIR and other reporting requirements, such as the Quantitative Reporting Templates (QRTs). However, the PRA justifies the collection of overlapping data to preserve the integrity of the MALIR and its effectiveness as a supervisory tool.
  1. Mandatory Application of Notched FS: The document proposes that firms, when calculating the Matching Adjustment (MA) for the purpose of their Technical Provisions (TPs), must adjust the Financial Spread (FS) to reflect, where appropriate and possible, differences in the credit quality of exposures by rating notch. This means that firms should consider the credit quality of their assets and adjust the FS accordingly.
  2. Framework for Determining Notching: The document provides a framework in which firms can determine if they need to reflect notching in their internal models. Firms are expected to justify any differences in the granularity at which the credit quality of their assets is reflected in their TPs and internal models used to calculate the Solvency Capital Requirement (SCR).
  3. Proportionate Approach: The Prudential Regulation Authority (PRA) supports firms being proportionate in their approach to notching, as long as the internal model meets the relevant requirements and calibration standards. The PRA acknowledges that certain considerations may be more pertinent for some firms than others.
  4. Flexibility in Methodological Approach: Firms are allowed to adopt an approach of their choosing when updating their internal models to allow for notching. This includes the use of linear interpolation of the stressed FS, provided that firms can demonstrate that it meets the internal model requirements and calibration standards.
  5. Considerations for Internal Models: Firms are expected to consider the impact of notching on the base balance sheet and ensure that the modelling approach used does not automatically back out the FS from notching in the SCR. The PRA encourages firms to be pragmatic and proportionate in their approach to notching in internal models.
  6. Clarification on Implementation Timeline: The document clarifies that the requirement for the MA calculation to reflect notching will not apply until 31 December 2024. However, firms will have the option to voluntarily include notching in their MA calculations from 30 June 2024.
  1. Assessment of Costs and Benefits: The document outlines that the Prudential Regulation Authority (PRA) assessed the costs and benefits of the proposed reforms to the Matching Adjustment (MA) framework. This assessment was based on the current legislative framework, supplemented by PRA Rulebook material in force, and anticipated future legislation.
  2. Baseline for CBA: The PRA established a baseline for the CBA, which included the existing legislative framework and the anticipated legislation in line with the November 2022 statement. This baseline served as a reference point for comparing the costs and benefits of the proposed reforms.
  3. Quantitative Estimates of Costs: The PRA sought to provide quantitative estimates of costs where possible, using information obtained from firms. These estimates were considered in the assessment of the costs and benefits of the proposals.
  4. Benefits Outweighing Costs: Based on the assessment, the PRA concluded that the benefits of the proposed reforms outweighed the costs. The reforms were deemed to advance the PRA’s primary objectives of safety and soundness and policyholder protection, while also facilitating effective competition, international competitiveness, and growth.
  5. Feedback on CBA: The PRA received feedback from respondents regarding the assessment of costs and benefits in the CBA. Some respondents agreed that the benefits outweighed the costs, while others raised concerns about specific cost estimates or the overall assessment. The PRA considered this feedback in its final decision-making process.
  6. Changes Impacting CBA: The document acknowledges that certain changes made to the draft policy may impact the CBA. These changes, which were made based on feedback received, were considered by the PRA in its final assessment of the costs and benefits.
  1. Legal Obligations: The Prudential Regulation Authority (PRA) is required by the Financial Services and Markets Act (FSMA) to have regard to certain legal obligations when making rules. These obligations include considering representations made to the PRA and publishing an account of those representations and its feedback to them.
  2. Consideration of Consultation Responses: The PRA is required to consider responses to consultation and publish an explanation of its reasons for believing that making the proposed rules is compatible with its objectives and regulatory principles. The PRA set out the applicable accountability framework and provided an assessment of relevant considerations for the proposed reforms against its objectives in each chapter of the consultation paper.
  3. Feedback to Responses: The PRA provided feedback to the responses received on the proposed reforms in the consultation paper. The feedback is structured into chapters that correspond with the chapters in the consultation paper, allowing for a clear and organized presentation of the PRA’s responses.
  4. Wide Range of Points Considered: The PRA considers that the final rules, near-final rules, and final policy have taken into account the wide range of points raised by respondents. The PRA believes that the responses to the consultation, along with the associated changes to the final rules, near-final rules, and final policy, did not significantly alter its consideration of the matters to which it must have regard in implementing the final policy.
  5. Changes in Have Regards Analysis: Where the PRA’s consideration of the matters to which it must have regard changed in relation to any proposed reforms, further explanation is provided in Chapter 11 (Have Regards Analysis) of the document. This chapter addresses any significant changes to the analysis arising from changes to the draft policy proposed in the consultation paper.

What are the next steps mentioned for the firms?

The document outlines the next steps for firms in relation to the proposed reforms. The key next steps mentioned are as follows:

  1. Implementation of the Reforms: Firms are expected to implement the reforms outlined in the document. The PRA has finalized the rules, near-final rules, and final policy based on the consultation responses received. Firms should review the final rules and policy to understand their obligations and ensure compliance.
  2. Preparation for the MALIR: Firms should prepare for the Matching Adjustment Asset and Liability Information Return (MALIR). The MALIR is a new reporting requirement that gathers structured information on the type of assets and the quantum of the Matching Adjustment (MA) benefit arising from them. Firms will have 130 business days from their respective financial year end to complete and submit their first formalized MALIR to the PRA.
  3. Attestation Requirements: Firms should be aware of the attestation requirements related to the MA. The PRA has specified that attestations will be required from firms annually and when there has been a material change in the risk profile of the firm. The responsibility for the attestation rests with the senior manager with the prescribed responsibility for the production and integrity of the firm’s financial information and regulatory reporting.
  4. Engagement with the PRA: Firms are encouraged to engage with the PRA in advance of a formal MA application submission. The PRA has developed an Application Readiness Assessment Process (ARAP) to support this engagement. The ARAP helps assess the firm’s readiness to submit a formal MA application and assists the PRA in determining resourcing needs.
  5. Reach Out for Concerns: Firms with particular concerns around the year-end 2024 MALIR or any other aspects of the reforms are advised to reach out to their usual supervisory contact at the PRA. This allows firms to discuss their concerns and seek clarification or guidance from the PRA.

These next steps emphasize the importance of firms implementing the reforms, preparing for the MALIR reporting requirement, fulfilling attestation requirements, engaging with the PRA, and seeking clarification or guidance when needed. Firms should review the document in detail to ensure they understand their specific obligations and take appropriate actions accordingly.

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