The PRA consultation on Solvency II review and Matching Adjustment came out today.
Life firms will be weighing up the additional investment flexibility and streamlining of the approvals process against the increased complexity around modelling, risk management and reporting.
Commenting on the PRA’s publication of CP19/23, ‘Review of Solvency II: Reform of the Matching Adjustment’:
Huw Evans, KPMG UK Insurance Partner, said:
“This detailed final set of proposed changes to Solvency II will primarily affect the 19 life insurance companies in the UK that use the Matching Adjustment mechanism.
“This is an important set of design changes which should enable more flexible investment of assets by life insurers and a more streamlined process. However, with these additional benefits, the PRA is also introducing more complexity to the modelling, risk management and reporting of the Matching Adjustment which may well be more costly than the PRA’s initial cost benefit analysis allows for.
“Put simply, life insurers will gain some more freedoms but with significantly more complex responsibilities to go with them.”
James Isden, KPMG UK Insurance Director, said:
“Insurers will welcome the widening of asset eligibility for the Matching Adjustment to allow the inclusion of assets with ‘highly predictable’ cash flows and to remove the cap on sub-investment grade assets. But insurers will need to be sure the uplift on Fundamental Spread requirements does not negate the benefit of including ‘highly predictable’ assets and that the granular and complex regulatory requirements are going to be worth it.”
Matthew Francis, KPMG UK Insurance Director, said:
“Life insurers will need to enhance their risk management approaches to respond to the risks of investing in novel asset classes. The changes introduce senior manager attestation over the appropriateness of the size of the Matching Adjustment and data collection for the new Matching Adjustment Asset & Liability Information Return (MALIR). Firms’ use of internal credit assessments will also be subject to more independent external assurance.”
Summary of key proposals:
Improving business flexibility
- Asset eligibility: expanding to include assets with Highly Predicable (HP) cashflows.
- Subject to safeguards including:- HP contribution to overall MA benefit is capped at 10%.- Firms expected to request additional safeguards, such as exposure limits, to mitigate limitations in modelling – PRA to grant as condition of MA use.- Prudent Person Principle (PPP) : firms to demonstrate internal expertise to manage investments on an asset and portfolio basis, including over the long-term; firms to set and monitor exposure limits.- Two new ALM tests to assess asset liquidity and reinvestment risks.
- Fundamental Spread: de minimus uplift of 10 bps for assets with HP cashflows as an estimate for reinvestment and/or rebalancing costs.? Additional modelling to account for uncertainty of timing and/or amount of cashflows – PRA standardised approaches available as an alternative.
- Sub-investment grade (SIG) assets: removal of the limit on SIG assets within the MA – subject to appropriate risk management.
- Additional reporting: introduction of new Matching Adjustment Asset & Liability Information Return (MALIR) – firms to report on assets and MA benefit annually.
- Liability eligibility: to include in-payment income protection and with-profit annuities where the fixed element can be clearly isolated. Motor books with PPO out of scope.
Responsiveness to level of risk
- Application process: 6 months approvals, and faster/streamlined process for clear cases or where firms have proposed safeguards.
- MA breaches: a more proportionate response to MA breaches – a reduction in MA benefit instead of total loss.
- Notching: introducing differentiation based on credit quality into the Fundamental Spread (FS) to make it more risk sensitive.? Firms to consider SCR implications.
Enhancing firms’ responsibility for risk management
- General theme: greater flexibility for firms, subject to increased responsibility for firms to model, evidence, attest and report.
- Attestation: senior managers will be required to attest to the appropriateness of MA and FS, with ‘a high degree of confidence’. Where relevant firms will have to increase the FS for assets where the base FS does not capture all risks. ?Proposals largely in line with industry expectations.
- New MA reporting requirements: introduction of a new Matching Adjustment Asset and Liability Information Return (MALIR) - firms to report granular data on assets and MA benefit annually.
- Internal credit assessments: introduction of need for external assurance
Watch out for further KPMG analysis to follow, and please reach out if you want to discuss.