PRA Consults on Reforms to Solvency II Matching Adjustment
The Prudential Regulation Authority (PRA) has recently announced its intention to consult on a significant package of reforms to the Matching Adjustment (MA) under Solvency II. The aim of these reforms is to enhance the flexibility for life insurers to make long-term investments in the UK economy while ensuring policyholder protection and maintaining safety and soundness.
Proposed Reforms to MA Regulations
The proposed reforms cover various aspects of MA regulations, including greater investment flexibility, revised eligibility rules, and more flexibility in the MA processes. Additionally, the reforms include risk management enhancements, a greater role for senior manager responsibility, and changes to MA calculation and reporting.
The PRA’s objective with these reforms is to improve insurers’ investment flexibility by enabling broader and quicker investments in their MA portfolios. However, this is accompanied by the need for insurers to manage the additional risks involved. The PRA plans to support insurers in this endeavor through a range of proportionate supervisory measures.
Enabling Greater Investment Freedom
The proposed reforms, in conjunction with upcoming legislation, aim to facilitate greater investment freedom for insurers to increase their investments in productive finance from 2024 onwards. This is expected to provide a boost to the UK economy while ensuring that policyholder protection remains a priority.
Sam Woods, the Deputy Governor for prudential regulation, emphasizes the importance of these proposals in promoting policyholder protection while enabling the annuity sector to fulfill its commitments to increasing investment in the UK economy.
Industry Expert Engagement
To ensure a comprehensive understanding of the industry’s needs and perspectives, the PRA engaged several industry expert groups earlier in the year. These engagements allowed for the collection of a broad range of information and exploration of various options for implementing the proposed reforms.
The PRA welcomes further constructive engagement and feedback from industry participants during the consultation period. This collaborative approach ensures that the reforms take into account the practical implications for insurers and leads to effective implementation.
Industry Response and Expectations
The PRA’s announcement has garnered mixed responses from industry professionals. While certain aspects of the proposed reforms are well-received, some firms had hoped for greater flexibility and a wider range of assets with predictable cash flows to be included in the MA.
David Burton, UK Financial Services Regulatory Capital Lead at EY, acknowledges that the proposed reforms provide greater clarity on how the MA will function in the new regime. However, he also points out that the proposals may not meet the expectations of many firms, as they fall short of the desired level of flexibility.
Huw Evans, KPMG UK Insurance Partner, highlights the importance of the proposed design changes for the 19 life insurance companies in the UK that utilize the Matching Adjustment mechanism. While the changes enable more flexible investment of assets, they also introduce additional complexity in terms of modeling, risk management, and reporting.
Asset Eligibility and Potential Impact
Insurers will welcome the widening of asset eligibility for the Matching Adjustment, which allows for the inclusion of assets with “highly predictable” cash flows. The removal of the cap on sub-investment grade assets is also a positive development. However, insurers must carefully consider the impact of the uplift on Fundamental Spread requirements to ensure that the benefits of including highly predictable assets are not negated.
Michael Abramson, Partner and Risk Transfer Specialist at Hymans Robertson, notes that the proposed reforms provide more flexibility for insurers to invest in long-term productive assets like infrastructure. However, he highlights the limitations and restrictions that may affect the practical implementation of these reforms.
Implications for Pension Schemes
The proposed reforms could have implications for pension schemes considering an insurance buy-out. While the asset freedoms may facilitate the inclusion of illiquid assets, the limitations and restrictions surrounding the MA should be taken into account. These factors may affect the feasibility and benefits of such arrangements.
Conclusion
The PRA’s proposed reforms to the Solvency II Matching Adjustment aim to strike a balance between investment flexibility for insurers and policyholder protection. While the reforms provide greater freedom for insurers to invest in productive finance, there are limitations and additional complexities to consider.
Industry participants have expressed varying opinions on the proposed reforms, with some welcoming the changes while others had hoped for greater flexibility. The consultation period allows for further engagement and feedback, ensuring that the final regulations strike the right balance and meet the needs of insurers and policyholders alike.
As the consultation progresses and the reforms are implemented, insurers will need to assess the practical implications on their operations and engage in ongoing discussions with the regulator. The ultimate goal is to create a regulatory framework that supports the growth of the insurance industry while maintaining financial stability and protecting policyholders.
