This insight is for: Board members, senior executives and actuaries of UK insurers with approvals to use the MA or considering doing so, who work on balance sheet management, pricing, reporting, capital optimisation, risk, finance, and compliance.
On 6 June, the PRA published PS10/24 - Review of Solvency II: Reform of the Matching adjustment (‘final rules’) following CP19/23 (see our previous blog outlining the main aspects of the proposals). The final rules are among the most keenly awaited elements of the SUK reform. Overall, the final rules differ little from the proposals in the PRA’s original consultation, with some targeted modifications and clarifications that provide some helpful guidance as insurers press ahead with implementation.
In this blog, we outline: the expected impact on firms of the final rules, where we are in the overall SUK reform process and the more material changes included in the final rules since consultation
The PRA has taken on board some industry feedback in relation to several of its original proposals. For example, the PRA has decided not to carry forward certain changes – including those that could have resulted in the reclassification of current MA portfolio assets considered fixed into the Highly Predictable (HP) category. In certain cases, the PRA has gone even further than originally anticipated by, for example, removing some documentation requirements in the MA application process and widening the liability eligibility criteria to ensure in-payment GDAs are MA‑eligible and clarifying that all in-payment group income protection business is also MA‑eligible. Firms will welcome a slightly more pragmatic approach to the attestation requirements, allowing them to carry out a top-down analysis by Homogeneous Risk Groups (HRGs) and to rely on the basic Fundamental Spread (FS) for corporate bonds subject to certain conditions. Despite this pragmatism, it is clear the PRA expects firms to determine if FS additions are required for assets such as illiquids, internally rated assets and Equity Release Mortgages (the PRA clarified that its published Expected Value Test parameters should be applied as a minimum).
With clarity on the final rules and timelines, MA firms can start the detailed implementation. Given the short timelines, life insurers need to determine which elements of the reforms to prioritise. We expect that the outputs required for year-end 2024 (e.g., the attestation) will require firms’ immediate attention. Adopting the requirements for the investment flexibility reforms (which come into force by the end of June) will depend on firms’ appetite for investing in HP assets but making an early start to this might provide a commercial advantage and should be a strategic decision.
Firms will also need to consider the impact of the reforms on their future acquisitions and other significant transactions as they may materially affect the year-end attestation process (for example a transaction completed in November 24 would bring in the acquired MA portfolio under the scope of the year end attestation), or trigger an out-of-cycle attestation (from 1 January 2025). Depending on each firm’s major model change policies, approach to notching and sub-investment grade (SIG) investments, there might be changes required to internal model processes, permissions and applications. We discuss this in more detail here.
Firms should also prepare to engage bilaterally with the PRA in some areas – for example in relation to fixed asset conditions and assumptions on timing of cashflows and ratings of assets. The PRA has also indicated that it will keep the new MA framework under review, and that further changes are possible (through sandboxes and SEGs). It will be important for firms to continue to raise issues and come up with suggestions on how to improve the regime over time.
PS10/24 completes a first batch of SUK final rules (PS2/24 and PS3/24) published earlier this year. One last Policy Statement to transfer retained EU laws into the Rulebook is still expected from the PRA in Q3 2024. Most of the new SUK rules will apply from 31 December 2024, but some MA provisions will be effective from 30 June 2024.
Implementation timeline of the Matching Adjustment (MA) reforms
Some aspects of the reform are being implemented on a voluntary basis from 30 June to 31 December 2024:
The PRA is introducing more flexibility around MA investments, particularly by allowing insurers to include assets with ‘highly predicable cashflows’ (HP assets). The PRA will allow a limited proportion of HP assets (10% of the MA benefit) to be included in the MA portfolio provided they meet a set of strict criteria and appropriate controls are in place.
What has changed since the consultation?
The MA attestation requirement was one of the most controversial areas of reform, and this is reflected strongly in industry feedback. Below we outline the key changes, but also some issues on which the PRA has stood its ground in the face of pushback:
The PRA has confirmed the expansion of the liabilities allowed in the MA portfolio to include the guaranteed benefits of with-profits annuities and in-payment income protection liabilities. Following industry feedback, the PRA has made changes from the consultation to allow the inclusion of in-payment GDAs in MA portfolios. It has also clarified that it is the policy intent to allow in-payment individual and group income protection liabilities in the MA portfolio. Firms will welcome the clarification and expansion, in particular to group policies, which are a significant part of the market for income protection.
In its original consultation the PRA proposed reforms to improve the overall MA operation. This included creating a streamlined MA application approach and introducing a new annual reporting requirement for firms to provide detailed metrics and information on the assets and liabilities held in MA portfolios as a form of safeguard against widening eligibility criteria. While the PRA for the most part has taken industry feedback on board, there are a few areas where it has also introduced new elements, including notably the Application Readiness Assessment Process (ARAP), which may come as a surprise to some firms.
What has changed since the consultation?
The final rules are the last material piece in the SUK puzzle and provide much needed clarity for firms to focus on implementation. Overall, the clarifications and modifications the PRA has carried through to the final rules will be welcomed by the industry. Firms need to consider their implementation plans and resources for the next six to nine months carefully to ensure they will be on time for the submission of the first attestation. Considering this is a very active market with many more material transactions expected in the next months, firms will also need to consider carefully the impact of the new rules on the ease of merging new portfolios of assets into their MA portfolios and the impact on both annual and out-of-cycle attestations. Firms also need to decide whether and, if so, how quickly to move into HP asset investment, as increased demand for HP assets will have commercial and competitive implications. The final rules open a new chapter in the prudential regime for UK insurers, offering opportunities for firms to invest in a wider range of assets but also bringing in the need to demonstrate the insurer’s ability to earn its MA benefit with a high degree of confidence. The next few months will be challenging for insurers navigating these new risks and opportunities.
[1] Extended implementation timeline compared to CP19/23.
[2] For FS additions, the PRA notes that firms are likely to carry out their attestation processes first, which means that firms are unlikely to be in a position to apply any voluntary FS additions to the 30 June 2024 balance sheet.