Industry gives positive reaction to PRA matching adjustment changes

The Prudential Regulatory Authority’s latest releases on Solvency II/Solvency UK reforms has given more detail to the changes.

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What has the industry reaction been to the PRA's matching adjustment changes?

The Prudential Regulatory Authority (PRA) published its long-awaited policy statement PS10/24, following CP19/23 last year, on reforms to the Solvency II (SII) regime post-Brexit – the new UK 'version' is colloquially known as Solvency UK - for Matching Adjustment (MA) portfolios on 6 June 2024.

This PRA policy statement said it aimed to provide feedback to responses received to the consultation paper 19/23, 'Review of Solvency II: Reform of the Matching Adjustment'.

CP19/23 was the second PRA consultation to deliver significant reforms to Solvency II and implement the conclusions of the Government’s Review of Solvency II: Consultation - Response in November 2022.

The consultation paper set out the PRA’s proposed reforms that will enable, what it says are, broader and quicker investment by insurers in their matching adjustment (MA) portfolios, whilst "improving responsiveness to risk and enhancing firms’ responsibility for risk management functions and outcomes". The changes could have massive implications for the investment arms of UK-based insurers in terms of their financial matters and investment strategies.

Last month, Siân Barton took the temperature for the industry on the impending Solvency UK legislation and how it planned to reform the fundamental spread of the matching adjustment and focus on unblocking long-term productive investment by making it easier to include a wider range of assets in matching adjustment portfolios.

The UK’s changes to investment and solvency was also discussed by the Insurance Investor European Advisory board, with many saying the post-Brexit realities would lead to wider investment changes. One Chief Investment Officer for a life insurer said the “concept of ‘investing in UK’” was something they were seeing and hearing a lot about – and that various mechanisms were being introduced to try and encourage the idea, such as the solvency reforms and the Mansion House Compact.

What are the changes?

The Solvency rules were one of the first EU-led regulatory frameworks to be reassessed following the Brexit vote in 2016. Insurers, the PRA, and other stakeholders have been thrashing out the terms of the new regime since June 2020 when the government announced that Solvency II would be reviewed, with consultation documents first published in April 2022.

Currently, under Solvency II, the matching adjustment is applied as an increase to the liability discount rate; it is calculated by deducting the fundamental spread from the credit spread on the assets backing matching adjustment liabilities.

The PRA has this month published PS10/24, which built on other key Solvency II reforms confirmed by the PRA in PS2/24 and PS3/24 in February 2024.

The changes, in detail, mean that the December 2023 Insurance and Reinsurance Undertakings (Prudential Requirements) Regulations 2023 (IRPR Regulations) align with the PRA’s proposals in CP19/23.

“The IRPR Regulations maintain most of the existing methodology and calibration of the fundamental spread (FS) and broaden the MA eligibility criteria to allow assets with highly predictable cash flows,” said PwC in its summary of the industry moves. “The IRPR Regulations also reform the PRA’s powers for breaches of MA eligibility conditions and enable the PRA to make rules on other MA policy aspects.”

It added that PS10/24 implements will work alongside the IRPR Regulations. These are wide-ranging with significant impacts on insurers’ balance sheets, reporting requirements, and senior management responsibilities. 

The PRA stated that respondents to CP19/23 were generally supportive of its proposals. However, in line with the feedback received, the PRA confirmed that it identified several areas where changes were needed to the draft policy.

“Compared to the proposals set out in CP19/23, we think the changes are generally positive, although arguably they still do not go as far as firms would have liked,” said PwC, in response to the measures.

Others in the industry were more positive than PwC. “This is a case of evolution, not revolution,” said Huw Evans, Head of Insurance at KPMG UK, on the changes. “These rules ensure a more distinct UK Solvency II regime with some greater flexibility to invest in long-term assets such as infrastructure. Alongside this, are more complex rules policing the Matching Adjustment mechanism.”

“The PRA’s creation of Solvency UK has made improvements that will work better for the UK than the original regime,” said Evans. “With the EU having also made changes to Solvency II, there is nothing in the final UK version that would prevent it being deemed ‘equivalent’ to the EU’s regime in due course.”

“This final set of rule changes to Solvency II will only affect life insurance and insurers selling individual or group protection products in the UK that use the Matching Adjustment mechanism now or in the future."

Consultant Hymans Robertson also praised the changes and said that UK life insurers would be able to invest more of their assets into the UK productive economy due to the new rules. “These deliver on the most technical component of the initial phase of Solvency UK reform which primarily impacts how insurers invest to secure the payments they will be making to pensioners for decades to come,” said Nick Ford, Partner, Head of Risk & Capital risk. “With around £50 billion of funds transferring from pension funds to these insurers each year this has the potential to deliver some of the £100 billion of extra investment sought by the UK government into productive and green finance.”

It also said the changes confirmed an increase in flexibility in the type of assets that insurers can invest in, he added, but that it would take time to ramp up flows into these permitted assets, and there will still be asset classes, such as some infrastructure funds that pension schemes currently hold, that they will find very challenging to include in their portfolios.

“Expecting that, insurers have already engaged with the PRA to explore suggestions on further reform to accelerate these moves and deliver the extra investment that the government is seeking,” said Ford.

Solvency UK has been a major driving force for decisions and innovation in the London market for insurers.

Phoenix Group, one of the UK’s largest insurers, has recently introduced a Matching Adjustment Sandbox.