2A
Intended purpose of the VA
2A.1
The PRA expects firms to consider, before applying for approval to use the VA, whether the application is consistent with the intended purpose of the VA.
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2A.2
The purpose of the VA is to mitigate the effect of exaggerations of bond spreads in order to prevent pro-cyclical behaviour.[4] The PRA considers that the VA achieves this by preventing the requirement for market-consistent valuation of assets and liabilities under Solvency II from dis-incentivising insurers from investing in assets that it would otherwise be appropriate for the insurer to hold, taking into account the nature and duration of their insurance liabilities. The VA therefore aims to mitigate ‘artificial’ balance sheet volatility caused by short-term market volatility in the value of assets arising from the exaggerations of bond spreads by allowing insurers to reflect movements to those asset prices within the market-consistent valuation of the corresponding liabilities. The purpose of the VA is not to help smooth volatility generally in the Solvency II balance sheet arising from movements in the risk-free rate.
Footnotes
- 4. Recital 32 of the Omnibus II Directive.
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2A.3
Using the VA in a way that is not aligned with its intended purpose could give rise to undue capital relief. Such use is also likely to be incompatible with good risk management, since it can introduce new risks to the balance sheet, such as the risk of future loss of own funds if the VA reduces in size. And it may suggest that the firm’s risk profile deviates from the assumptions underlying the VA.
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2A.4
For these reasons, firms are expected to satisfy themselves, and on request show the PRA how they have satisfied themselves, that the VA is applied in a manner that is consistent with its intended purpose.
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