Prudential Regulation Authority Rulebook

1.1

This supervisory statement (SS) sets out the Prudential Regulation Authority’s (PRA) expectations of firms regarding the application of the Solvency II matching adjustment (MA) within the calculation of the Solvency Capital Requirement (SCR).

1.2

The SS is addressed to UK Solvency II firms and to the Society of Lloyd’s and its managing agents. It is most relevant to firms with or seeking MA approval and which use a full or partial internal model to determine the SCR, together with UK Solvency II firms making an assessment as to the appropriateness of the standard formula for their risk profile.

1.3

This statement should be read in conjunction with the following Parts of the PRA Rulebook:

• Technical Provisions (Chapters 6 and 7);
• Solvency Capital Requirement – General Provisions (Chapter 3);
• Solvency Capital Requirement – Internal Models (Chapters 10 to 16); and
• Investments (Chapter 2).

1.4

It should also be read in conjunction with the document ‘The PRA’s approach to insurance supervision’.¹

1.5

The PRA has considered the relevant sections of the Solvency II Directive² and the Solvency II Delegated Regulation (Delegated Regulation)³ when setting the expectations noted in this SS.

1.6

The European Insurance and Occupational Pensions Authority (EIOPA) publication entitled ‘The underlying assumptions in the standard formula for the Solvency Capital Requirement calculation’⁴ will also be relevant for firms using this SS in the context of an assessment of standard formula appropriateness.

1.7

The MA allows firms to adjust the relevant risk-free interest rate term structure for the purposes of calculating the best estimate of a portfolio of MA-eligible insurance or reinsurance obligations. In order to calculate the MA for a portfolio, firms must determine the fundamental spread (FS) to be used in the calculation. To apply an MA, firms must have PRA approval, as per Regulation 42 of The Solvency 2 Regulations 2015. Firms with MA approval are permitted to apply an MA for the purposes of determining both technical provisions (TPs) and the SCR. Firms should have confidence that the level of MA benefit assumed in each of these calculations is fit for purpose. This SS covers the application of an MA as part of the SCR calculation. In general, the references to stressed MA and stressed FS in this SS are intended to apply to the entire MA portfolio on the stressed balance sheet unless otherwise stated.

1.8

The PRA recognises that many firms hold a relatively wide range of assets in their MA portfolios. These assets will differ in terms of liquidity and complexity; many of them may not be traded assets. The PRA’s expectations set out in this statement primarily apply to the risks arising in respect of corporate bond assets within firms’ MA portfolios. However, many of the expectations apply irrespective of the assets held and the PRA would therefore expect firms to consider the expectations set out in the SS to be more widely applicable unless specifically stated otherwise. In a number of places (eg paragraphs 4.10, 4.15, 4.20, 4.22, 5.17 and 5.18) the SS sets out specific expectations in relation to less liquid assets. In future, the PRA may issue further, more bespoke, expectations for the SCR treatment of other assets within an MA portfolio, such as illiquid assets.

1.9

The chapters that follow set out the PRA’s expectations in relation to the modelling of the MA within the SCR calculation. The PRA considers that meeting these expectations will be in line with its general approach to the supervision of firms.

• Chapter 2 of the SS clarifies the PRA’s overarching expectations as to how the MA should be captured in the SCR and the extent to which firms’ modelling approaches for the MA should be constrained by the approach used in the calculation of TPs.
• Chapter 3 then discusses a framework for the modelling of the MA within internal models.
• Chapters 4 to 6 expand on the steps within this framework.