Prudential Regulation Authority Rulebook

2.1

The requirements for the calculation of the MA are set out in Technical Provisions 7.2(2), which states that ‘the matching adjustment shall not include the fundamental spread reflecting the risks retained by the firm’.

2.2

For the purposes of determining TPs, the fundamental spread (FS) calibrations used in the MA calculation are provided by EIOPA in technical information produced in accordance with Technical Provisions 7.3 to 7.5. However, no similar technical information is provided in order to calculate the SCR.

2.3

A firm’s SCR should capture all material and quantifiable risks⁵ to which it is exposed. The calculation of the SCR should therefore allow for any changes to the FS and MA following a stress event. In doing this, firms should determine the risks to which the MA portfolio is exposed, how these risks could affect the FS and MA and assess how this impact is captured within the SCR calculation.

2.4

The PRA has identified at least three high-level reasons why the FS could change following a stress:

1. (i) changes in investment portfolio quality due to the occurrence of a stress;
2. (ii) assumption changes to reflect an updated forward-looking view of the FS following the stress; and
3. (iii) assumed management actions, including rebalancing of the MA portfolio, that are required to maintain MA compliance following a stress. The extent of the actions required will be driven by the extent of any mismatch between the asset and liability cash flows following a stress event within the MA portfolio.

2.5

For the purposes of assessing how the assumptions underlying the FS calibration could change post-stress (2.4[ii] above), it is important that firms’ internal models are not inappropriately constrained by the assumptions and parameters used to calculate TPs. The PRA would therefore not expect firms to adopt a purely ‘mechanistic approach’ to determine the FS following a stress that directly follows the assumptions and methodology used to determine the FS for the purpose of calculating TPs. The PRA considers that a ‘mechanistic approach’ based on the re-application of the approach used to calculate TPs is unlikely to result in an SCR that takes into account all quantifiable risks to which a firm is exposed, including the risk of losses that are not allowed for within the TP calculation.

2.6

Firms should ensure that their chosen method to determine the FS under stress takes account of all quantifiable risks to which they are exposed. Firms should particularly consider those risks that have been retained within their MA portfolio(s) and ensure that their modelling approach results in an SCR that covers those risks at the 99.5% confidence level.