Prudential Regulation Authority Rulebook

3.1

Under Solvency II, firms may apply to the PRA for approval to apply a transitional measure for technical provisions (TMTP). This chapter sets out the PRA’s expectations of the calculation methodology that firms should use for the transitional measure.

3.2

The scope of this chapter is limited to the calculations a firm must perform to apply the transitional deduction. 

3.3

Solvency I Pillar 2 insurance liabilities are the starting point for the transitional deduction. They will capture all relevant features of the liabilities, including those that may not be adequately reflected in a firm’s Solvency I Pillar 1 technical provisions as set out in INSPRU 1.

3.4

When calculating the Solvency I Pillar 2 insurance liabilities, the PRA’s default assumption is that firms will use methodologies, assumptions and input data that are consistent with their current Solvency I Pillar 2 insurance liabilities valuation basis, including any margins held (eg unearned premium reserves, management margins), or amounts included within the insurance liabilities following guidance given by the PRA or its predecessor.

3.5

Where the Solvency I Pillar 2 insurance liabilities valuation basis contains material differences from that which was used for the firm’s most recent Individual Capital Assessment (ICA) review, these differences should be clearly explained within the application, along with an indication of their impact.

3.6

Where firms have voluntarily decided to hold additional margins alongside their Solvency I Pillar 2 insurance liabilities, and do not believe it would be appropriate for these margins to be included when calculating the transitional deduction, firms should discuss this with their supervisory contact. Where Individual Capital Guidance (ICG) was issued taking into account the holding of these additional margins, this may also need to be revisited for the purposes of assessing the limit to the amount of the deduction. Firms who believe they will be in this position should notify the PRA at the earliest opportunity.

3.7

Approval for use of the TMTP remains with the legal entity which sought the approval. For business transferred under Part VII of Financial Services and Markets Act (2000) (FSMA), any associated TMTP relief which applied within the ceding firm will not therefore be automatically transferred with the liabilities. Both the transferor and transferee should consider how their risk profile has changed.

3.8

Where the business transferred is material and should the transferee firm seek to benefit from the TMTP relief in respect of the transferred business, the PRA’s view is that an application to recalculate the value of the TMTP, would be reasonable where the business transferred was written on or before 31 December 2015. 

3.9

Furthermore the PRA’s expectation is that the transferor will also need to seek approval to recalculate the value of the TMTP. The value of the TMTP within the transferor would be expected to decrease, reflecting the reduction in business in force. 

3.10

The PRA notes that the amount of the TMTP in respect of liabilities not subject to the transfer may also change as a result of the transaction. This might arise where the transaction results in a change to the assumptions underlying the technical provisions (eg expenses), or the balance of risks in the solvency capital requirement (SCR) and hence the risk margin.

3.11

The reinsurance of risks arising from liabilities can result in a similar economic impact to the transfer of business to a third party. A reinsurance arrangement and transfer of business are, however, not equivalent transactions. The reinsurance arrangement is a new contract written by the reinsuring entity which transfers risks, with the original contract remaining in force between the cedant and their policyholder(s). 

3.12

Where reinsurance materially changes the value of technical provisions used to calculate TMTP in the cedant, the PRA expects that the cedant will seek approval to update the calculation of the TMTP. 

3.13

The PRA expects that there may be circumstances under which it would be reasonable for the reinsurer to seek approval to update its calculation of the TMTP given the expected increase in technical provisions which would result from the transaction. However, given the wide variation in the nature of reinsurance arrangements, firms should discuss the position with their PRA supervisory contact, and the PRA will need to make a decision on a case-by-case basis considering the specific details of the proposed transaction. 

3.14

The PRA expects the application of TMTP to be limited to business that was in force on or before 31 December 2015. 

3.15

Firms can select the individual Homogeneous Risk Groups (HRGs) that they wish to include within the scope of the transitional deduction. For this purpose, HRG has the meaning as under Technical Provisions 10.1, ie the HRGs are those that are used to segment the technical provisions under Solvency II.

3.16

The PRA expects that the only limitations on the level of granularity chosen for the scope of the deduction are that:

1. (i) an HRG should not be ‘split’, with part of the HRG in scope of the transitional calculation and part of the HRG excluded from scope;
2. (ii) it should be possible for the firm to identify corresponding HRGs for the purpose of the Solvency I Pillar 2 insurance liabilities calculation, and to calculate Solvency I Pillar 2 insurance liabilities in respect of these HRGs reliably; and
3. (iii) the firm must demonstrate that the technical provisions calculations made at HRG level can be reconciled with the technical provisions calculation for the entity as a whole.

3.17

The PRA’s view is that an ability to limit the amount of the transitional deduction is likely to be necessary to ensure that the deduction will not reduce the current level of policyholder protection. The assessment of whether it is necessary to limit the amount of the deduction is made at the level of the legal entity, regardless of the scope that the firm has chosen for calculating and applying the deduction. 

3.18

The PRA is aware that at 31 December 2015, some firms had not had a review of their Individual Capital Assessment (ICA) or received Individual Capital Guidance (ICG) for some time. The PRA does not generally expect to revisit or reassess ICG as part of the process of approving the transitional deduction. However, where firms believe that the assumptions underlying their most recent ICA review and ICG are out of date, and that the effect on the resulting transitional deduction is material, the PRA will consider conducting a proportionate review of those areas of the firm’s ICA that have altered since ICG was last set.

3.19

When deciding whether to undertake such a review, the PRA will consider whether the resource burden involved for the firm and the PRA would be proportionate.