The Prudential Regulation Authority (PRA) has announced it is consulting on a significant package of reforms to the Matching Adjustment (MA) to “improve the flexibility for life insurers to make more productive, long-term investments in the UK economy while supporting safety and soundness and policyholder protection.”
The PRA said the proposals cover reforms to MA regulations relating to greater investment flexibility and revised eligibility rules and more flexibility in MA processes, along with risk management enhancements, a greater role for senior manager responsibility including through attestations, and certain changes to MA calculation and reporting.
According to the Authority, the proposed reforms “improve insurers’ investment flexibility by enabling broader and quicker investments by insurers in their MA investment portfolios, while supporting the PRA in holding insurers to account for managing the additional risks involved, through a range of proportionate supervisory measures.”
The PRA noted that the reforms, working with upcoming legislation, will facilitate greater investment freedom by insurers to increase their investments in productive finance, from 2024 onwards.
Sam Woods the Deputy Governor for prudential regulation, commented, “We propose to adjust regulations to reflect the decisions made by the Government about the level of financial resilience that should be required of insurance companies.
“These proposals aim to promote policyholder protection while enabling the annuity sector to meet its commitments to the Government to increase investment in the UK economy.”
The PRA convened a number of industry expert groups earlier in the year to gather a broad range of information and explore options for implementing the reforms.
The PRA has now said it “looks forward to further constructive engagement and feedback during the consultation period.”
Commenting on the PRA’s announcement, David Burton, UK Financial Services Regulatory Capital Lead at EY, said, “The MA has been a key area of contention and debate in discussions about UK Solvency II reforms.
“Today’s announcement from the PRA should give the industry greater clarity around how the MA will work in the new regime, however, some of the proposals do not go as far as many firms had hoped.”
Burton continued, “While certain directional changes will be welcomed – such as the introduction of notching, the removal of the two-month MA elimination, and proposals to widen the scope of assets and liabilities to be included in the MA – many firms hoped to see greater flexibility and a wider range of assets with predictable cashflows included in the MA.
“Firms need to understand the practical implications of the proposals on their operations, which will likely lead to further discussions with the regulator. Whether this will result in any changes to the eventual rules, however, especially considering the tight implementation deadlines, is unclear.”
Huw Evans, KPMG UK Insurance Partner, said, “This detailed final set of proposed changes to Solvency II will primarily affect the 19 life insurance companies in the UK that use the Matching Adjustment mechanism.
“This is an important set of design changes which should enable more flexible investment of assets by life insurers and a more streamlined process. However, with these additional benefits, the PRA is also introducing more complexity to the modelling, risk management and reporting of the Matching Adjustment which may well be more costly than their PRA’s initial cost benefit analysis allows for.
“Put simply, life insurers will gain some more freedoms but with significantly more complex responsibilities to go with them.”
Meanwhile, James Isden, KPMG UK Insurance Director, added, “Insurers will welcome the widening of asset eligibility for the Matching Adjustment to allow the inclusion of assets with ‘highly predictable’ cash flows and to remove the cap on sub-investment grade assets.
“But insurers will need to be sure the uplift on Fundamental Spread requirements does not negate the benefit of including ‘highly predictable’ assets and that the granular and complex regulatory requirements are going to be worth it.”
Michael Abramson, Partner and Risk Transfer Specialist, Hymans Robertson, noted, “The Government has previously made much of Solvency UK giving more flexibility to invest in long-term productive assets like infrastructure.
“Today’s PRA consultation puts meat on the bones of this flexibility, although insurers may feel that the meat is rather lean. The PRA proposals set out which types of assets would newly be eligible, along with a limit of such assets such that they cannot provide more than 10% of the portfolio benefit and various other restrictions.
“However, with nearly £300bn of assets held in matching adjustment portfolios overall and plenty of demand for bulk annuities, this could provide a modest boost to certain sectors over time.
“Some pension schemes considering an insurance buy-out will have been hoping that these asset freedoms will allow insurers to take on their illiquid assets. There may be some instances where the proposals would facilitate this, but given the various limitations, it will be no panacea.”
