Solvency II: Upcoming PRA consultation on amendments to the matching adjustment

Last week, Gareth Truran of the Bank of England gave a speech on behalf of the Prudential Regulation Authority (PRA) outlining recent updates in respect of the reforms to Solvency II (so-called “Solvency UK”). The speech provides a high-level overview of the coming proposals in relation to the matching adjustment (MA) as part of the wider Solvency II reforms. The PRA’s Consultation Paper on the reforms to the MA is expected at the end of September.

Background and Proposals

The MA is a tool by which insurers may take credit upfront for part of the expected returns on investment assets, where such assets are used to closely align with insurers’ long-term liabilities.  As part of the MA construct, the fundamental spread is the allowance insurers must make in their reserves for risks they retain, such as credit risk. In November 2022, the UK government announced that updates to the MA were to be included as part of the reforms to Solvency II, and the government’s substantive updates form the basis of the PRA’s MA proposals. The overall aim is stated to be the streamlining of MA processes. The main proposals are:

  • Expanding the criteria of assets eligible for the MA
    • Although the PRA expects the “vast majority” of assets to remain fixed, some assets with highly predictable cashflows (including assets with early repayment risk) will be permitted.
  • Incentives
    • The PRA proposes to review the relative investment incentives within the MA regime. Current incentives are focused on property-backed assets; the review is intended to support financing for new infrastructure and sustainable economic growth.
    • This is part of the drive for the financial services sector to support increased investment in long-term productive assets and help support the transition to a net-zero economy.
  • Consulting on a revised MA attestation framework
    • The PRA wants to ensure that senior management accepts responsibility for any MA benefit they obtain and explain their assessment to the PRA.
    • Firms will be allowed to increase their fundamental spread risk allowance where appropriate for their portfolios. For example, the current standard allowance is based on risk in “vanilla” corporate bonds; the Consultation Paper will set out a framework to help insurers consider where the standard allowance might not be appropriate, and to respond accordingly.
  • Enhancing MA reporting frameworks from firms
    • The PRA intends to implement a reporting framework that allows the PRA to monitor the evolution of MA portfolios in light of significant changes resulting from both market trends and the Solvency UK regulatory reforms. In terms of market trends, the PRA specifically notes the growth in the bulk purchase annuity market.

Next steps

The PRA expects the MA reforms to be in place by mid 2024, and expects to publish its final policy on all the Solvency II reforms during the first half of 2024, with all Solvency UK regulations coming into force from the end of 2024. The PRA has announced that a further consultation will be published early next year in relation to the transfer of the remaining provisions of Solvency II into the PRA rulebook. This will result in all the Solvency UK regulations being in one place.

The PRA also issued a “teaser” of further reforms to expect after 2024, which includes possible changes to the standard formula and enhanced stress testing which (for life companies) will include publication of individual firms’ stress testing results.

To find out more or to discuss any of the implications of the proposals, please contact our insurance team.