On 25 July 2014 the PRA released an update on Solvency II implementation. Firms have been making significant progress towards the implementation date of 1 January 2016, but there are still areas of regulatory uncertainty.
The PRA has used this update to provide the industry with further clarity in a range of different areas. The focus of the update is on group insurers and the troublesome matching adjustment.
Availability of group own funds
One area of uncertainty is how capital from one part of an insurance group can be shared by other parts. The PRA has provided the following clarifications:
- firms need to consider the fungibility of the own funds and whether they are dedicated to absorb only certain losses
- firms need to consider whether there are significant obstacles to moving own fund items from one entity to another
- firms need to consider the regulatory restrictions in addition to the legal restrictions when providing information to the PRA on the availability of own funds at the group level
- firms need to evidence that there are no legal or regulatory restrictions on transferability of own funds and that the transfer of funds would take less than 9 months
- the evidence should cover the scenarios in which the insurer is likely to want to transfer own funds around the group
- assessments of the availability at group level of own funds from a third country equivalent sub-entity need to consider the third country rules as well as the Solvency II group rules
- firms should note that when determining group level own funds, own funds of non-insurance entities will be subject to the availability assessment
The PRA expects that the above will be in line with the yet-to-be-published European Commission’s Delegated Acts.
Operation of limits at a group level
Another area of uncertainty has been the operation of capital tiering limits at group level. The PRA has clarified:
- capital tiering limits will not apply at interim stages in the calculation for determining eligible own funds; only at the end of the process
- firms need to comply with the regulations on the classification of own funds at group level for externally issued items and make an assessment of the group level availability in respect of the amounts recognised in the group reconciliation reserve
- the minimum group consolidated SCR is used as a proxy at group level where the relevant solo articles refer to the minimum capital requirement
The matching adjustment (MA)
The PRA has held back from responding to many questions related to the matching adjustment as it is awaiting further policy developments from the European Commission and EIOPA. The PRA also hopes to be able to give more details when it publishes a supervisory statement on the matching adjustment in Q4 2014 and once they have finished analysing the results of the trial of the MA Implementing Technical Standards (ITS) submission.
The PRA did make the following comments:
- it is likely that an assessment of mismatching materiality that only references the SCR will not be sufficient
- there is no particular method prescribed for the treatment of diversification benefit in relation to the MA in internal models
- there will be no closed list of assets eligible for the MA – firms will be responsible for reviewing the eligibility of their assets and demonstrating their compliance to its supervisor
- when considering asset eligibility, a key question for firms should be whether they are exposed to the risk of changing spreads on the underlying asset
The PRA acknowledges that deferred tax may potentially have a significant effect on the calculation of own funds and capital requirements. The PRA recommend firms read Supervisory Statement 2/14 to understand its expectations.
The PRA has explained that insurers need to protect their policyholders against the risk posed by their occupational pension scheme. Firms should also have regard to the EIOPA guidelines currently under consultation and ensure that internal models cover all of the material risks.
What is happening next?
We are eagerly anticipating the PRA’s consultation paper on transposing the Solvency II Directive into the PRA Rulebook at some point during August 2014.
The PRA expects EIOPA to adopt the remaining implementing measures (currently under consultation) by July 2015.
Most firms we have spoken to are making good progress with their Solvency II implementation plans and we expect their good efforts to continue.