The consultation on the Matching Adjustment (MA) reform is the second PRA consultation to implement the conclusions of the UK government's Solvency II review. The PRA's first consultation, released in June 2023, proposed streamlining in areas such as internal models, transitional measures on technical provisions (TMTP) calculations, and the removal of capital and reporting requirements for third country branches.

The MA proposals are of relevance to life insurers. They are being given greater investment flexibility but subject to increased responsibility to model, evidence, attest and report any associated risks.

Commenting on the consultation, James Isden, Partner at KPMG in the UK noted:

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.

The ABI gave the proposals a cautious welcome.

Summary of the Matching Adjustment reform

  • Expanded asset eligibility to include assets with Highly Predictable (HP) cashflows — but subject to safeguards and an increased responsibility on firms to step up modelling capabilities, governance, reporting and risk management.
  • HP contribution capped at 10% of the total MA benefit and subject to a Fundamental spread (FS) uplift of at least 10 bps, with further modelling necessary to account for the uncertainty of the timing and/or amount of cashflows.
  • Removal of cap on sub-investment grade assets — but subject to risk management and general warning of caution from the PRA on how these are to be used.
  • Liability eligibility extended to include in-payment income protection and the guaranteed/fixed elements of with-profits annuities. Motor books with periodic payment orders (PPOs) are out of scope.
  • Streamlining of the application process and more proportionate consequences for MA breaches.
  • Introduction of notching to reflect differences in credit quality — insurers need to model and assess impact on the Solvency Capital Requirement (SCR).
  • Attestation by senior managers, usually the CFO, on the appropriateness of the MA benefit and FS — largely in line with insurers' expectations.
  • A new reporting requirement on MA benefit and its underlying assets.
  • Need for external assurance for internal credit rating assessments.

    You can also read KPMG in the UK's analysis of the first consultation and a recap of the PRA's changes on private reporting and public disclosure by insurers here

    Objectives of the Matching Adjustment review

    The PRA consultation on MA reform aims to deliver on one of the core objectives of the government's review of Solvency II of “supporting insurance firms to provide long-term capital to underpin growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the Government's climate change objectives”. This is an objective supported by insurers, with the Association of British Insurers (ABI) forming a new Investment Delivery Forum for cross-sector cooperation to drive £100 billion into UK infrastructure projects over the next ten years as a result of UK review of Solvency II.

    Impacted firms

    The MA review will be of particular interest to the life insurers who currently use the MA — there are 19 such permissions in the market — and those who do not but may now consider it. The MA increases the rate insurers apply to discount their future liabilities to reflect that, as buy-to-hold investors, they can manage short-term market volatility through well-matched assets and liabilities.  

    The MA is predominantly used by writers of annuities, whose asset portfolios seek to mirror their long-dated liabilities — as such, the reform of the MA also fits with the government's objective to tailor Solvency II to the needs of the UK economy.

    Timelines and process for the Solvency II reform in the UK

    The consultation is open until 5 January 2024. 

    Solvency UK will be implemented in stages:

    • Risk margin reform comes into force at year-end 2023.
    • PRA rulebook changes consultation is expected `early' in 2024.
    • Final policy and rules on MA in Q2 2024.
    • MA rules come into effect on 30 June 2024.
    • Remainder of Solvency II in the UK review takes effect from the beginning of 2025.

    The changes proposed by the PRA need to be read in conjunction with — and will be contingent upon — further legislative and secondary regulation that will set out the broad framework for Solvency UK and grant the PRA the powers to implement it.

    Matching adjustment: key areas of reform

    Asset eligibility

    Highly predicable cashflows

    Currently, to be eligible for the MA, assets must have cashflows that are fixed and cannot be changed by the issuer or any third party. The PRA proposes to expand this to also include assets with `highly predictable' (HP) cashflows, subject to various safeguards including a 10% cap of total MA benefit.  

    To be eligible, assets with HP cashflows would need to be:

    • Contractually bound in timing and amount;
    • Be bonds or have bond-like cashflow characteristic;
    • Be capable of receiving either an external or internal credit rating.

    Insurers should also consider whether they would be suitable for matching liability cashflows.

    The PRA is also proposing (PDF 1.18MB) to clarify the boundary between fixed and HP cashflows and refine its expectations on what kind of contractual clauses are likely to be suitable to be considered `fixed'.

    The PRA notes that assets in current MA portfolios are intended to be treated as having fixed cashflows. Assets or pools of assets that are currently structured to meet `fixity' requirements (i.e. restructured to meet the definition of `fixed' cashflows) can be unstructured so that assets with HP cashflows can included in the MA directly, which may allow for an additional mezzanine tranche of assets. Firms with such structures would want to weigh up the benefits of including such assets directly as HP, compared to alternative ways to use up the 10% HP cap.

    Controls on quality of matching

    The PRA considers that having HP cashflows introduces additional reinvestment and liquidity risks, with economic or non-economic variability. Examples of this include Residential Mortgage-Backed Securities where prepayment behaviour may be linked to the economic cycle, or where the borrower has a contractual option for early redemption in certain conditions, e.g. if the underlying assets are destroyed.

    Recognising that these idiosyncratic risks may be difficult to model, the PRA is instead proposing certain controls on the quality of matching:

    • Total exposure: A maximum of 10% of the total MA benefit may be generated by assets with HP cash flows. Firms will need to model this — any breaches to be rectified within two months.
    • Additional safeguards: A firm may want to propose further safeguards, such as exposure limits, on assets with HP cashflows. These safeguards will be included by the PRA as a condition of MA use.  
    • Risk management and prudent person principle (PPP): Firms would need to set and regularly consider internal quantitative investment limits and their expertise in managing these new assets.
    • Further asset liability matching (ALM) testing: The introduction of two further asset-liability matching tests for assets with HP cashflows to model the worst-case scenarios relating to reinvestment and liquidity risks, e.g., if cashflows are not received as expected or insurers become forced sellers of assets and minor amendments to two of the existing matching tests.

    In addition, the PRA is looking to require firms' MA applications to include all sources of uncertainty in cashflows and what allowances are made for this under PPP — this will apply to all types of assets (fixed and HP). 

    Fundamental spread

    The fundamental spread (FS) represents the risk retained in insurers and captures the risk of default and credit downgrades. In addition to the controls on matching above, the PRA believes that assets with HP cashflows require an addition to the FS to reflect their higher credit spread.

    Insurers have the option to either:

    • Model this additional risk and propose to the PRA on how they can adequately allow for this; or
    • Use one of the PRA's standard methodologies.

    Under both approaches, the PRA expects a minimum FS addition of 10 basis points as an estimate for reinvestment and/or rebalancing costs, unless firms have sufficient evidence to justify it.

    Implications for firms

    • Timings: Firms can either decide to focus on compliance for HY24 and, in effect, ignore most of this section (as their existing assets are all classified as fixed), or they could decide to move into these new assets classes to get access to a wider pool of assets quickly.
    • Consider expansion into new asset classes: The definitions of HP and fixed assets leave some uncertainty as to what kind of new asset classes insurers could now invest in, with callable bonds being one potential example.
    • Assess portfolio composition: Insurers will want to work through existing portfolios and future investment possibilities to identify the best composition of assets under the HP 10% cap, and how these interplays with securitisation structures used to achieve `fixity'.
    • Enhance asset modelling capability : To be able to evaluate and assess the risks of HT assets enabling firms to move away from the standard methodologies that do not full reflect the specific risks of these assets.
    • Weigh up bespoke and standardised approaches: The PRA's safeguards add a significant level of complexity that insurers need to grapple with to benefit from increased flexibility. While more straightforward standardised approaches are available, they offer a crude approach and rely on additional capital to offset modelling gaps. Firms should consider the benefits of expanding modelling and risk management capability.
    • Governance: revise PPP policies, prepare for attestations, seek assurance where required.
    • SCR: update the internal model to allow for these new features in the base balance sheet.

    Liability eligibility

    The PRA is proposing to extend eligibility to include in-payment income protection liabilities and the guaranteed element of with-profits annuities, where the fixed elements may be clearly identified and for which no future premiums are payable.

    This expansion of eligibility would not apply to the guaranteed elements of other policies such as periodic payment orders for motor books.  The PRA is estimating the impact as a `small reduction' (within the range of £30 million to £120 million) in best estimate income protection liabilities and a less material and more uncertain reduction for with-profits annuities.

    Implications for firms

    • Providers of income protection and with-profits annuity products should weigh up the net benefits of an MA application.

    Sub-investment grade (SIG) assets

    The PRA proposes to remove a cap on the MA benefit for SIG assets, which is expected to benefit all SIG assets. Also, all BBB assets will benefit through the SCR calculation. This change is particularly beneficial for projects in construction phase and certain green investments that have lower credit ratings due to a lack of historic data. 

    The PRA notes that firms are expected to specifically consider the lower credit quality and other additional risks (e.g. concentration, matching) from such liabilities and adds that SIGs should play a limited role in portfolios. This therefore does not represent a pathway for insurers to start backing policyholders' liabilities materially with risky assets.

    Implications for firms

    • Risk management could be considered as to the overall risk appetite across the ratings spectrum, including whether the firm could have some limited appetite, in the right circumstances, for SIG and/or increase their appetite for BBB assets.
    • Consider adequacy of risk management, modelling and in-house expertise for new risks or asset classes.

    Streamlining applications

    As an alternative to the standard six months window for considering MA applications, there will be a streamlined process for straightforward cases or where firms have proposed safeguards. The assessment of other factors relating to the ongoing application of the MA (e.g. ratings or valuations) may be deferred until after MA permission has been granted. The streamlined approach will also be available for simple variations to existing MA permissions.

    A streamlined application process would be welcomed by firms, who in practice can face significant delays in having their applications considered and approved.


    The relevant Senior Management Function holder, usually the CFO, will be required to attest on an annual basis, that the fundamental spread reflects all risks and that the matching adjustment can be earned with a high degree of confidence for each matching adjustment portfolio. 

    The insurer must also produce an attestation report and have an internal policy on how this assessment and attestation is performed. The attestation and underlying reports are not required to undergo an external audit.

    These proposals are largely as expected and reflect the insurance industry's concerns around the challenges of introducing an auditing requirement. Nevertheless, attestation represents a significant new requirement for firms and meeting the `high level of confidence' hurdle will be challenging. 

    Implications for firms

    • Policy on the assessment of the assets' risks in the MAP will need to be produced. This would focus on assets that are not included in the calibration of the fundamental spread.
    • Processes will need to be built to provide the analysis of the risks of these assets so that the CFO can form a view on the attestation.
    • Fundamental spread increases required for assets where these have additional risks that are not fully captured by the fundamental spread. A methodology to determine these is needed.
    • SCR will need to consider how any fundamental spread behaves under stress.

    Assumptions underlying the MA

    The PRA sets out the conceptual and technical assumptions that underly the MA — this is mainly a summary of how the MA works with no significant changes from firms' current understanding. It provides a useful reference for firms to consider when performing any MA work (managing the MA, application of the prudent person principle, elements of discretion in the MA, MA applications, treatment in the SCR) and to ensure that all elements of their approach are consistent with these assumptions.

    Matching Adjustment Asset and Liability Information Return (MALIR) data collection

    The MALIR is a new template that firms will need to complete annually, from YE24, that details the assets and liabilities in the MA portfolio. This template includes a large volume of information, although firms can apply for a full or partial waiver if they consider it to be overly onerous. For end year reporting firms, it will be due on 23 June each year.

    Previously, this type of information had been requested in an ad hoc way using a varying format. This new template will help firms know exactly what is needed and when so that it can be appropriately planned for and relevant resources arranged. 

    Implications for firms

    • Review the additional reporting requirement and any system changes necessary to provide the data at the required level of granularity on an annual basis.


    The PRA will continue to calculate and publish the FS for each letter rating, then firms will be expected to linearly interpolate to obtain specific probability of defaults and FS for each notch. Firms will have to determine how this impacts their internal models - [LONG HPYHEN] the SCR needs to allow for how the attestation would work under the stress scenarios, and in particular consider adding further FS for other risks or risks specific to the HP deductions.

    The notches will not be applied to AAA assets nor to “Central Government and Central Bank bonds".  The PRA has not updated the standard formula to allow for the new notches in the MA, but this may come in due course.

    The PRA expects firms to either make the granularity consistent in the internal model and based on technical provision (i.e. both allowing for notches) or justify why it is appropriate to have this difference. The PRA acknowledges that, given the timelines, this might not be possible at first, hence firms could continue with their existing internal models and instead hold some additional capital as an allowance.

    Implications for firms

    • If required, enrich the input data to include notches. For internally rated assets, extend the methodology to include notches.
    • Review the extra assurance requirements around internally rated assets.
    • Develop the matching adjustment model to allow for notches.
    • Prepare for additional reporting requirements and any system changes necessary to provide the data at the required level of granularity on an annual basis.
    • Update the internal model to allow for this appropriately.

    Next steps for insurers

    Must dos

    • Map out the impacts of the proposals on the end-to-end reporting process allowing for all the different aspects, including additional granularity in analysis and producing SST.
    • Expand asset data (including internal credit ratings) and develop the MA model to cover the new notching requirements; add the capability for fundamental spread add-ons and remove the BBB cliff adjustment. Update the existing matching tests and develop the two new matching tests.
    • Consider the SCR implications of notching and fundamental spread additions, then make adjustments to internal model as required.
    • Assess capability to produce the MALIR, then address any process or controls gaps.
    • Write an attestation policy, then deliver the process to the produce the analysis required to justify the attestation.
    • Assess the risk appetite of credit mixes allowing for all of the changes.
    • Review governance arrangements to deliver/oversee changes and also final operating model.

    Optional areas

    • Consider whether to respond to the consultation.
    • Assess the capital and investment benefits of including assets with HP cashflows against the additional risk management, modelling, governance and disclosure requirements.
    • Evaluate existing modelling capability to evidence the reinvestment and liquidity risks - and compare this to the impact of using the PRA's standardised approaches
    • Consider the SCR impacts of HP assets.
    • Providers of income protection or with-profits annuities may want to consider the value of an MA application.

    Beyond Solvency II review — what's next

    The PRA is starting to look beyond the implementation of Solvency UK towards a broader policy agenda:

    • Adjusting the Standard Formula once the PRA has been empowered to do so via changes to its rulebook. For example, this consultation notes that the standard formula needs to be adjusted as a result of the MA reform as it does not capture the additional risks from the widening pool of MA-eligible assets.
    • Stress testing: enhanced stress testing and publication of individual results for life insurers, including the impact of the MA where this is most material. The first of the new stress tests will be launched in Q1 2025 with the publication in Q4 that year. General insurers' results will continue to be published in aggregate for the time being (but will be subject to a dynamic stress test, which the PRA describes as a `significant change').
    • Macroprudential impact of insurers and regulation: the PRA is making use of its new competitiveness objective to assess the benefits and risks of how life insurers provide funding and risk transfer to the economy. Research to be published in 2024.
    • International capital standards (ICS): Solvency UK regime will be an “outcomes equivalent” implementation of the ICS.
    • Proportional regime for smaller insurers: The PRA is considering a framework similar to that  being introduced for smaller banks and building societies.

    Final note

    KPMG professionals have a wealth of experience in regulatory change, capital optimisation and risk  and investment management. If you want to discuss your preparations for the UK Solvency II review, please reach out to your KPMG contact.


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