PS 10/24 Policy Statement on Matching Adjustment

Key takeaway — the PRA has left the proposal for the inclusion of assets with highly predictable (HP) cash flows within MA portfolios broadly unchanged and confirmed that there is to be no change to the existing classification of assets with `fixed' cash flows (which insurers had been worried about based on the wording of the original CP). The maximum contribution to the overall MA benefit from assets with HP cash flows is confirmed at no more than 10%. The PRA suggests a number of options to firms to help stay within the 10% limit and ensure that they get maximum benefit from this new flexibility should they wish. There has also been a slight softening to the matching tests for portfolios containing assets with HP cash flows, which should improve insurers' capacity to hold these assets.

Further information

Fixed assets

The PRA has confirmed that there is to be no change to the existing classification of assets with `fixed' cash flows. This was first announced in April 2024 and will be welcomed, as the original CP suggested that the fixed assets in insurers' existing MA portfolios might be reclassified as `highly predictable'. 

However, the PRA has also stated its intention to get a better understanding of firms' approaches to fixed cash flow assets to ensure consistency and a level playing field between firms. 

There is particular focus on ensuring firms are making appropriate assumptions in their treatment of assets, particularly in relation to the timing of cash flows and the rating of the assets. The PRA is seeking to understand the extent to which there may be a build-up of concentrated exposures in individual firms, or systemic risk across the industry. Such concentrations/levels of system risk could arise from changes to cash flows in low probability events where insufficient compensation is paid on early redemption or there is a deferral of cash flows. 

The PRA will initially look to address these matters through bilateral supervisory engagement with firms.

Assets with HP cash flows

The threshold for Matching Tests 4 and 5, which test the exposure to HP cash flows arising both sooner and later than expected and/or of lower amount, has been increased from 3% to 5% of the overall MA benefit and present value of liabilities respectively. 

The PRA has provided several clarifications regarding the calculation of the FS add-on for timing and other risks associated with assets with HP cash flows. Insurers can use standard or more sophisticated approaches where they have relevant data. Where an insurer chooses to use a more sophisticated approach, it is unlikely to go through the streamlined MA application process.  

The PRA also sets out standard approaches for assets subject to economic and/or event risk. It clarifies that, where assets are subject to both risks, the insurer should consider the dominant risk in deciding which one to model. It also highlights that, for some pooled asset exposures such as residential mortgage-backed securities (RMBS), where the underlying mortgages may be subject to economic risk, the note cash flows may exhibit sufficient predictability that the note can be considered as subject to event risk and the FS add-on modelled accordingly. 

The PRA clarifies that where firms have the relevant permissions, they may move between fixed and HP cash flow treatments, provided this is subject to an appropriate level of internal governance and oversight.

Key takeaway — the PRA has updated its Rulebook to clarify the inclusion of in-payment individual and group income protection liabilities and allow the inclusion of in-payment group dependant annuities (GDAs) in the MA portfolio. This is perhaps the biggest change in the PS compared to the CP proposals.

Key takeaway — the final policy removes the sub-investment grade (SIG) cap and instead includes a range of metrics for insurers to consider when determining the importance of SIG assets to their MA portfolios. Additionally, the MA on SIG assets should be appropriate post-stress, including for assets that downgrade to SIG because of that stress. 

Further information 

The PRA has introduced an expectation around modelling of the FS, that insurers' internal models adequately reflect the risk profile for SIG assets even if the SIG MA cap is removed (and that this can be demonstrated). It has clarified that the MA on SIG assets should be appropriate post-stress and has emphasised its expectations on complying with internal model calibration standards. 

The function responsible for internal credit assessments should have effective controls to maintain independence and manage any potential conflicts of interest within the firm. Internal credit assessments will also be subject to proportionate and independent external assurance, thus ensuring that the outcomes lie within a plausible range of issue ratings that could have resulted from a Credit Rating Agency (CRA). The PRA notes that in most cases CRAs will be best placed to provide this external assurance, but insurers can use other provides. Insurers should select the validation frequency and sample size according to the complexity and materiality of their internally rated assets. 

Key takeaway — there are new Prudent Person Principle (PPP) conditions for insurers to satisfy, together with a more practical approach to adding new assets and liabilities to the MA portfolio. The PRA has also committed to more transparency on its MA approvals process. 

Further information 

The PRA's consultation proposed an additional MA eligibility condition where insurers must demonstrate that each individual asset within the MA portfolio could be managed in line with the prudent person principle (PPP). The PRA has adopted this PPP approach in PS 10/24 and also streamlined the MA permissions process. It has removed references to `new risks' triggering variations of permissions, meaning that under the new regime further assets and liabilities may be included in an MA portfolio where they have the same features as those assets and liabilities for which the MA has already been granted.

Where insurers do make applications to the PRA, they will have a reduced scope of documentation to submit and will not be required to await the decision of one MA application before submitting another, meaning they can have concurrent applications awaiting decision. The PRA will make decisions on MA applications within six months and will publish regular reports to disclose review timelines and decision rates. The first report is expected in 2025. 

Where insurers have applied a reduction to the MA resulting from a breach of MA eligibility conditions, they will not be expected to recalculate the SCR to reflect this reduction. 

Key takeaway — the PRA has allowed for more simple analysis of assets in homogenous risk groups (HRGs) and the treatment of corporate bonds in the MA attestation and the analysis. However, it has maintained the degree of confidence it requires in attestations. The first attestation reference date is 31 December 2024. 

Further information

Respondents to the consultation expressed concern that the PRA's expectations on the treatment of corporate bonds were onerous and disproportionate. The PRA has adjusted its requirements to allow for a simplified analysis that reflects the calibration data available and includes accurate ratings. Under the CP proposals, firms had to consider forward looking risks that were not already adequately captured in the FS, with the PRA citing climate risks as a possible example. In the PS, this has been softened in relation to vanilla corporate bonds, although firms are still expected to consider the need for any FS additions for other reasons.

The PRA has clarified that insurers are expected to be able to group assets into HRGs when determining whether FS additions are needed as part of their attestation, followed by analysis on specific assets where necessary. It has maintained its stance that prudence for one asset cannot be offset against an insufficient FS for another. 

The PRA has maintained the high degree of confidence (HDC) requirement despite pushback from firms. It states that technical provisions (TP) adequacy requires a suitable adjusted risk-free discount rate, and the risk-free nature of the discount rate necessitates the HDC requirement for the MA. It has not set a specific target percentile to meet the HDC and instead emphasises the qualitative interpretation of HDC. 

MA attestations must be made annually or when there is a material change in a firm's risk profile, with responsibility sitting with the senior manager responsible for financial information and regulatory reporting (Prescribed Responsibility Q). The implementation date is the first financial year-end from 31 December 2024 onwards. Neither the attestation report nor its evidence falls within scope of external audit. 

Key takeaway — insurers will need to submit an annual return to the PRA to allow the regulator to assess how MA portfolios change over time. 

Further information 

The PRA has introduced requirements for insurers to submit a new Matching Adjustment Asset and Liability Information Return (MALIR) on an annual basis. The MALIR provides a holistic picture of insurers' asset holdings in the MA portfolio and will allow the PRA to understand the nature of firms' investments and the extent to which they evolve as part of the MA reforms. The PRA is open to waiving certain requirements to submit a MALIR based on materiality and proportionality and has set out the process for waiver application. The MALIR will not be subject to external audit. 

Other key changes in PS 10/24 include removing the requirement for firms to submit cash flows extending beyond 50 years. This has been replaced with a requirement for those cash flows to be discounted to the last month of the 50th year. Additionally, there are new definitions for `Other Loans' and `Other Sovereigns, Sub-sovereigns, Quasi-government/Supranationals'. 

Key takeaway — mandatory notching in the MA calculation must be implemented by 31 December 2024, though firms can choose to implement it at half year if they wish. The PRA has allowed for flexibility and pragmatism in its approach to internal models and the internal ratings validation processes. 

Further information 

The PRA will make notching mandatory for TP calculations. 

It has not set a timescale for reflecting notching in the internal model, allowing firms to update their models, if required, in line with their own priorities and model development plans. In determining whether a capital add-on is required in the interim, the PRA will need to consider whether there is a significant deviation in the risk profile of a firm from the assumptions underlying the SCR. The PRA would also not expect a new MA application to be required unless a firm was making changes beyond updates to its MA calculation and ratings processes to reflect notching. 

The PRA has not specified a granular approach to internal rating validation as it recognises the challenges with validating internal credit assessments at a notched level. It has set a six-month timeframe from the date at which an asset first becomes an `assigned asset' for a notched rating to become `available'.

Key takeaway — the MA attestation report and underlying evidence are not subject to external audit. The PRA has clarified that voluntary additions to the FS will also not be subject to external audit, while mandatory FS add-ons will be. 

Further information 

The PRA had already made clear in CP 19/23 that the attestation report, as well as the underlying evidence, would not be subject to external audit. In PS 10/24 it has confirmed that voluntary additions to the FS, which are at the discretion of firms, also do not require external audit. However, this is different to any mandatory FS additions arising out of HP assets, as such mandatory FS additions would be in scope of external audit. 

The PRA recognises the related incremental external audit costs. Insurers considering adding HP assets to their MA portfolios will therefore benefit from discussing their approach with their external auditors so that any incremental work can be reflected in audit planning.