Matching adjustment [UK]
The fundamental spread
The UK government will legislate
- to maintain the existing methodology for calculating the fundamental spread (having rejected the case for reform); and
- make a change to the fundamental spread calculation to allow ‘notched’ ratings within rating bands.
The government will review in five years’ time whether the calibration for the fundamental spread remains appropriate.
The Prudential Regulation Authority (PRA) will be given increased regulatory powers to introduce new measures to:
- require insurers to take part in regular stress tests, the results of which will be published by the PRA;
- require a nominated senior manager to attest whether or not the level of the fundamental spread on their firm’s assets is sufficient to reflect all retained risks and that the resulting matching adjustment reflects only liquidity premium; and
- allow insurers to apply a higher fundamental spread through an add-on where the PRA concludes that the standard allowance is insufficient.
Asset and liability criteria
The government will legislate
- to allow investments with ‘highly predictable’ cashflows (rather than ‘fixed’ cashflows) – although note that the government states that there will be an expectation that the ‘vast majority’ of assets in a matching adjustment portfolio will have fixed cashflows and the PRA may require firms to have adequate risk management of such assets including concentration limits.
- to broaden the scope of assets/liabilities eligible for the matching adjustment:
- to include assets with prepayment risk or construction phases;
- include products that insure against morbidity risk (e.g. income protection products); and
- remove the disproportionately severe treatment of assets with a rating below BBB.
Other changes
A new streamlined eligibility application process for less complex assets.
Greater flexibility for the treatment of innovative assets.
A more proportionate approach to matching adjustment breaches.