Stand out for the right reasons Financial Services Risk and Regulation. Hot topic. Solvency II Long Term Guarantee Package Update

What did the PRA publish in March 2015?
What did the PRA publish in 2015?

Transcription

1 26 March 2015 Stand out for the right reasons Financial Services Risk and Regulation Hot topic Solvency II Long Term Guarantee Package Update Highlights On 20 March 2015 the PRA published Supervisory Statement 17/15: Solvency II: Transitional Measures on the risk-free interest rates and technical provisions, as part of a wider Solvency II Policy Statement, covering the implementation of transitional measures. In addition, on 21 March 2015, the PRA released supplementary information forms on the transitional measure applications. On 20 March 2015 the PRA published Consultation Paper 11/15: Solvency II: supervisory approval for the volatility adjustment covering the approval process for firms intending to apply the VA. The publication of the Her Majesty s Treasury Statutory Instrument 1 ( the Statutory Instrument ) in March formalises a number of Solvency II regulations and its application in the UK. This includes the need for firms to gain approval from the Prudential Regulation Authority (the PRA ) in order to use the Volatility Adjustment and the clarification on how transitional measures should be applied. Following on from this, the PRA has published a policy statement along with a number of supervisory statements and consultation papers on various aspect of Solvency II implementation. PwC believes that UK insurers are now in a position to understand the cost and implications of applying each aspect of the Long Term Guarantee ( LTG ) package, and will need to mobilise resources swiftly to finalise the required applications. This paper provides an update of the latest regulatory developments on the three components of the LTG package: Volatility Adjustment ( VA ) Transitional Measures Matching Adjustment ( MA ) The approval process runs parallel for all three components and will likely place significant pressure on resources for firms wishing to apply for all aspects of the LTG package. In this paper we summarise the content of the latest regulatory updates. These releases provide clarity for insurers wishing to optimise their LTG package. 1

2 Volatility adjustment On 20 March 2015 the PRA published Consultation Paper 11/15: Solvency II: supervisory approval for the volatility adjustment 2 ( the Consultation ) covering the approval process for firms intending to apply the VA. The VA provides an uplift in the discount rate used to calculate best estimate liabilities and may be of particular interest for insurers for whom the MA is not appropriate. The Consultation is open for comments until 20 April Summary Firms wishing to apply the VA to their portfolio will have to seek approval from the PRA. The approval process opens on 1 April 2015, before the end of the consultation period. The Statutory Instrument sets out three statutory conditions that firms need to demonstrate compliance with in order to gain approval from the PRA to use VA. Firms intending to proceed with the application process will need to ensure that there are processes and governance in place to comply with the statutory conditions, as well as detailed quantitative analysis on the balance sheet impact of using VA. Approval process for the VA Firms should notify the PRA at the earliest opportunity should they wish to apply for the VA. All insurers will be able to send to the PRA a formal application from 1 April This overlaps with the consultation period which may indicate that the PRA is not expecting material changes to the proposal set out in the Consultation. It is unclear how long the PRA will have to confirm the application is complete although we note that the standard period is 30 days. For the majority of insurers, the PRA will have 6 months from the date of receipt of the complete application to assess it and communicate the results of the assessment to the insurer. For insurers whose VA application is independent of other approval decisions, such as internal model applications, the PRA will endeavour to communicate decisions within 6 weeks. For insurers intending to use the VA as a contingency option should another application be rejected, the PRA is willing to consider these applications in parallel. Whilst this will help provide certainty to firms whose applications are interdependent, the timescale available for those firms considering an early application may need to be evaluated given the short time available to develop their VA application. When submitting this application insurers should inform the PRA of any other approvals for which they have applied and are also encouraged to include details of other approvals they intend to apply for within the next year. The Consultation does not mention the need for sensitivity tests to be carried out showing the impact on the VA if other applications are rejected. This may indicate a belief from the PRA that this information will be available in other applications. Content of the VA application The application should allow the PRA to be satisfied that the regulation as set out in the Statutory Instrument has been met, namely: 1. The VA is correctly applied to the relevant risk-free interest rate term structure in order to calculate the best estimate liabilities; 2. The application of the VA does not create an incentive for firms to engage in pro-cyclical investment behaviour; and 3. The firm does not breach a regulatory requirement as a result or consequence of applying the VA. The Consultation specifies that the VA application should include the following: 1. The written policy on risk management including the criteria for application of the VA as well as the required assessment of sensitivity; 2. The liquidity plan in relation to the assets and liabilities subject to the VA; 3. An assessment of the impact when VA is reduced to zero. Where this results in non-compliance with the Solvency Capital Requirement, an analysis of the measures that could be used to restore compliance; and 4. An assessment, as part of the Own Risk and Solvency Assessment, of compliance with capital requirements with and without taking into account the VA. Key considerations for the VA application Firms will need to adapt their current risk management framework, process and governance to include ongoing compliance with the criteria as set out in the application. This will include ensuring that the criteria are aligned with how the portfolio is managed and do not cause excessive disruption to business. The implementation of these is likely to incur additional initial and ongoing costs. 2 cp/2015/cp1115.aspx 2 Hot Topic Financial Services Risk and Regulation

3 Whilst the Consultation does not specify the type of liabilities eligible for VA, the focus is on the liquidity of the liabilities. The need to demonstrate that cashflows are sufficiently predictable means that it may be difficult to gain approval on a range of liabilities, for example unit linked. The quantitative assessment needs to demonstrate that use of the VA is in line with the investment policy. Management may wish to consider how the VA may impact on the portfolio investment strategy and the basis risk between the reference portfolio and the current portfolio, in particular the need to maintain a portfolio yield that will ensure the discount rate is representative. Insurers will also need to consider carefully actions that will be taken under stress, which may confine freedom of management to react appropriately to market conditions. Transitional measures On 20 March 2015 the PRA published Supervisory Statement 17/15: Solvency II: Transitional Measures on the risk-free interest rates and technical provisions 3 ( the Statement ), as part of a wider Solvency II Policy Statement 4, covering the implementation of transitional measures. In addition, on 21 March 2015, the PRA released supplementary information forms on the transitional measure applications 5. The transitional measures give insurers the opportunity to delay some of the impact of moving from Solvency I to Solvency II. However there are a number of implications to consider and it is critical that firms fully understand how to apply the transitional measures and how to embed these into the business plan. Summary Firms wishing to apply transitional measures will need to seek approval from the PRA. Both transitional measures decrease linearly for up to a maximum of 16 years. The risk free rate ( RFR ) transitional can only be applied to liabilities which are not included in the MA calculation. Technical provisions transitional A transitional deduction should be calculated as the difference between the Solvency II TPs and the Solvency I Pillar 2 (ICA) TPs. This deduction is limited by the FRR test which reduces the transitional adjustment to ensure the FRR under the transitioned Solvency II position is greater than or equal to that under Solvency I. The FRR test should be calculated based on all liabilities at entity level, and firms should explain why any non-technical reserves have been removed for the calculation of the technical provisions. The transitional deduction calculated as at 31 December 2015 is not expected to be assessed again except in the following cases: The firm has received approval from the PRA to recalculate the deduction; A material change in the firm s risk profile or market conditions has occurred; and At the instruction of the PRA. For firms applying the TP transitional measure at homogenous risk group level, this can be no more granular than the HRG used to segment the TPs under Solvency II. Risk-free interest rate transitional The transitional adjustment for the risk-free rate ( RFR ) transitional is calculated as at 31 December 2015 and is the difference between the Pillar 1 interest rate (calculated in line with INSPRU 3.1) and the single discount rate that, when applied, will result in a value equal to the best estimate of the portfolio using the Solvency II risk-free rate, adjusted for the VA (where firms have been granted approval). Firms may apply to dynamically recalculate the Technical Provisions ( TP ) transitional measure. The amount of the TP transitional measure is limited at legal entity level to ensure the Financial Resources Requirement ( FRR ) under the transitioned Solvency II position is greater than or equal to the FRR under Solvency I. The TP transitional measure can be applied at Homogenous Risk Group ( HRG ) level. 3 ss1715.aspx 4 ps215.aspx 5 applying.aspx 3 Hot Topic Financial Services Risk and Regulation

4 Implications for insurers seeking to apply the transitional measures Approval process Firms should notify the PRA at the earliest opportunity should they wish to apply for the transitional measures. Formal application opens on 1 April The PRA will have 30 days to confirm the application is complete. Applications will take 6 months for the PRA to review. Insurer should inform the PRA of any other approvals in progress, or planned for the coming 12 months, with a sensitivity of the impact of the transitional measures if other applications are rejected. The PRA has provided more guidance on the application for the TP transitional compared to the RFR transitional. Hence firms may wish to infer the information the PRA may require for the RFR transitional application based upon the TP transitional guidance. The PRA may request firms to obtain external validation of the calculations performed. The guidance for the content of the TP transitional measure application includes a calculation template, notes on the application and supplementary information requested. The focus is on the explanation and justification of the calculations. The application should be made based on figures as at 31 December 2014, with an explanation for why these figures are appropriate. If the risk profile of the firm is likely to materially change during 2015, firms are asked to estimate the figures for the calculation at 31 December Recalculation Firms using the TP transitional need to decide whether to apply to recalculate the transitional. Should the transitional adjustment remain static, firms will be exposed to relative movements between the credit spreads over time which could create significant balance sheet volatility. In any case, the requirement to re-assess the level of TP deduction under a material change in risk profile, or at the insistence of the PRA could introduce a considerable practical burden for firms; it will likely require that the Pillar 1 and ICA models and assumptions are kept up-to-date and re-run each year for the assessment. Deciding on the right group of liabilities Applying the TP transitional at HRG level introduces additional complexity for calculations. Firms must demonstrate the calculations at HRG level are consistent with calculations for the entity as a whole. Firms must consider how to limit each HRG to allow for the FRR limit being applied at legal entity rather than HRG level, taking into account the contribution to the TP transitional measure from that HRG and the effect on the level of policyholder protection. Validation of the calculations There may not be time for the year end 2015 technical provisions to be validated prior to using them to calculate the transitional and applying it to the Solvency II balance sheet in Q Firms need to factor this into their plans for external validation. The PRA also appears to have opened the door for firms to discuss the appropriateness of any existing ICA margins/icg where these are felt to no longer be appropriate. Firms should discuss this with their usual supervisory contact before completing their application and factor this into the critical path. Impact on the business plan There are wider implications of using transitional measures on the asset hedging and new business strategies. The relative benefits between different firms of using the transitional measures will be a function of the internal structures and HRG liabilities held at legal entity level. Matching adjustment The following recent regulatory updates have continued to inform firms preparing their MA final application: Letter on Equity Release Mortgage 6 published by the PRA on 20 February 2015; Risk Free Rate technical documentation 7 published by EIOPA on 23 February 2015; and Letter on Matching Adjustment published 8 by the PRA on 9 March We note however that there continues to be high level of uncertainty within the papers published as well as on the criteria for MA approval. Firms who have submitted a pre-application document will receive feedback from the PRA on 28 March 2015, with the approval process commencing on 1 April fisherermletterfeb15.pdf 7 solvency-ii-technical-information/risk-free-interest-rate-term-structures 8 intmodmaupdatemar2015.pdf 4 Hot Topic Financial Services Risk and Regulation

5 How PwC can help you understand the implications for your business Our team has a significant amount of expertise working with insurers on the various components of the LTG package. We can work with you on: Understanding the impact on your balance sheet of the various components, such as investment strategy and capital; Develop application documents for regulatory approval; and Update the systems that will need to be in place to implement the measures. Contacts Shazia Azim James Tuley Scott McNeill Nicola Kenyon T: +44 (0) T: +44 (0) T: +44 (0) T: +44 (0) E: shazia.azim@uk.pwc.com E: james.tuley@uk.pwc.com E: scott.mcneill@uk.pwc.com E: nicola.kenyon@uk.pwc.com This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, PwC refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom), which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity NK-OS

6 Stand out for the right reasons Financial services risk and regulation is an opportunity. At PwC we work with you to embrace change in a way that delivers value to your customers, and long-term growth and profits for your business. With our help, you won t just avoid potential problems, you ll also get ahead. We support you in four key areas. By alerting you to financial and regulatory risks we help you to understand the position you re in and how to comply with regulations. You can then turn risk and regulation to your advantage. We help you to prepare for issues such as technical difficulties, operational failure or cyber attacks. By working with you to develop the systems and processes that protect your business you can become more resilient, reliable and effective. Adapting your business to achieve cultural change is right for your customers and your people. By equipping you with the insights and tools you need, we will help transform your business and turn uncertainty into opportunity. Even the best processes or products sometimes fail. We help repair any damage swiftly to build even greater levels of trust and confidence. Working with PwC brings a clearer understanding of where you are and where you want to be. Together, we can develop transparent and compelling business strategies for customers, regulators, employees and stakeholders. By adding our skills, experience and expertise to yours, your business can stand out for the right reasons. For more information on how we can help you to stand out visit