The Prudential Regulation Authority (PRA) has published a ‘Dear CEO’ letter from Charlotte Gerken, Executive Director, Insurance, at the PRA concerning the launch of the data gathering exercise for the UK review of Solvency II.
The data gathering exercise is known as a quantitative impact study (QIS). Firms have been invited by the PRA to participate in the QIS. The exercise will collect data on a range of economic scenarios and policy outcomes. The QIS focuses on three areas: the risk margin, the matching adjustment and transitional provisions on technical provisions.
The letter provides some perspectives on both the risk margin and the matching adjustment. These are that the risk margin as it currently stands is too volatile and in the current low-interest rate environment is too high. The PRA believes that there is a strong case for making the risk margin less sensitive to interest rates. The matching adjustment plays an important role in making a market for annuities and provides a strong incentive for insurers to invest in long-term assets and helps insurers ride out temporary market fluctuations. The PRA has expressed concerns, however, that some returns treated as liquidity premium might be compensation for variability around credit losses. The current matching adjustment therefore allows insurers to recognise upfront as capital, returns that may not materialise.
As a one-size-fits all regime, Solvency II was never suited to the UK insurance market. Accordingly the PRA will explore through the QIS different calibrations that might improve the regime for UK insurers.