Prudential Regulation Authority Rulebook

3.1

This chapter sets out the PRA’s expectations in relation to MA eligibility conditions that are applicable to liabilities in the MA portfolio.

3.2

To demonstrate that the liabilities satisfy the relevant MA eligibility conditions, a firm should produce a comprehensive breakdown of its liabilities and should identify all policyholder options and relevant contractual terms (such as the ability of the policyholder to surrender their policy, or the potential for future premium adjustments). A high-level description of the liabilities would generally not be sufficient to enable the PRA to assess compliance with the relevant conditions.

3.3

[Deleted]

3.4

For the purposes of demonstrating compliance with MA eligibility conditions that are applicable to liabilities, firms are expected to consider all the features of the liabilities against all the relevant conditions, not just the condition(s) that the firm considers to be most material.

3.5

The PRA expects firms to be able to provide quantitative evidence to demonstrate compliance with the mortality risk threshold in Matching Adjustment 2.2(3).

3.5A

Matching Adjustment 2.3 sets out that a component of a with-profits annuity contract may be eligible for inclusion in an MA portfolio, provided that the component is legally established and identifiable as guaranteed within an insurance contract, is capable of being organised and managed separately in accordance with regulation 4(6) of the IRPR regulations, and otherwise meets the MA eligibility conditions. The PRA expects that for a firm to include such components of liabilities within an MA portfolio, it will provide a detailed assessment to demonstrate that the only elements of the liabilities included are contractually guaranteed and are not dependent on future premiums or future investment performance. The PRA also expects that the firm should set out a clear policy regarding the addition of future attaching bonuses in the MA portfolio or elsewhere.

3.5B

Matching Adjustment 2.2(2) specifies that the permitted underwriting risks connected to the portfolio of liabilities may include recovery time risk, where this is the risk that policyholders in receipt of income protection payments take longer to recover from sickness than expected. Matching Adjustment 2.3 and 2.5 provide that in-payment elements of income protection contracts may be eligible for inclusion, where they are separately identifiable and can be organised and managed separately in accordance with regulation 4(6) of the IRPR regulations. The PRA considers that this will allow in-payment claims under both group and individual income protection policies to be permitted within MA portfolios, where the claims are not subject to future premiums. Unlike with mortality risk, there is no restriction on the exposure to recovery time risk in firms’ MA portfolios. The PRA does not expect that the inclusion of recovery time as an underwriting risk should lead to types of liabilities other than income protection claims in payment being included in MA portfolios.

3.5C

Matching Adjustment 2.3 and 2.5 provide that in-payment annuities under group policies providing death-in-service dependant annuities may be eligible for inclusion in MA portfolios, where they are separately identifiable and can be organised and managed separately in accordance with regulation 4(6) of the IRPR regulations. The PRA considers that this will allow in-payment claims under group dependant annuity policies to be permitted within MA portfolios, where the claims are not subject to future premiums.

3.6

Some contracts of insurance include an option for the premium to be paid as an initial sum followed by a series of further (smaller) instalments. Except in the limited cases set out in paragraphs 3.5A, 3.5B and 3.5C above, the PRA does not view any approach that notionally splits a contract into parts as being compatible with Matching Adjustment 2.3. The PRA’s view is that such a treatment would also undermine the ability of the insurer to manage its MA portfolio separately from the rest of the business, as required by regulation 4(6)(b) of the IRPR regulations.

3.7

Some contracts of insurance include a premium adjustment clause that permits the initial premium paid to be adjusted post-contract inception, eg following a data cleansing exercise. The PRA does not consider that a premium adjustment clause will necessarily lead to a contract giving rise to future premium payments for the purposes of Matching Adjustment 2.2(1) if the adjustment is made only to correct for an overpayment or underpayment of a defined premium (resulting from inaccurate information at the contract inception) and does not have the effect of varying the contract.

3.8

The PRA expects firms to be able to submit strong quantitative evidence to demonstrate meeting the MA eligibility conditions in Matching Adjustment 2.2(4).

3.9

In assessing the risks associated with the exercise of surrender options, the PRA expects firms to consider (among other things):

• the processes and controls in place to manage surrenders;
• the likelihood of peaks and troughs in surrenders, and the drivers of these;
• historical surrender experience;
• the impact of increased or reduced surrenders on cash flow matching; and
• any liquidity strain associated with increased or reduced surrenders.

3.10

The PRA expects these considerations to form a part of a firm’s risk and liquidity management of an MA portfolio.

3.11

In the case of deferred annuity contracts that are subject to a right of surrender before the start of the annuity payments, the PRA does not consider that the absence of a contract-level surrender basis will necessarily disqualify the obligations for the purposes of Matching Adjustment 2.2(4). When assessing compliance with this MA eligibility condition, the PRA expects firms to, at least:

• undertake a qualitative assessment of each contract that is proposed for inclusion in an MA portfolio to identify those contracts where the surrender basis is non-discretionary (or only contains limited discretion).^[24] Such contracts should be considered carefully to assess the extent of surrender risk posed, and may need to be excluded from the portfolio on that basis;
• be able to demonstrate that none of the contracts proposed for inclusion could cause a surrender loss that is material in the context of an MA portfolio, including under stressed conditions. This is expected to include consideration of possible correlation effects between contracts. One possible mitigation for larger or more material policies could be to demonstrate that an individual surrender basis can and will be used for these policies;
• be able to provide evidence that the management of the surrender basis has not historically led to losses at portfolio level; and
• be able to provide a detailed description of how the surrender basis is set and the controls in place around this to manage the risk of loss on surrender. If an individual surrender basis would be used for specific contracts then this should be described separately in each case.

3.12

Where a single contract covers a number of individual scheme members or beneficiaries, the PRA would expect the points above to be considered in respect of these individual members or beneficiaries when assessing compliance with Matching Adjustment 2.2(4).

3.13

For the purposes of assessing whether the surrender value exceeds the value of the assets held, the PRA’s preferred approach is for the surrender value to be compared against the BEL. Where firms have compared against the BEL plus risk margin, the PRA expects firms to be able to clearly demonstrate that the contribution of an MA portfolio to any surrender pay-out would be limited to the amount of assets held in that MA portfolio in respect of the surrendered contract(s), in order to be able to demonstrate compliance with Matching Adjustment 2.2(4)(b). For the avoidance of doubt, the PRA considers that including the contract’s contribution to the SCR in the cost-neutrality assessment would be appropriate only in exceptional circumstances.