Prudential Regulation Authority Rulebook

4.1

The Solvency II Regulations set out the legal requirements of the application process for the MA, AOF and USPs. This chapter sets out the PRA’s expectations of firms and provides guidance on applications for these approvals.

4.2

The timescales for the PRA to decide whether a firm’s application for one of these approvals is complete and then whether to approve or reject the application are detailed in the Solvency II Regulations and Financial Services and Markets (the Solvency 2 Regulations 2015) (‘the Statutory Instrument’).

4.3

When submitting an application for these approvals, firms are required to inform the PRA of any other approvals for which they have applied. The PRA encourages firms to also include details of other approvals for which they intend to apply during the next twelve months.

4.4

For the approvals discussed in this section, the PRA has produced a checklist which firms should use when submitting their applications. These checklists are not mandatory, but are designed to help firms submit the necessary information to allow the PRA to consider the application and avoid delays that may arise from incomplete applications. The application checklists are based on requirements set out in the Solvency II Directive, and the Solvency II Regulations.

4.5

Under Article 77(b) of the Solvency II Directive, firms may apply for approval to use a MA. The PRA’s detailed expectations on the MA have been set out in a series of industry communications, including letters from the Executive Director for Insurance, that are available on the Bank’s website.^[4]

4.6

Firms wishing to apply to use the MA can submit a formal application after 1 April 2015. Those firms that participate in the MA pre-application process are also expected to provide the PRA with a detailed breakdown of any changes that have occurred since pre-application.

4.7

The MA calculation requires a fundamental spread to be assigned to each asset, based on the credit quality, duration and asset class. Where firms have unrated assets, and have rated these assets using an internal rating system, the PRA may consider undertaking a review of the process followed to produce the internal rating to determine its appropriateness.

4.8

If a firm uses internal ratings, suitable documentation should be provided with their MA application to allow the PRA to review the process followed in order to determine its appropriateness. The PRA expects that this should include details of the ratings methodologies; the calibration and back testing of the ratings; the governance around the ratings process; and the processes in place for the review of internally assigned ratings.

4.9

Under Article 90 of the Solvency II Directive, firms may apply to the PRA for approval to recognise AOF when determining own funds.

4.10

The Solvency II requirements regarding AOF applications are designed to ensure that firms only receive approval when they can provide robust supporting evidence regarding the:

• loss absorbing capacity of the basic own fund item into which the AOF would convert upon call;
• ability and willingness of the counterparties to pay when called upon; and
• recoverability of funds (including the existence, or not, of any legal impediments to payment and whether collateral is held).

Since the AOF must be callable on demand, firms will also need to demonstrate that there is no trigger event or restrictions affecting when the AOF item can be called.

4.11

The PRA does not expect firms to treat AOF items as emergency capital to be applied for when a firm is in danger of breaching its solvency capital requirement (SCR). In such a situation, raising basic own funds is likely to be a more appropriate action. AOF should be considered as part of a firm’s medium term capital management planning. As such, the PRA will expect firms to submit their medium term capital management plan as part of any AOF application.

4.12

Under Article 104(7) of the Solvency II Directive, firms may apply to the PRA to use USPs when calculating their SCR using the standard formula. Firms are encouraged to submit the application checklist as this will help to ensure firms meet the requirements of the Solvency II Directive.

4.13

The use of USPs is designed to ensure firms’ SCR is being measured appropriately and firms should consider whether the USP is a more accurate reflection of risk. As part of the decision-making process the PRA will consider the reasons why a firm has decided to apply to use USPs and whether they have been applied appropriately across a firm’s business.

4.14

Under Article 230 of the Solvency II Directive, groups can also apply to the PRA to use group specific parameters (GSP) when calculating the group SCR with the standard formula. Groups seeking to use GSPs should use the same application process as described for USPs, including the submission of the application checklist.