Prudential Regulation Authority Rulebook

1.1

Unless otherwise stated, this Part applies to:

1. (1) a UK Solvency II firm;
2. (2) in accordance with Insurance General Application 3.1, the Society; and
3. (3) in accordance with Insurance General Application 3.2, managing agents.

1.2

In this part, the following definitions shall apply:

attestation reference date

means:

1. (1) where 9.1(2)(a) applies, the effective date of the firm’s SFCR; or
2. (2) where 9.1(2)(b) applies, a date no later than three months after the date of the material change in risk profile.

eligible element

means a portion of insurance or reinsurance obligations forming part of a wider contract of insurance or reinsurance contract and which:

1. (1) comprises:
   1. (a) the guaranteed element of a with-profits policy that is either an immediate annuity or a deferred annuity; or
   2. (b) the in-payment element of a group death in service dependants’ annuity or an income protection policy,

in each case, where the element can be organised and managed separately in accordance with regulation 4(6) of the IRPR regulations; and

1. (2) would otherwise meet the matching adjustment eligibility conditions, but for the fact that it forms part of a contract of insurance or reinsurance contract which does not so comply, when taken as a whole. 

exposure limit

means any limit that forms part of the firm’s matching adjustment permission in respect of the inclusion of a particular asset or assets in the relevant portfolio of assets.

highly predictable

has the meaning given to that term in Matching Adjustment 5.3.

2.1

A firm must not apply a matching adjustment to the relevant risk-free interest rate term structure to calculate the best estimate of its insurance or reinsurance obligations unless it has a matching adjustment permission.

2.2

The conditions referred to in regulation 4(11) of the IRPR regulations are: 

1. (1) except as set out in 2.5, the contracts underlying the relevant portfolio of insurance or reinsurance obligations do not give rise to future premium payments;
2. (2) the only underwriting risks connected to the relevant portfolio of insurance or reinsurance obligations are longevity risk, expense risk, revision risk, mortality risk or recovery time risk;
3. (3) where the underwriting risk connected to the relevant portfolio of insurance or reinsurance obligations includes mortality risk, the best estimate of the relevant portfolio of insurance or reinsurance obligations does not increase by more than 5% under a mortality risk stress that is calibrated in accordance with Chapter 3 of the Solvency Capital Requirement – General Provisions Part and otherwise complies with 2.4;
4. (4) the contracts underlying the relevant portfolio of insurance or reinsurance obligations include:
   1. (a) no options for the policyholder; or
   2. (b) only a surrender option with a surrender value not exceeding the value of the assets, valued in accordance with Valuation 2.1 and 2.2, covering the insurance or reinsurance obligations at the time the surrender option is exercised;
5. (5) the relevant portfolio of assets cannot be used to cover losses arising from the other activities of the firm; and
6. (6) the relevant portfolio of assets and each individual asset contained in it meets the requirements of the prudent person principle contained in Chapters 2 and 3 of the Investments Part.

2.3

For the purposes of this Part, the insurance or reinsurance obligations of an insurance or reinsurance contract must not be split into different parts when composing the relevant portfolio of insurance or reinsurance obligations, other than in the case of an eligible element.

2.4

1. (1) The mortality risk stress referred to in 2.2(3) shall be the more adverse of the following two scenarios in terms of its impact on basic own funds:
   1. (a) an instantaneous permanent increase of 15% in the mortality rates used for the calculation of the best estimate; or
   2. (b) an instantaneous increase of 0.15 percentage points in the mortality rates (expressed as percentages) which are used in the calculation of technical provisions to reflect the mortality experience in the following 12 months.
2. (2) For the purpose of (1) the increase in mortality rates shall only apply to those policies for which the increase in mortality rates leads to an increase in technical provisions, taking into account the following:
   1. (a) multiple policies in respect of the same insured person may be treated as if they were one policy; and
   2. (b) where the calculation of technical provisions is based on groups of policies as referred to in Article 35 of Commission Delegated Regulation (Solvency II) 2015/35, the identification of the policies for which technical provisions increase under an increase of mortality rates may also be based on those groups of policies instead of single policies, provided that it yields a result which is not materially different.
3. (3) With regard to reinsurance obligations, the identification of the policies for which technical provisions increase under an increase of mortality rates shall apply to the underlying insurance policies only and shall be carried out in accordance with (2).

2.5

The condition set out in 2.2(1) does not apply in respect of an eligible element specified in 1.2 eligible element (1)(b).

[Note: In accordance with regulation 4(11) of the IRPR regulations, this Chapter sets matching adjustment eligibility conditions in addition to those set out in regulation 4(3) to (9) and (11) of the IRPR regulations, under which a firm is eligible to apply a matching adjustment]

3.1

A firm making a matching adjustment permission application must confirm to the PRA in writing and submit, as a minimum, documentary evidence that demonstrates that the relevant portfolio of assets and relevant portfolio of insurance or reinsurance obligations, and, if the context requires, the firm, satisfies the matching adjustment eligibility conditions.

3.2

A firm that applies the matching adjustment to a relevant portfolio of insurance or reinsurance obligations must not revert back to the approach that does not include a matching adjustment.

4.1

This Chapter applies to a firm that has been granted a matching adjustment permission.

4.2

A firm with a matching adjustment permission must calculate the matching adjustment in accordance with 4.3 to 4.8.

4.3

For each currency the matching adjustment must be equal to the difference of:

1. (1) the annual effective rate, calculated as the single discount rate that, where applied to the cash-flows of the relevant portfolio of insurance or reinsurance obligations, results in a value that is equal to the value of the portfolio of assigned assets; and
2. (2) the annual effective rate, calculated as the single discount rate that, where applied to the cash-flows of the relevant portfolio of insurance or reinsurance obligations, results in a value that is equal to the value of the best estimate of the relevant portfolio of insurance or reinsurance obligations where the time value of money is taken into account using the basic relevant risk-free interest rate term structure.

4.4

For the purpose of the calculation referred to in 4.3:

1. (1) assigned assets only includes assets whose expected cash-flows are required to replicate the cash-flows of the relevant portfolio of insurance or reinsurance obligations, excluding any assets in excess of that;
2. (2) valuations must be calculated in accordance with the Valuation Part.

4.5

In 4.4(1), the ‘expected cash-flow’ of an asset means the cash-flow of the asset adjusted to allow for the probability of default of the asset that corresponds to the element of the fundamental spread set out in 4.10(1) or, where no reliable credit spread can be derived from the default statistics, the portion of the long term average of the spread over the basic relevant risk-free interest rate term structure (as provided in 4.11 and 4.12).

4.6

The matching adjustment must not include the fundamental spread (as calculated in accordance with 4.10 to 4.17) reflecting the risks retained by the firm.

4.7

The deduction of the fundamental spread under 4.6 from the result of the calculation set out in 4.3 must include only the portion of the fundamental spread that has not already been reflected in the adjustment to the cash-flows of the assigned portfolio of assets in accordance with 4.3 to 4.5.

4.8

The fundamental spread referred to in 4.6 and 4.7 must be calculated in a transparent, prudent, reliable and objective manner that is consistent over time and based on relevant indices where available.

4.9

The fundamental spread must be calculated in accordance with 4.10 to 4.17.

4.10

The fundamental spread must be equal to the sum of the following:

1. (1) the credit spread corresponding to the probability of default of the assets; and
2. (2) the credit spread corresponding to the expected loss resulting from downgrading of the assets.

4.11

For exposures to the central government of the United Kingdom and the Bank of England, where the fundamental spread would otherwise be lower than 30% of the long-term average of the spread over the risk-free interest rate of assets of the same duration, credit quality and asset class, as observed in financial markets (the ‘average spread’), the fundamental spread must be 30% of the average spread.

4.12

For assets other than exposures to the central government of the United Kingdom and the Bank of England, where the fundamental spread would otherwise be lower than 35% of the long-term average of the spread over the risk-free interest rate of assets of the same duration, credit quality and asset class, as observed in financial markets (the ‘average spread’), the fundamental spread must be 35% of the average spread.

4.13

For the purposes of 4.10 to 4.12:

1. (1) the calculation of the ‘credit spread’ must be based on the assumption that in case of default 30% of the market value of the assets can be recovered;
2. (2) the ‘probability of default’ must be based on long-term default statistics that are relevant for the asset in relation to its duration, credit quality and asset class;
3. (3) the ‘expected loss’ must be based on long-term statistics that are relevant to changes in the credit quality of the asset and correspond to the probability-weighted loss the firm incurs where the asset is downgraded to a lower credit quality and is replaced immediately afterwards, and the calculation of the expected loss must be based on the assumption that the replacing asset meets all of the following criteria:
   1. (a) the replacing asset has the same cash-flow pattern as the replaced asset before downgrade;
   2. (b) the replacing asset belongs to the same asset class as the replaced asset; and
   3. (c) the replacing asset has the same credit quality as the replaced asset before downgrade or a higher one;
4. (4) the ‘long-term average of the spread over the risk-free interest rate’ must be based on data relating to the previous 30 years;
5. (5) the methods to derive the fundamental spread of a bond must be the same for each currency and each country and may be different for government bonds and for other bonds.

4.14

For the purposes of 4.13(2) and (3), where no reliable credit spread can be derived from the default statistics, the fundamental spread must be equal to the portion of the long-term average of the spread over the risk-free interest rate set out in 4.11 or 4.12.

4.15

Where part of the data referred to in 4.13(4) is not available or where the available data is not reliable, constructed data based on prudent assumptions may be used; and the constructed data must be based on available and reliable data relating to the previous 30 years.

4.16

A firm must increase the fundamental spread calculated under 4.10 to 4.15 in accordance with 8.2.

4.17

A firm may increase the fundamental spread calculated under 4.10 to 4.16 where necessary to ensure it covers all risks retained by the firm.

[Note: This Chapter replicates the provisions for the calculation of the matching adjustment and fundamental spread contained in regulations 5 and 6 of the IRPR regulations]

[Note: The IRPR regulations refer to the ‘assigned portfolio of assets’. This has the same meaning as the relevant portfolio of assets, except for regulation 5(5) which is replicated in 4.7 where the ‘assigned portfolio of assets’ is referring to assigned assets as set out at 4.3 and 4.4]

5.1

For the purpose, and without limiting the generality, of the condition in regulation 4(9) of the IRPR regulations, assets with cash-flows that are not fixed are only capable of being included in a firm’s relevant portfolio of assets without giving rise to material risks to the quality of matching if the cash-flows that are not fixed are highly predictable.

5.2

For the purposes of the condition in regulation 4(9)(a)(ii) of the IRPR regulations, the proportion of a firm’s relevant portfolio of assets that comprises assets with highly predictable cash-flows is subject to the following limits:

1. (1) no more than 10% of the matching adjustment benefit is attributable to an asset with highly predictable cash-flows, either on its own or when taken together with other assets with highly predictable cash-flows in the relevant portfolio of assets; and
2. (2) any applicable exposure limit.

5.3

The cash-flows of an asset are highly predictable for the purposes of 5.1 where:

1. (1) the contractual terms of the asset provide for a bounded range of variability in respect of the timing and amount of the cash-flows; and
2. (2) failure to meet such contractual terms is a default.

5.4

In assessing asset cash-flows for the purposes of 5.3, a firm must:

1. (1) base the best estimate of the cash-flows on the contractual payments of the asset;
2. (2) use assumptions consistent with the economics of the asset; and
3. (3) where expert judgment is used in determining the cash-flows, ensure that it is subject to the level of controls specified in Article 2 of Commission Delegated Regulation (Solvency II) 2015/35.

5.5

For the purposes of 5.2(1), the matching adjustment benefit means, where a firm has a matching adjustment permission, an amount equal to the impact on its best estimate of the scenario set out in Conditions Governing Business 3.2(2)(c) (and for the purposes of this calculation, ignoring any impact of rule 13.5).

6.1

Where an assigned asset has a credit rating or internal credit assessment of a comparable standard (within the meaning of 7.1(1)) mapping to credit quality steps 1 to 5 (inclusive), a firm with a matching adjustment permission must make an adjustment to the fundamental spread derived from the credit quality step attributed to that asset in order to reflect the corresponding rating notch, in accordance with 6.3 and 6.4.

6.2

The obligation in 6.1 does not apply in the circumstances described in 6.5.

6.3

A firm must derive the adjustment referred to in 6.1 for at least:

1. (1) the probability of default referred to in 4.5; and
2. (2) the overall fundamental spread,

in each case, applicable to the cash-flows of that asset.

6.4

A firm must:

1. (1) derive the adjustments referred to in 6.3 using linear interpolation of the information published by the PRA under regulation 3(1) of the IRPR regulations;
2. (2) use linear interpolation for each consecutive credit quality step pair; and
3. (3) assume for the purposes of this Chapter that each intermediate rating notch is evenly spread between each consecutive credit quality step pair.

6.5

Where there is no rating notch available for a particular asset falling within the scope of 6.1:

1. (1) a firm must not adjust the fundamental spread, or component thereof, applied to the cash-flows of that asset, other than to account for additions to the fundamental spread in accordance with 4.16 and/or 4.17, as applicable; and
2. (2) a firm must consider the appropriateness of the fundamental spread and matching adjustment in respect of that asset as part of its analysis and verification process and policy under Chapter 10, in relation to the attestation made under Chapter 9.

6.6

By way of derogation, during the period from, and including, 30 June 2024 to, and excluding, 31 December 2024, a firm may, but will not be required, to comply with the obligation in 6.1.

7.1

Where a firm uses any internal credit assessment of assets within the relevant portfolio of assets, the firm must ensure on an ongoing basis:

1. (1) that, as required by regulation 4(4) of the IRPR regulations, such internal credit assessment is of a comparable standard to a credit rating; and
2. (2) the appropriateness of:
   1. (a) its process to produce such internal credit assessments; and
   2. (b) the outcomes of such internal credit assessments.

7.2

For the purposes of 7.1, the firm must ensure at a minimum that:

1. (1) the internal credit assessments have considered all possible sources of credit risk, both qualitative and quantitative, and how these types of credit risk may interact;
2. (2) the internal credit assessment outcomes lie within a plausible range of issue ratings that could have resulted from a credit rating agency;
3. (3) both at the level of the relevant portfolio of assets and of each asset type, there is broad consistency and no bias between:
   1. (a) internal credit assessment outcomes; and
   2. (b) issue ratings that could have resulted from a credit rating agency;
4. (4) the internal credit assessment process is subject to appropriate validation, and appropriate assessment of its on-going appropriateness;
5. (5) the firm has obtained proportionate independent external assurance in respect of 7.2(2); and
6. (6) the firm’s internal credit assessment function is independent and there are effective controls to manage any potential conflicts of interest.

7.3

Upon request, the firm must be able to demonstrate its compliance with 7.1 to the PRA.

7.4

The use of credit ratings in the calculation of the matching adjustment shall be in line with the specifications set out in Articles 4 - 6 of the Commission Delegated Regulation (EU) 2015/35 and Commission Implementing Regulation 2016/1800.

8.1

A firm with a matching adjustment permission must identify all sources of uncertainty regarding the timing and amount of cash-flows from any asset in the relevant portfolio of assets with cash-flows that are highly predictable.

8.2

A firm must add to the fundamental spread an amount that reflects the risks arising from the uncertainties identified in accordance with 8.1 to ensure that the fundamental spread reflects risks retained by the firm in accordance with 4.6.

9.1

A firm with a matching adjustment permission must provide to the PRA the attestation set out at (1) at the time set out in (2) by a person in (3) in the form set out in 12.1 in respect of each relevant portfolio of assets as a whole held by the firm.

1. (1) The attestation is that, as at the applicable attestation reference date:
   1. (a) the fundamental spread used by the firm in calculating the matching adjustment reflects compensation for all retained risks in accordance with 4.6; and
   2. (b) the matching adjustment can be earned with a high degree of confidence from the assets held in the relevant portfolio of assets.
2. (2) Subject to 9.2, the attestation must be provided:
   1. (a) annually, no later than 14 weeks after the firm’s financial year-end, commencing with its first financial year-end after the matching adjustment permission took effect; and
   2. (b) where there is a material change in risk profile of the firm, as soon as reasonably practicable after the applicable attestation reference date.
3. (3) The attestation must be provided by the PRA senior management function holder in the firm responsible for the prescribed responsibility of the production and integrity of the firm’s financial information and its regulatory reporting (PR Q), as provided for in Insurance – Allocation of Responsibilities 3.1(4).

9.2

In respect of a firm with a matching adjustment permission that took effect prior to 31 December 2024, that firm will not be required, but may nevertheless elect, to provide the attestation set out at 9.1(1) in respect of any financial year-end or material change in risk profile for which the applicable attestation reference date would fall within the period commencing on 30 June 2024, up to, and excluding, 31 December 2024.

10.1

Before providing any attestation in accordance with 9.1, a firm must analyse and justify that the fundamental spread used by the firm reflects compensation for all retained risks, and that the matching adjustment can be earned with a high degree of confidence from the assets held in the relevant portfolio of assets.

10.2

A firm must have in place appropriate internal processes, systems and controls to allow it to produce the analysis and justification required by 10.1.

10.3

A firm must put in place and maintain a policy on providing the attestation at 9.1 and the analysis and justification required in 10.1 and must ensure that its governing body has approved that policy.

11.1

A firm with a matching adjustment permission must disclose in its SFCR whether it has or has not provided the attestation in accordance with 9.1 in respect of the financial year to which that SFCR relates.

12.1

The attestation must be:

1. (1) provided in the form of an attestation document and which must include the information set out at 12.2; and
2. (2) accompanied by a supporting attestation report as set out at 12.3.

12.2

The attestation document must include:

1. (1) the attestation in 9.1;
2. (2) the name and role of the PRA senior management function holder giving the attestation;
3. (3) the relevant portfolio of assets to which the attestation applies; and
4. (4) the date of the attestation.

12.3

The supporting attestation report must include the following information:

1. (1) either:
   1. (a) a copy of the latest version of the policy referred to in 10.3; or
   2. (b) confirmation that such policy has not been updated since it was last provided to the PRA;
2. (2) confirmation that the firm and attestor complied with the terms of the policy referred to in 10.3 in making the attestation, or if not:
   1. (a) details of the alternative approach followed by the firm and the attestor; and
   2. (b) an explanation as to why this occurred;
3. (3) a list detailing the evidence the attestor relied on in making the attestation; and
4. (4) in relation to any increase(s) in the fundamental spread that the firm has elected to use in accordance with 4.17, a list of:
   1. (a) all assets in each relevant portfolio of assets to which these apply;
   2. (b) the reasons for the increase(s); and
   3. (c) the amount of the increase(s) and the matching adjustment resulting from those assets,

   as at the applicable attestation reference date.

13.1

This Chapter applies to a firm that has been granted a matching adjustment permission.

13.2

A firm with a matching adjustment permission must comply with the matching adjustment eligibility conditions and the terms of its matching adjustment permission, including any applicable exposure limits, at all times.

13.3

A firm that applies the matching adjustment to a relevant portfolio of insurance or reinsurance obligations must not apply a risk-free interest rate transitional measure or volatility adjustment in respect of those obligations.

13.4

Where a firm that applies the matching adjustment is no longer able to comply with the matching adjustment eligibility conditions, it must immediately:

1. (1) inform the PRA; and
2. (2) take the necessary measures to restore compliance with these conditions as soon as possible.

13.5

Where a firm is not able to restore compliance with the matching adjustment eligibility conditions within two months of the date of non-compliance it must then, on a monthly basis and for the duration of the period of non-compliance, adjust the matching adjustment it applies in respect of the relevant portfolio of insurance or reinsurance obligations according to the following formula:

\[\mathrm{MA^{*}=MA-\left ( n-1 \right )\times p\times max\left \{ MA,0 \right \}}\]

where:

MA^* is the reduced matching adjustment applied to the relevant portfolio of insurance or reinsurance obligations;

MA is the matching adjustment, where the matching adjustment is calculated assuming no restrictions relating to the breach of matching adjustment eligibility conditions;

n is the whole number of months since the date of non-compliance, and shall not be greater than 11; and

p is 10%.