Prudential Regulation Authority Rulebook

7.1

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

7.2

The matching adjustment shall be calculated for each currency in accordance with the following principles:

1. (1) the matching adjustment shall be equal to the difference of the following:
1. (a) 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 (in accordance with the Valuation Part of the PRA Rulebook) of the relevant portfolio of assets;
2. (b) 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 is taken into account using the basic relevant risk-free interest rate term structure;
2. (2) the matching adjustment shall not include the fundamental spread reflecting the risks retained by the firm;
3. (3) notwithstanding (1), the fundamental spread shall be increased where necessary to ensure that the matching adjustment for assets with sub-investment grade credit quality does not exceed the matching adjustment for assets of investment grade quality, of the same duration and asset class; and
4. (4) the use of external credit assessments in the calculation of the matching adjustment shall be in line with the specifications set out in the Solvency II Regulations adopted under Article 111(1)(n) of the Solvency II Directive.

7.3

For the purposes of 7.2(2) and subject to 7.5, the fundamental spread shall be:

1. (1) equal to the sum of the following:
1. (a) the credit spread corresponding to the probability of default of the assets; and
2. (b) the credit spread corresponding to the expected loss resulting from downgrading of the assets;
2. (2) for exposures to EEA States’ central governments and central banks, no 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;
3. (3) for assets other than exposures to EEA States’ central governments and central banks, no 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;

7.4

The probability of default referred to in 7.3(1)(a) shall be based on long-term default statistics that are relevant for the asset in relation to its duration, credit quality and asset class.

7.5

Where no reliable credit spread can be derived from the default statistics referred to in 7.3, the fundamental spread shall be equal to the portion of the long term average of the spread over the risk-free interest rate set out in 7.3(2) and 7.3(3).

[Note: Art. 77c and Art. 77e(3) of the Solvency II Directive]