Dear friend,
Throw in half a pound of self-raising asset flour and half a pound of sugar liabilities, add a smidgen of discounting and there you have it, a nicely matched portfolio for the life market.
If only matching assets with liabilities were that simple, but of course as anyone remotely associated with the development of Solvency II in recent years will appreciate this has been one of the most contentious areas of development, especially where the formulation of the matching adjustment (MA) and volatility adjustment (VA) is concerned.
In essence Solvency II allows insurers to use the MA to shield their balance sheets against short-term market volatility, and has been designed to apply to fixed cash-flow matched portfolios of assets and liabilities.
UK insurers in particular have been taking the issue of the MA very seriously indeed, because it largely applies to their business models, and last week the Prudential Regulation Authority (PRA) issued another consultation paper (CP23/14) in relation to applying for certain Solvency II approvals, including internal models and the MA.
The consultation paper spelt out that, although not mandatory, firms considering applying to use the MA are encouraged to participate in the pre-application process. A supplementary letter was also included from Paul Fisher, executive director for insurance regulation, providing further guidance.
More information of this sort is to be welcomed. After all, a lack of guidance from the PRA over the MA and internal model validation has been one of the most consistent complaints from insurers in recent months. Yet despite the PRA's best intentions, there are still a number of areas where insurers are still relatively clueless. For example, the letter makes no comment on the treatment of the risk margin, and whether or not capital for credit risk needs to be assumed when calculating the risk margin.
What do we make of such omissions? I suppose they must be infuriating for many out there who don't want to put a huge amount of effort into applications which might turn out to be misguided.
Perhaps, though, a less prescriptive approach ultimately allows the industry to be more involved in the interpretive process? It's a very anxious time for the market but if the PRA is really prepared to listen to the unofficial soundings of those insurers involved in the MA application process throughout this period without being overly prescriptive this could turn out to the industry's long-term advantage.
I remain to be convinced, however. The PRA has indicated that the amount of work firms will need to carry out for MA approval is extensive, and that the burden of proof is high where individual asset eligibility is concerned. Not the most positive signals as far as insurers are concerned…
Marcus Alcock
Editor, InsuranceERM