PwC UK outlines possible pathways for MA relaxation in the UK

Written by Adam Cadle

24/07/2023

Four broad ways exist in which the UK Government could allow relaxation of the matching adjustment (MA) rules under Solvency UK to include assets with highly predictable cash flows, PwC UK has argued.

Firstly, PwC UK said new rules could be developed to allow a range of new and variable asset classes to be included as long as the cash flows of the portfolio as a whole remain demonstrably fixed. It said that this could be enacted through a simple market value (MV) ratio test (i.e., less than x% of assets can have variable cash flows); or it could be assessed through a cash flow matching test at the aggregate level, allowing stressed cash flows at a 1-in-x level along with rehypothecation for matching purposes. “A cap on the exposure to assets with highly predictable cash flows may be an option to let insurance firms invest in assets without fixed cash flows and, together with suitable matching tests, limit the occurrence of asset/liability cash flow mismatches, and so ensure that policyholder benefits continue to be met.”

Secondly, PwC UK said a scenario-based quantitative approach could be used. One of the components underpinning the definition of highly predictable cash flows is the ability to project asset cash flows under a set of different scenarios, it stated. In order to align to the risk identification exercise preceding the investment into an asset class and informing the internal credit rating methodology, a firm could be required to demonstrate that an asset has highly predictable (but not fixed) cash flows over a wide range of scenarios. PwC UK said two possible approaches for implementing such an approach could include a fixity hurdle rate for each individual asset or an adjustment to the fundamental spread (FS) to allow for the fixity of the cash flows. For the first approach, the consultancy said: “The cash flows of an asset are stressed over a range of scenarios, and the cash flows common across all the scenarios are then compared against the best estimate cash flows. If the ratio of the common cash flows to the best estimate cash flows exceeds a given hurdle rate, then the asset is allowed to be included within the MA portfolio.”

For the second approach, PwC UK said this is similar to the previous method, “but this time only the common stressed cashflows can be captured within the MA calculations”.

“The difference between the best estimate cash flows and the common stressed cash flows effectively represents an addition to the FS,” it added.

Thirdly, PwC UK said the draft legislative changes published by the UK Government in June 2023 might be interpreted by some as meaning that the approach to highly predictable cashflows will be considered at a portfolio level (rather than a lower level). “However, we await further details for how the regime will operate in practice, with a PRA consultation expected in September 2023. The PRA may choose only to allow specific assets and asset features to be included within the MA portfolio. For example, prepayment events which act as risk mitigants for the lender; or specific infrastructure, or green energy asset classes to be included in the MA despite having non-fixed cash flows.”

Lastly, PwC UK said the UK Government could use a combination of all of the above. “Each option has pros and cons, and it is possible that a combination of the above is needed to appropriately manage the liquidity and capital risk implications of including assets with variable cash flows within the MA portfolio.”

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