The regulatory requirement for unit matching is a significant capital efficiency issue for life insurers with large unit-linked portfolios particularly with regard to the availability of assets for other purposes. At Financial Risk Solutions (FRS), we believe that more clarity is required on the Prudential Regulatory Authority (PRA) definition of technical provisions for the close matching rules (COBS 21.2.2R) under Solvency II. This is in the context of the Article 132(3) Solvency II requirement for unit-linked contracts, which specifies that technical provisions for unit-linked contracts must be represented as closely as possible by those units.
Consider an example where
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A policyholder’s unit-linked liability is £1,000
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In cash-flow projections the value of income less expense items which are proportional to unit values is £80
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In cash-flow projections the value of income less expense items which are not proportional to unit values is -£60
Under Solvency II, the required technical provisions in this example are 980 but it is arguable that for the purposes of applying Article 132(3) the technical provisions could be interpreted as £1,000-80 = £920, based on the face value of units less Present Value In Force (PVIF) of future management charges. The rationale is that without regulatory restrictions, the optimum matching approach (‘immunisation matching’) could be considered as where the value of unit-linked assets changes by the same amount as technical provisions when unit values change i.e. no change in net assets (subject to changes in the risk margin).
There are parts of the calculation of the technical provisions that are proportional to unit values and other parts are not, and we firmly believe that it is only those parts that are proportional that should be matched if the objective is to avoid volatility in net assets arising from changes in unit values. By definition, this approach would also mean that the market risk Solvency Capital Requirement (SCR) on unit-linked assets would be zero (unless the life insurer choose to hold more unit-linked assets – e.g. in respect of the risk margin or to match the SCR for lapse risk).
This is an industry issue that has been highlighted by the Actuarial Profession’s Linked Matching Considerations Working Party to the PRA and we await with interest any statements from these organisations around it.
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