In June 2020, the UK Government announced that it would review certain features of the Solvency II regulatory regime. The IFoA Matching Adjustment (MA) Working Party provided input to the IFoA’s response to the HM Treasury’s Solvency II Call for Evidence, which closed in February 2021. Following this exercise, the Working Party continued to examine areas of the MA which could be pragmatically modified in order to align with HM Treasury’s objectives for its ongoing review.
Insurance firms with MA portfolios require attractive long-dated assets to back their long-term liabilities. They are therefore well placed to invest in long-term, productive assets and support the wider economy in a meaningful way. However, the ability to invest in these assets is constrained (sometimes severely so) by the need to satisfy the strict “fixity of cash flows” requirements under the current MA regime. The interpretation of what may satisfy the regulatory view of “fixity” of asset cash flows is a key area of subjectivity and expert judgement.
In December 2021, the Working Party published its “Fixity of cash flows” paper in which, through illustrative case studies for three commonly used asset classes (infrastructure with a construction phase, clean energy infrastructure, and sale and leaseback assets), the Working Party sets out areas where it considers that the MA framework could be readily adapted to accommodate a more pragmatic interpretation of “fixity”, leading to more beneficial outcomes for policyholders, the insurance industry, and the wider economy.
The paper focusses on the income stream elements of these assets that are more readily MA-eligible, consider the challenges posed by the current regulatory treatment, and present proposals to address some of the key issues. These proposals include the haircutting of cash flows, the use of make-whole clauses, the use of more “MA-friendly” contractual definitions, and the holding of capital.