The Prudential Regulation Authority (the PRA) has published a consultation paper CP9/18setting out its proposal to consider applications from internal model firms that include a dynamic volatility adjustment (DVA) under the Solvency II Directive.

The DVA aims to stabilise the Solvency II balance sheet during short periods of high market volatility by adding an extra spread component to the discount rate used for the calculation of technical provisions. It is one of the measures introduced in the so-called long term guarantee package concerning Solvency II valuation of insurance contracts with long term guarantees.

The proposal is relevant to all UK Solvency II firms and to the Society of Lloyd’s and its managing agents, and in particular to those with or seeking volatility adjustment approval and who use a full or partial internal model to determine their solvency capital requirement.

The consultation paper sets out the proposed expectations of internal model firms when determining the risks that might arise from the DVA when calculating the solvency capital requirement. The PRA are also consulting on whether to allow firms to apply DVA in internal models when calculating solvency capital requirements.

The PRA’s proposal is in a new supervisory statement: Solvency II: Internal models – volatility adjustment in the modelling of market risk and credit risk stresses. The PRA is also proposing to amend the Supervisory Statement 17/16 ‘Solvency II: internal models – assessment, model change and the role of non-executive directors’. These are set out in the appendices to the consultation paper.

The consultation will close on Wednesday 11 July 2018 and all feedback on the proposals should be provided on or before that deadline.

Please click here to read the PRA Consultation Paper.