The PRA published a Solvency II Directors’ Update on 13 March 2015. The update summarises recent developments, before attaching a timetable of immediate next steps.
The summary includes:
- Hyperlinks to the PRA’s recent Executive Director letters about:
- The PRA’s expectations of firms that are planning to restructure their equity release mortgage portfolios to meet the matching adjustment eligibility criteria; and
- How internal models allow for matching adjustment portfolios; the quantitative framework the PRA will use when it reviews internal model applications; and the PRA’s initial feedback from the matching adjustment pre-application process;
- A brief update on Solvency II and the recognition of deferred tax – the PRA has:
- Updated its supervisory statement (SS 2/14) so that it more fully describes its expectations in a variety of areas, including the IAS12 ‘more likely than not’ recognition test, and the projection methodology it expects firms to adopt;
- Reviewed a number of initial proposals from firms to support their calculation of the tax effects of the 1 in 200 shock when calculating the SCR. (“Where the calculation relates to components of an SCR which are not calculated using the standard formula, the calculation of the tax effect is part of an internal model. Firms will need to comply with guidelines concerning internal models; the PRA emphasises that the feedback on internal models … in … the PRA Directors’ update of 12 February is relevant to all aspects of the calculation of the tax effects in an internal model“);
- Found, with regards to the recognition test itself, that “firms’ documentation of their assessment of the extent to which resources would need to be replenished, and the sources of that replenishment … has been poor. To meet the recognition test the PRA expects that the resources needed to support a level of trading in the post-shock environment would be consistent with a firm’s [ORSA] in that environment. Further, the documentation regarding availability and timing of capital replenishment … has not always been of a standard to give the PRA the confidence it requires to accept the expert judgements made by a firm”; and
- “identified that the tax effects recognised in an internal model SCR are often based on assumptions, judgements and documentation specific to the particular SCR scenario and … not shown to be valid across the probability distribution forecast. Such an approach does not demonstrate that the tax effects across the probability distribution forecast generated by the internal model meet calibration standards, and there is potential for the incorrect pre-tax effects scenario to be selected as the biting scenario. It would be difficult for the PRA to conclude that such an internal model meets the statistical quality standards required by Solvency II“;
- Some brief internal model review feedback – “the PRA continues to observe that validation materials provided by firms are primarily focussed on the bottom-up justification of parameters and assumptions and may not be clearly aligned to enable senior management and Boards to challenge effectively the key assumptions and limitations of the model … Although a bottom-up approach is an important aspect of the internal model validation, the PRA emphasises that Boards should value the role that good validation can play in helping them to understand the key drivers and limitations of a model. On application, the PRA’s expectation is that firms will provide evidence that the Board has challenged: the validation process and its results; understood and satisfied itself on the key assumptions and limitations of the model; considered the possible quantification of these limitations; and taken appropriate mitigating actions. The PRA would expect Boards to be tracking actively progress in addressing key issues identified by validation work“;
- A reminder for general insurance firms that they need to consider variability in premium provisions on their year-end Solvency II balance sheet – “events can occur that cause claims provisions to vary, some of those same events will also cause premium provision to vary … Firms that do not consider this risk may fall short of the internal model tests and standards. The PRA considers this risk exists for all actively underwriting internal model firms who model on a one-year earned basis…”
The timetable includes:
Click here to view table.