What is the matching adjustment Solvency II?
Solvency II’s Matching Adjustment (MA) provisions give insurers relief for holding certain long-term assets which match the cash flows of a designated portfolio of life or annuity insurance and reinsurance obligations. References to “insurers” and “insurance obligations” include reinsurers and reinsurance obligations.
How does matching adjustment work?
The matching adjustment is an upward adjustment to the risk-free rate where insurers hold certain long-term assets with cashflows that match the liabilities. It reflects the fact that long-term buy-and-hold investors are not exposed to spread movements in the same way that short-term traders of such assets are.
What is the fundamental spread Solvency II?
Fundamental spreads (FS), used by insurers to calculate the risk-free curve for liabilities within a matching adjustment portfolio; Risk-free rate curves for liabilities where the insurers are permitted to use a volatility adjustment (VA).
Why do we adjust volatility?
The volatility adjustment is a measure to ensure the appropriate treatment of insurance products with long-term guarantees under Solvency II. (Re)insurers are allowed to adjust the RFR to mitigate the effect of short-term volatility of bond spreads on their solvency position.
What is the fundamental spread?
The Fundamental Spread is used by firms as a part of their Matching Adjustment calculation and represents the expected cost of default and downgrade of assets which back providers’ annuity business and that firms are therefore exposed to.
How is the Matching adjustment used in Solvency II?
Under Solvency II, insurers are required to calculate the value of their liabilities using a risk-free interest rate. The matching adjustment is an upward adjustment to the risk-free rate where insurers hold certain long-term assets with cashflows that match the liabilities.
Why do we need Solvency II for annuities?
Such an explanation doubtless must rely on a distinction between the short-term risk horizon of Solvency II and the long-term nature of the risks involved in the cash-flow matching of (illiquid) life annuities. This is the essential rationale for the MA and its application to annuity business.
How to calculate risk free Rate Matching Adjustment?
Risk free rate Matching adjustment Fundamental spread Asset yield Credit spread Cost of Downgrade Probability of default =max(35%LTAS,CoD+p(default)) LTAS = Long Term Average Spread
How does the Matching Adjustment ( MA ) work?
In this Supervisory Statement (SS), the Prudential Regulation Authority (PRA) sets out its expectations of firms in respect of application of the matching adjustment (MA). The MA allows firms to adjust the relevant risk-free interest rate term structure for the calculation of a best estimate of a portfolio of eligible insurance obligations.
