PRA clarifies expectations for illiquid asset management

The Prudential Regulation Authority today tightened and clarified its expectations for how UK life insurers manage illiquid, unrated assets in matching adjustment portfolios, updating Supervisory Statement SS3/17 in 2024. The changes sit alongside wider Solvency UK reforms and new liquidity and funded reinsurance rules that reshape how large balance sheets support annuity-focused investment in private credit and other illiquid assets.

The updated SS3/17 confirms that the PRA expects internal credit assessment functions to be led by individuals with appropriate experience, reflecting the growing weight of internally rated assets in matching adjustment portfolios. Under the Insurance Regulatory Prudential Requirements regulations, the credit quality of all matching adjustment assets must be capable of being assessed either through an external credit rating or an internal assessment of comparable standard. The PRA said this framework is particularly relevant for life insurance and reinsurance companies holding or intending to hold unrated assets in matching adjustment portfolios.

Governance of internal credit assessment and asset selection

The PRA’s updated statement sets out a clearer governance line for internal credit assessment, requiring a named individual with suitable experience to take responsibility for the function. This expectation is framed within the existing requirement that internal assessments must be of a standard comparable to external ratings where these are used to support matching adjustment eligibility.

The PRA also expects firms to prioritise scrutiny of assets that are more complex, generate material matching adjustment benefit, or deliver a high proportion of spread as matching adjustment relative to comparable reference instruments. The statement gives examples of complexity including restructured assets, indicating that these should attract heightened internal credit analysis and governance focus where they sit within matching adjustment portfolios. This formalises the expectation that actuarial oversight extends beyond liability valuation to the quality and sustainability of matching adjustment benefit derived from illiquid and unrated assets.

Matching adjustment reforms and internally rated assets

Solvency UK reforms are reshaping the matching adjustment framework, including the removal of the cap on sub‑investment grade assets and an expansion of eligible asset types. Milliman reported that the removal of the matching adjustment cap on sub‑investment grade assets is expected to lead to some increase in holdings of these instruments. At the same time, Milliman noted that internally rated assets now provide more matching adjustment benefit than externally rated assets, increasing the importance of strong internal credit processes.

Regulation Tomorrow reported that the new rules extend matching adjustment eligibility beyond fixed cash flow assets to allow up to 10% of aggregate matching adjustment benefit to derive from assets with highly predictable cash flows. The PRA has clarified that existing matching adjustment approvals, including the characterisation of fixed cash flow assets, will remain valid under the reforms, providing continuity for current portfolios.

Despite the relaxation of some constraints, the PRA has set out that it expects firms to keep holdings of sub‑investment grade assets at prudent levels because of the higher default risk they pose. Clifford Chance noted that the matching adjustment remains a particularly material benefit for insurers writing annuity business, which are incentivised to invest in a wide range of long‑term, illiquid, fixed‑interest assets.

Funded reinsurance and collateral recapture expectations

Alongside the matching adjustment changes, the PRA has introduced a dedicated supervisory statement on funded reinsurance, mandating procedures for UK insurers to assess and limit associated risks. Skadden reported that the statement requires insurers to set an aggregate limit for funded reinsurance that reflects their own need for a diversified asset strategy and their operational capabilities in the event of collateral recapture, independent of counterparties.

The same statement requires UK insurers to formulate an executable recapture plan under stressed conditions and to maintain a reliable estimate of the impact of recapture, taking account of the value and quality of asset‑liability matching of the recaptured collateral. These expectations directly affect how insurers structure and monitor funded reinsurance arrangements that transfer illiquid assets or associated risks off balance sheet.

Milliman observed that most firms have already experienced an increase in the complexity of managing and monitoring collateral, driven by bulk purchase annuity business volumes and more complex hedging and reinsurance strategies. The PRA’s funded reinsurance requirements add formal expectations around limits and recapture planning to this operational backdrop. New liquidity reporting for large derivative and repo users

The PRA’s consultation paper CP19/24 proposes extensive new liquidity reporting requirements for insurers, with implementation scheduled for 31 December 2025. KPMG reported that the PRA identified shortcomings in its existing liquidity risk reporting framework, particularly during market stress events including the volatility in the UK gilt market in September 2022.

CP19/24 introduces four new liquidity reporting templates designed to give the PRA more timely, consistent and accurate information on the liquidity positions of large UK insurers with significant derivative or repo exposures. Two of these are cash flow mismatch templates, which would be reported monthly, while a shorter template containing 150 key data points could be required on a daily basis at the PRA’s discretion.

The proposed reporting regime would apply to firms with more than £20bn in assets, excluding assets held for index or unit‑linked contracts, on average over the last three quarters, and which also meet at least one of two additional thresholds. KPMG said these additional thresholds are either gross nominal derivatives exposure of more than £10bn or the presence of securities financing transactions, bringing the largest and most derivatives‑intensive insurers into scope.

Capital reforms and the risk margin

The Solvency UK package also includes a substantial reduction in the risk margin, which Clifford Chance reported will fall by around 65% for life carriers and 30% for non‑life carriers. This change sits alongside the matching adjustment reforms and is part of the broader recalibration of capital requirements for UK insurers. Clifford Chance noted that the matching adjustment is particularly important for annuity writers, which are incentivised to invest in long‑term, illiquid, fixed‑interest assets to back their liabilities. The combination of a lower risk margin and revised matching adjustment rules therefore directly affects the capital treatment of illiquid asset strategies used to support annuity business.

Next steps on matching adjustment policy

Milliman reported that the PRA’s funded reinsurance policy statement expected in June will settle the remaining details of the matching adjustment changes under Solvency UK. Once finalised, the updated SS3/17, funded reinsurance expectations and new liquidity reporting regime will together define the regulatory environment for UK insurers’ use of illiquid assets in matching adjustment portfolios.

--- Sources: https://www.bankofengland.co.uk/prudential-regulation https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2024/ss317-november-2024-update.pdf https://www.bankofengland.co.uk/prudential-regulation/publication/2017/solvency-2-matching-adjustment-illiquid-unrated-assets-and-equity-release-mortgages-ss