Solvency II: Q&A Application of the matching adjustment

Answer:

Under Solvency II, insurers have the option of applying a matching adjustment to a specific portfolio of insurance obligations. They may submit an application to DNB from 1 April 2015 onwards. More information about the application procedure can be found on DNB's Open Book on Supervision web pages.

The Solvency II Directive contains a list of conditions that govern application of the matching adjustment (Article 77b). An insurer must demonstrate that it satisfies the statutory requirements, which in some cases it may do in a variety of ways ("open standards"). We will assess whether the way in which the insurer addresses the open standards satisfies the statutory framework, without specifying the open standards in any further detail. Specifications of open standards applied in previous impact assessments that do not form part of the statutory framework or arise from them will not be applicable.

Below, we will address various frequently asked questions about applying the matching adjustment

Do immediate annuity insurance contracts meet the criteria for applying the matching adjustment (Article 77b)?

For each insurance contract to which an insurer wishes to apply the matching adjustment, it must demonstrate that the criteria are met. Immediate annuity insurance contracts typically do not contain any provisions that conflict with the criteria for applying the matching adjustment. We therefore expect that such contracts may be eligible for applying the matching adjustment.

What is the definition of the insurance contract in the case of group pension insurance contracts, and how must the criteria for the matching adjustment be applied (Article 77b(1)(i))?

The criteria for the matching adjustment apply at the level of the insurance contract, which means that an insurer must demonstrate these criteria are met at this level. Article 77b(1)(i) provides that an insurance contract may not be split into different parts for the purpose of applying the matching adjustment. Accordingly, a pension insurance contract entered into with an employer may not be split according to individual members or types of cover for the purpose of applying the matching adjustment.

Consequently, they must be applied at the level of the employer. For example, a pension insurance contract providing for future premium payments does not meet the statutory criteria for applying the matching adjustment, as provided in Article 77b(1)(d). If no future premium payments are involved, the matching adjustment may potentially be applied if the insurer demonstrates that the other criteria for application are also met. One of the aspects it must demonstrate is that, at the level of the employer, the contract includes no options other than a surrender option whose surrender value does not exceed the current value of the assets, as provided in Article 77b(1)(g). In addition, it must demonstrate that the cash flows of the assets replicate those of the obligations and that possible mismatches do not give rise to any material risk. Any options that exist at member level may be considered within the context of any resulting mismatches and risks. In that case, such options are not the same as the ones existing at contract level to which Article 77b(1)(g) refers.

In the case of group pension insurance contracts, may the criteria for applying the matching adjustment be used at member level?

Theoretically, an insurer could apply the criteria for the matching adjustment member level, for instance if the terms of the pension insurance contracts distinguish between various types of members, such as active members, sleepers and pensioners. In such cases, the insurer would need to demonstrate that the criteria for applying the matching adjustment are met at the level of each member type, taking into account a possible surrender option at the level of the employer. Assessment of the options that exist at the level of the member will then be unrelated to the materiality of mismatches and risks to which such options give rise. In this case, such options are the same as the ones to which Article 77b(1)(g) refers, and the insurer will need to demonstrate that no options exist. Pension insurance contracts typically offer members various options, statutory or otherwise, such as those relating to transfer of accrued benefits, trade-off and settlement upon divorce, which is why we do not expect that the matching adjustment can generally be applied where the criteria are assessed at the level of the member.

How can an insurer demonstrate that the surrender value does not exceed the value of the corresponding assets, for example, in the event of an individual or group transfer of accrued benefits (Article 77b(1)(g))?

If the conditions governing group transfer of accrued benefits have been stipulated in the pension insurance contracts and do not contain any discretionary elements, the insurer must demonstrate on the basis of those conditions that the surrender value does not exceed the value of the assets covering the insurance or reinsurance obligations at the time the surrender option is exercised, as provided in Article 77b(1)(g).

If the conditions have not been fully stipulated or if they contain discretionary elements, the insurer must at least:

• prepare a detailed assessment and explanation of the extent of the lapse risk;
• demonstrate that none of the pension insurance contracts can cause a material loss upon surrender, not even under exceptional market conditions; and
• explain how the principles for establishing the surrender value have been selected and how the lapse risk is managed.

Based on the above, such pension insurance contracts may potentially not be eligible for application of the matching adjustment.

The foregoing applies correspondingly to individual transfers of accrued benefits.

Is it possible for an insurer to demonstrate that direct Dutch mortgage loans meet the criteria for applying the matching adjustment?

Direct Dutch mortgage loans do not qualify as assets for the purpose of applying the matching adjustment. This is because each year 10% of the original amount of a Dutch mortgage loan may be repaid. Besides, such a mortgage loan may generally be repaid in full when the debtor moves house. Owing to these options, Dutch mortgage loans do not meet the criteria for applying the matching adjustment (Article 77b(1)(h)).

We will assess any applications for qualification of structured mortgage loans for the matching adjustment on the basis of the statutory criteria.

How can an insurer demonstrate that the mismatch between the cash flow of the assets and those of the obligations do not give rise to material risks (Article 77 b(1)(c))?
We expect an insurer to demonstrate that it meets the criteria for applying the matching adjustment set in Article77b(1)(c).

This article is an example of an open standard established by law. We will not specify the standard in further detail. Insurers may demonstrate compliance with the requirements in a variety of ways, without any single criterion being decisive in our assessment.

An insurer must at least submit the following to demonstrate that it meets the criteria set in Article 77b(1)(c):

• the cash flow projection showing the cash flow deficit or surplus based on the shortest possible and available time interval;
• an explanation of the distribution of the cash flows within the selected time interval;
• an explanation of the actions planned to mitigate unexpected mismatch; and
• a quantitative assessment of the interest rate, foreign exchange, inflation and other relevant risks that may arise from a cash flow mismatch, and an assessment of their materiality.