association of british insurers - abi

ABI response to CP3/15 – Solvency II: transitional measures and the treatment of participations | 20/Feb/2015 | of 17

Association of British Insurers

ABI response

CP3/15 | Solvency II: transitional measures and the treatment of participations

20 February 2015

The UK Insurance Industry The UK insurance industry is the largest in Europe and the third largest in the world. It plays an essential part in the UK’s economic strength, managing investments of £1.8 trillion (equivalent to 25% of the UK’s total net worth) and paying nearly £12bn annually in taxes to the Government. It employs around 315,000 individuals, of whom more than a third are employed directly by insurers with the remainder in auxiliary services such as broking. Insurance helps individuals and businesses protect themselves against the everyday risks they face, enabling people to own homes, travel overseas, provide for a financially secure future and run businesses. Insurance underpins a healthy and prosperous society, enabling businesses and individuals to thrive, safe in the knowledge that problems can be handled and risks carefully managed.

The ABI The ABI is the voice of the UK insurance industry, representing general insurance, long-term savings and life insurers. Formed in 1985, it today has over 250 members who account for around 90% of UK insurance premiums. The ABI’s role is to:

- Be the voice of the UK insurance industry, leading debate and advocating on behalf of insurers

- Represent the UK insurance industry to government, regulators and policy makers in the UK, EU and internationally, driving effective public policy and regulation

- Advocate high standards of customer service within the industry and provide useful information to the public about insurance

- Promote the benefits of insurance to government, regulators, policy makers and the public

We welcome the opportunity to comment on the PRA’s consultation CP3/15 Solvency II: transitional measures and the treatment of participations.


Key messages Introduction

The ABI welcomes the additional guidance and clarity provided by the PRA in this consultation as we approach transposition then implementation of Solvency II. The draft rules and supervisory statements provide more guidance on the PRA’s expectations of firms in the areas of transitional measures and treatment of participations, both which are highly relevant to the ABI’s members.

Such guidance brings increased policy certainty, which firms can reflect in their Solvency II planning and preparations.

We support the PRA’s application of “intelligent copy out” to the transposition of the Solvency II Directive.

We note the PRA’s positive statements about the benefits of transitional measures, and the importance of therefore making them effective. However we do have strong concerns regarding the PRA’s proposed implementation as it will not allow for transition from ICA to SII in all circumstances, as was the policy intention. The provisions are unnecessarily prudent and confer too much discretion on the PRA without providing any principles for applying that discretion. The provisions also seem far from comprehensive.

Resolution of these concerns is sought from the PRA urgently, to eliminate uncertainty and inform Solvency II planning. Transitional measures on technical provisions will not allow for a transition from ICA to SII in all circumstances, as intended

We are disappointed with the treatment of the transitional measure for technical provisions that is proposed in this consultation.

We do not believe this will achieve the intended objective, reached through the Omnibus II negotiations, of ensuring a smooth transition from Solvency I into Solvency II and may lead to quite different outcomes between different firms.

We agree with the PRA’s general principle of taking pillar 2 (ICA) technical provisions as the most appropriate starting point.

We also agree with and understand the requirement from the Directive to limit the transitional deduction by reference to overall financial resources requirement.

In order to provide absolute clarity, the definition of the financial resources requirement that applies to a firm, pre-Solvency II, should be more clearly specified. This is currently ambiguous: It may refer to the more onerous of pillar 1 and 2; or only to pillar 2 in line with the PRA’s general principle of starting with ICA.

By starting with pillar 2 technical provisions and limiting the transitional deduction by reference to overall financial resources requirements, the PRA ensures firms can benefit from transitional relief on the risk margin – a benefit the PRA has previously welcomed as sensible1 – and other aspects of Solvency II such as contract boundary requirements, but caps this relief to ensure no immediate capital release relative to the current Solvency I and ICA regime. We believe that these principles are sufficient to ensure a sensible and

1 “Solvency II – a turning point” speech by Julian Adams, Deputy Head of the Prudential Regulation Authority and Executive Director of Insurance, 12/Dec/2013

(http://www.bankofengland.co.uk/publications/Documents/speeches/2013/speech699.pdf)


smooth transition to Solvency II.

The requirement to take as a starting point the higher of pillar 1 or pillar 2 technical provisions is unnecessary since there is a safeguard to prevent any immediate capital release through the use of this transitional arrangement by testing the overall financial resources requirements. Instead, this requirement (of selecting the highest technical provision to compare to the Solvency II technical provision) creates discontinuity in transition (and potentially binary outcomes of having a material transition or having none at all) and unexpected inconsistency between firms with different balance sheet structures.

By comparing Solvency II technical provisions (market consistent and so volatile to market movements) to the higher of pillar 1 (which is less exposed to market movements) and ICA best estimate liabilities (with similar sensitivity to SII technical provisions), firms will be exposed to market movements between their current position (which plans are based on) versus position on implementation of Solvency II. Therefore, what firms ultimately receive in terms of transitional relief may not be consistent with current expectations due to market risk until Solvency II implementation. Basing the transitional measure on ICA makes this exposure less significant.

We thus propose the calculation is simplified to be based solely on pillar 2 (ICA) technical provisions, with a limit then applied based on the overall financial resources requirement. This limit will ensure the post-transitional position is at least onerous as pillar 1 (including meeting the EU minimum requirement) as well as pillar 2.

Impact of transitionals on dividend policies

Transitional measures are a key component of the Solvency II Directive and we seek confirmation from the PRA that the post-transitional position is the one that will primarily be taken into by the PRA when considering firms’ capital distribution strategies.

We note a firm’s capital distribution strategy must be developed in light of their phasing-in plan as defined in Article 308e of the Directive.

Solvency I EU minimum amount

The rationale for requiring that pre-Solvency II technical provisions are at least equal to the Solvency I EU minimum amount is unclear and seems at odds with the PRA’s view that the pillar 2 (ICA) technical provisions are the most appropriate starting point. It also seems at odds with the original intention of para 2(b) of Article 308d, as negotiated by HM Treasury.

Notwithstanding our primary concerns above regarding the unnecessary comparison between pillar 1 and pillar 2 technical provisions, if such a comparison must be made then we support the choice that is given to firms to base the comparison on EU minimum liabilities rather than their reported Pillar 1 technical provisions.

However, we note the concept of the EU minimum amount under Solvency I is not well defined in the UK. The industry currently acts to ensure it complies with the requirements of INSPRU rather than the Solvency I Directives per se, since INSPRU is more


onerous.

Thus firms choosing to use the EU minimum amount will need to make judgements about methodology and assumptions which will need to be agreed with the PRA and auditors. We suggest the PRA work with industry to develop guidance on which aspects of the INSPRU rules are considered to not to be required under the Solvency I Directives, in order to facilitate a common understanding and to ensure a level playing field.

Future review of technical provisions transitional measure

We ask the PRA to develop and outline an approach for assessing the future appropriateness of transitional relief that is proportionate, as requiring firms to maintain pillar 1 and 2 modelling and reporting for another 16 years, in parallel to Solvency II, would not be. A proportionate approach, with the PRA’s expectations clearly defined, will ensure firms can benefit from the transitional relief which formed a key outcome of the Omnibus II process.

Clarification on these future expectations is required as soon as feasibly possible, to inform firms’ assessments and current planning as to whether to use transitionals.

We believe the annual reassessment of the limitation feature described in section 3.16 of the draft supervisory statement is not in line with Article 308d(4) of the Directive. Our understanding of the Directive’s clause is that the limitation calculation is carried out once, on the day before Solvency II comes into force, and that the transitional deduction net of limitation then runs off over 16 years. Any subsequent review should come under Article 308d(3) of the Directive.

The approval process

We ask that the PRA communicates to firms as soon as feasibly possible their detailed requirements for the application process.

Similarly, we ask the PRA to communicate as soon as feasibly possible the criteria it will apply to approve or reject (or limit) the use of the transitional measures.

Clarification or confirmation is also required on the process to cease using transitionals in the future; to apply to use them in the future; and the interaction between solo and group approval processes.

Confirmation is required as to whether the approval decision will be binary (i.e. the transitional measures may be applied in full, or not at all) or more nuanced (e.g. available for certain homogeneous risk groups but not others, or a benefit lower than the maximum may be applied).


Detailed comments Chapter Reference Comments

1 Overview No comments

2 Transitional measures on risk-free interest rates and technical provisions

2.13 We welcome the PRA’s positive statements about the benefits of transitional measures, and note the importance of therefore making them effective.

2.15 Similar to 2.13, we welcome the PRA’s positive statements about the benefits of transitional measures to facilitate effective competition between incumbent and new entrants for new business. We therefore note the importance of ensuring these measures are effective.

App 1.1

PRA Rulebook — Transitional measures

10.1(1) The wording of this rule is ambiguous; it should be reworded to ensure it is interpreted in the way that we believe is intended by Article 308c(2) of the Directive:

o It potentially and unintentionally, we believe, suggests the calculation of the interest rate is a one-off calculation as at 31 December 2015 based on the rules, asset portfolio and market conditions at that date.

o We instead interpret this is as a dynamic calculation, based on rules as at 31 December 2015 but updated at each calculation date to reflect the portfolio and market conditions at that time. This is also more economically appropriate and risk sensitive.

o A refinement in wording would avoid ambiguity here.

We suggest the wording could also be refined to clarify that the interest rate in question is determined in respect of pre-Solvency II liabilities (i.e. admissible insurance and reinsurance obligations)

o This is the intention of the Directive and a refinement in wording would avoid ambiguity in its transposition.

10.4(1) There is ambiguity which it would be helpful to clarify regarding the volatility adjustment under draft rule 10.3 and 10.4(1):

o Rule 10.3 states the Volatility Adjustment can be applied to the Solvency II risk-free interest rate used in the risk-free interest rate transitional. This is in line with the Directive

o Rule 10.4(1) is an intelligent copy from the Directive however what it requires of firms is unclear. The calculation of the volatility adjustment is undertaken by EIOPA. Does this require firms using the risk-free interest rate transitional to only submit information in


Chapter Reference Comments

respect of post-SII implementation business to EIOPA for the volatility adjustment calculation?

Confirmation of this interpretation in the final supervisory statement would be helpful.

App 2.1

Supervisory Statement — Solvency II: transitional measures on risk-free interest rates and technical provisions

General comments

Discontinuities and inconsistencies in transition

We are disappointed with the treatment of the transitional measure for technical provisions that is proposed in this consultation.

We do not believe this will achieve the intended objective of ensuring a smooth transition from Solvency I into Solvency II and may lead to quite different outcomes between different firms. This is demonstrated in the graphics below.

We agree with the PRA’s general principle of taking pillar 2 (ICA) technical provisions as the most appropriate starting point.

We also agree with and understand the requirement from the Directive to limit the transitional deduction by reference to overall financial resources requirements.

This ensures that firms can benefit from transitional relief on the risk margin – a benefit the PRA has previously welcomed as sensible – and other aspects of Solvency II such as contract boundary requirements, but caps this relief to ensure no immediate capital release relative to the current Solvency I and ICA regime.

We believe that these principles are sufficient to ensure a sensible and smooth transition to Solvency II. The requirement to take as a starting point the higher of pillar 1 or pillar 2 technical provisions is unnecessary since there is a safeguard to prevent any immediate capital release through the use of this transitional arrangement by testing the overall financial resources requirements. Instead, this requirement (of selecting the highest technical provision to compare to the Solvency II technical provision) creates discontinuity in transition (and potentially binary outcomes of having a material transition or having none at all) and unexpected inconsistency between firms with different balance sheet structures.



We illustrate this inconsistency with two examples: Firms A and B, both the same size and with a mix of with-profits and unit-linked business (see above for simplified graphic of the liability side of each balance sheet):

o Firm A, which has material amounts of with-profits business relative to other business: It has pillar 2 (ICA) technical provisions greater than pillar 1 (Solvency I) technical

provisions. The ICA basis is also the biting capital constraint. It can use these higher ICA reserves across all its business and effectively

transition in its risk margin and contract boundaries on both its with-profits and unit-linked business.

Firm A will benefit from the full transitional relief under Article 308d. We believe this is the intention of Article 308d.

o Firm B, which has material amounts of unit-linked business relative to other business: It has pillar 2 (ICA) technical provisions less than pillar 1 (Solvency I) technical

provisions. However, the ICA basis is still the biting capital constraint. Under the PRA’s current proposals, firm B will be unable to apply the technical



provision transitional measure (or the benefit will be restricted) – despite surplus reducing due to introduction of risk margin. This is because, under the current proposal, the linear interpolation would be based on pillar 1 (Solvency I) technical provisions.

We do not believe that this is the intention of Article 308d which should enable the avoidance of such market disruption through a smooth transition to the Solvency II balance sheet.

As a secondary point: By comparing Solvency II technical provisions (market consistent and so volatile to market movements) to the higher of pillar 1 (which is less exposed to market movements) and ICA best estimate liabilities (with similar sensitivity to SII technical provisions), firms will be exposed to market movements between their current position (which plans are based on) versus position on implementation of Solvency II. Therefore, what firms ultimately receive in terms of transitional relief may not be consistent with current expectations due to market risk until Solvency II implementation. Basing the transitional measure on ICA makes this exposure less significant.

We thus propose the calculation is simplified to be based solely on pillar 2 (ICA) technical provisions, with a limit applied based on the overall financial resources requirement. This limit will ensure the post-transitional position is at least onerous as pillar 1 (including meeting the EU minimum requirement) as well as pillar 2. We do not believe the comparisons outlined in para 3.5-3.11 are therefore required.

Should the requirement to also consider pillar 1 technical provisions remain, another outcome is some firms may be at risk of switching between pillars 1 and 2 technical provisions, and this creates precipice points. Firms can go from having some transitional benefit to having no effective benefit. These precipice points again expose firms to market movements before Solvency II implementation. We would encourage the PRA to work flexibly with firms to manage the likelihood and consequences of such precipice points

Level of application

In line with the Directive, we understand these transitional measures apply at legal entity level. This also consistent with the level of technical provision valuation under ICA, the proposed starting point for the transitional measure on technical provisions.



Consistent with this view, we understand the transitional measures can apply across all funds in the legal entity in aggregate, whether ring fenced or not.

We would welcome confirmation from the PRA in the final supervisory statement that this is indeed the case, or for the rationale to be set out for any alternative approach.

Future review of technical provisions transitional measure

In additional to our specific comments below on limiting the amount of the transitional deduction in future years (see 3.16), there more generally must be an approach to assessing the future appropriateness of the transitional relief that is proportionate.

It would not be proportionate to require firms to maintain pillar 1 and 2 technical provision modelling and reporting for another 16 years, in parallel with SII modelling and reporting. Continuing to support pillar 1 systems (or systems to derive the EU minimum) for 16 years would be a disproportionate overhead.

Instead, firms should be required to provide sufficient but proportionate evidence to justify the transitional relief remains appropriate over the 16 year period.

We note that draft rule 11.6 states a firm may only recalculate the transitional deduction following approval from the PRA. This mechanism will help to facilitate engagement between firms and their supervisory contacts on when it would be appropriate to review the deduction and what approach would be proportionate.

Further clarity on the PRA’s approach to future reviews is also required, and in particular its approach to continuation of the current regime. Continuing to review ICA results and any associated ICG, every 2 years for the next 16 years, would be onerous on both the PRA and firms. There are uncertainties regarding how ICA reviews would be integrated with the SII internal model review and change process.

Clarity on approach to these future reviews is required to factor into a firm’s assessment of whether to use transitionals. A proportionate approach which avoids the parallel running of regimes will ensure firms can benefit from the transitional relief which formed a key outcome of the Omnibus II process.

We would propose a pragmatic and practical approach – for example, a simple demonstration of the speed of run-off of the pre-Solvency II business and comparing its ‘half-life’ to the simple 16 year linear assumption. If the business is running off more quickly, then a proportionate reduction to the transitional benefit could be sufficient without the need for full recalculations of



balance sheets. Future ‘resetting’ of transitional measure

In some circumstances it may be necessary for the transitional deduction to be reset (i.e. if there is a material change in the firm’s risk profile). Such a reset might be made on the instruction from the PRA or at the request of the firm.

The draft supervisory statement is silent on what might constitute a material change, what the process is for performing such a reset and the principles that the PRA will adopt when assessing the appropriateness of the reset. We suggest the PRA include such information in the final supervisory statement.

For instance, where a firm has received approval for a transitional deduction and its business is subsequently reorganised (e.g. through a Part VII transfer), it is anticipated that the deduction would be transferred alongside assets and liabilities as part of that reorganisation. Confirmation from the PRA on this point is sought.

In addition, confirmation of the treatment of the transitional deduction in internal reinsurance transactions is also required. Intra-group reinsurance/recapture and portfolio transfers play an important role in allowing firms to be run efficiently, and this should not be hindered by the risk of loss of transitional deductions. Without this clarification there is a risk that the rules may be interpreted as not allowing this to occur which would limit the ability of the industry to perform sensible capital management and recovery actions.

The approach for calculating the adjustment in subsequent periods should allow significant flexibility to deal with the practical issues that may arise. The recalculation of transitional adjustments, either after reorganisation or after some other material change in risk profile should not require the ongoing maintenance of systems to provide a full recalculation of the Solvency I position of the firm. Instead, scope should be explicitly made for calculations to be performed using results that are readily available.

Inter-dependency with outcome of CP16/14 Transposition of Solvency II: Part 3

It is also important to be aware of the impact that CP16/14 may have on transitional benefits due to its proposed treatment of estate distributions as surplus.

Under ICA, firms may have treated the estate distribution as a (loss absorbing) technical provision

If the proposals of CP16/14 to treat the estate distribution as a surplus are implemented, this will



reduce Solvency II technical provisions, gaining a lower transitional benefit.

Whilst lower SII technical provisions leading to lower transitional benefit is initially intuitive, this ignores the fact a higher notional SCR will have to be calculated under Solvency II (due to treating the estate distribution as surplus rather than a loss absorbing technical provision) and any excess surplus would then be restricted as unavailable for meeting losses elsewhere in the business.

By focussing on technical provisions, the transitional measure ignores this capital requirement impact of the proposals in CP16/14.

The net effect is the reduced transitional measure may in aggregate lead to some firms being materially worse off than under the ICA regime. This would only impact firms which recognised the estate as a liability under ICA, and could be solved by following the alternatives proposals set out in the ABI response to CP16/14.

2.1 It is not clear what is intended by the PRA’s expectation for firms to determine the single interest rate in rule draft rule 10.1(1) “in such a manner that the comparison with the annual effective rate in 10.1(2) is meaningful”.

Clarification from the PRA on what they expect in this regarding would be helpful.

3.4 We agree that pillar 2 (ICA) technical provisions are the most appropriate starting point for the transitional measure, given they represent a realistic economic valuation of liabilities – similar to the principles underlying the Solvency II valuation.

3.6 Clarification on scope of “guidance” given by the PRA

The draft supervisory statement specifies that when calculating the pillar 2 technical provision amount, these calculations should include “amounts held following guidance given by the PRA or [the FSA]”.

It is unclear whether this is in respect of guidance provided to firms in respect of technical provisions only, or the whole ICG which includes guidance on the capital requirement under ICA.

Given this is a test in respect of technical provisions only, it would be appropriate for the guidance referred to in the supervisory statement, to be only in respect of technical provisions. Confirmation of this in the final supervisory statement would be helpful.

Review of ICGs at 31/12/2015

The PRA should outline how it will review ICGs at 31/12/2015, in light of improvements that firms will have made to their internal models as part of the Solvency II internal model application.



For firms where pillar 2 technical provisions are greater than pillar 1, the pillar 2 technical provisions as at 31/12/2015 will be the starting point for the transitional model. Given this will include “amounts held following guidance given by the PRA or [the FSA]”, these amounts should be reflective of the firm’s position at 31/12/2015 rather than an earlier date.

A pragmatic approach here would be for the PRA to review at a high-level and on a case-by-case basis, only the ICGs of firms applying for transitional measures, focussing on issues that were the cause of the ICG but have now materially changed.

Exclusion of voluntary areas of prudence from INSPRU 7 technical provisions

Some firms currently go beyond the minimum requirements set down in INSPRU 7 when calculating pillar 2 (ICA) technical provisions – for example, the inclusion of a risk margin. We do not believe such voluntary areas of prudence are required in order to capture all relevant features of the liabilities as set out in INSPRU 7.

Confirmation of this interpretation should be included in the final supervisory statement, and would be in line with the definition of “INSPRU 7 technical provisions amount” in 1.2 of the draft PRA rules.

New business

Whilst not specifically addressed in the draft supervisory statement, we ask the PRA confirms whether ineligible new business written after 1 January 2016 will include ‘new business’ arising due to the imposition of contract boundaries (i.e. business that would otherwise have been treated as ‘in force’ as at 31 December 2015).

Other comments

When calculating the pillar 2 technical provisions amount, there may be specific instances where it will be appropriate for firms to refine this calculation to enable a more meaningful comparison between the current regime and Solvency II.

o For example, tax on future profits may be allowed for in ICA by adjusting the liabilities, whereas in Solvency II will come through as an accounting deferred tax liability.

We suggest that, in these instances, firms should be able to discuss and reach agreement with their normal supervisory contact, on a case-by-case basis.

3.7-3.8 The rationale for requiring that pre-Solvency II technical provisions are at least equal to the



Solvency I EU minimum amount is unclear and seems at odds with the PRA’s view that the pillar 2 (ICA) technical provisions are the most appropriate starting point. It also seems at odds with the original intention of para 2(b) of Article 308d, as negotiated by HM Treasury.

Notwithstanding our primary concerns regarding the unnecessary comparison between pillar 1 and 2 technical provisions:

o We note and support the proposal that, when pillar 1 is biting, firms have a choice of using either pillar 1 or pillar 2 (with adjustment for the EU minimum amount) as the basis for applying the transitional measure

o However, we note the concept of the EU minimum amount is not well defined in the UK since industry acts to ensure it complies with the requirements of INSPRU rather than the Solvency I Directive per se, since INSPRU is more onerous.

o Thus firms choosing to use the EU minimum amount will need to make judgements about methodology and assumptions which will need to be agreed with the PRA and auditors.

o This development will require significant time and resource (both in terms of conceptually developing and agreeing the “concept” of this number, and also in the calculation of this number) both internally and externally to reach agreement with the PRA and auditors.

o It will take significant effort to implement a common understanding of the “EU minimum” which is essential to ensure a level playing field. We suggest the PRA work with industry to develop guidance that facilitates a common understanding of the determination of the EU minimum amount and the evidencing requirements – for example, areas of INSPRU requirements that are not required for the EU minimum amount calculation.

o We are concerned that the EU minimum requirement could be interpreted in different ways. For example the rules set out in Article 20 of Directive 2002/83/EC allow the use of a very wide range of different approaches (such as the use of fixed discount rates to calculate technical provisions). Many of these are used across Europe by firms that will also be looking to make use of transitional arrangements, and hence the scope for variation in approach and inconsistent treatment of UK firms is high.

3.9 It is not clear what is intended by the PRA’s expectation for firms who calculate an adjusted pillar 2 technical provisions amount to then “make their own assessment of whether their Pillar 2 technical provisions are as least as great as the EU minimum amount”.



As per our response to section 3.7-3.8, further guidance on the determination of the EU minimum amount needs developed and, as per our response to section 4, the PRA should outline as soon as feasibly possible what they expect to be submitted to demonstrate this assessment is satisfactory.

3.14 The final supervisory statement could be clearer, in order to provide absolute clarity, on the definition of the financial resources requirements that apply to the firm, pre-Solvency II.

Does the PRA intend this as the sum of technical provisions and capital requirement under pillar 2? Alternatively, does the PRA mean the most onerous (i.e. resulting in the lowest surplus capital) when both pillars 1 and 2 are compared? If the latter, how would this result in firms being able to achieve transitional relief on the implementation of the Solvency II risk margin?

3.16 Linear run-off of the limit to the transitional deduction

Article 308(d) of the Directive states that when a supervisory authority applies a limit to the transition deduction, such a limitation must be “calculated in accordance with the laws, regulations and administrative provisions which are adopted in pursuant to [Solvency I] on [31/12/2015]” (para 4). After this limitation is applied, the transitional deduction is reduced linearly to zero over 16 years (para 2, final sub-para).

The PRA’s draft supervisory statement adopts a different interpretation: It appears to only apply the 16 year linear run-off to the unrestricted transitional, then confer discretion on the PRA, in each following year, to determine how the restriction to the transitional deduction will run-off over time.

It is not clear that Article 308d(4) implies an ongoing calculation to restrict the transition deduction. If intended, this would be stated in Article 308d(4), as indeed it is in Article 308d(3).

We suggest the final supervisory statement be amended to state the restriction will on implementation, then run-off linearly over 16 years. This would also be practically simpler, avoiding the challenges of running two regimes in parallel as discussed earlier.

Should the PRA’s interpretation remain, to confer such discretion on the PRA without any limitations or statement of principles would, we believe, be inappropriate. We suggest these are developed and communicated to firms.

Scope of re-assessment exercise

We interpret this re-assessment exercise as relating to the limiting, if any, of the transitional deduction through the comparison of financial resources requirements (as set out in para 3.13-



3.15).

We do not interpret this re-assessment exercise as relating to a re-calculation of technical provisions on a pillar 1 and 2 bases, and comparison between them. This would be highly onerous on firms and supervisors and require calculations under the current regime to be maintained and supervised for the next 16 years.

A proportionate approach

We propose that firms are able to adopt a proportionate approach to the re-assessment of transitional deduction in future years. Should the PRA have specific requirements, these should be reflected in the final supervisory statement so firms are aware of the requirements before considering an application to use transitional measures.

3.17 We note the option to apply the transitional measure on technical provisions at a homogeneous risk group, as stated in Article 308d(1) of the Directive, is reflected in the draft supervisory statement. However this is not explicitly referenced in the draft rules.

We assume it is acceptable for the calculations to be performed for groups of homogeneous risk groups (e.g. one group for unit-linked business and another for all other business). It would be helpful if this was confirmed in the final supervisory statement.

We suggest the last sentence would be clearer if slightly amended: ‘The firm must also be able to demonstrate that the amounts of the technical provisions calculated at the level of the selected homogeneous risk groups are consistent with the amount of technical provisions calculation for the entity as a whole’.

4 Further detail on the approval process

We ask that the PRA communicates to firms as soon as feasibly possible: o Detailed requirements for the application process. For example, the information and

format required as the PRA set out in ‘CP23/14 Solvency II approvals’ for other approval processes.

o Any requirement or preference for external review of the application. o The criteria or principles it will apply to approve or reject (or limit) the use of the

transitional measures. o Whether the approval decision will be binary (i.e. the transitional measures may be

applied in full, or not at all) or more nuanced (e.g. available for certain homogeneous risk groups but not others, or a benefit lower than the maximum may be applied).



Process to cease using transitional measures in the future

The PRA should include in the final supervisory statement, or in other firm communications, the process for and any expectations of firms which, in the future, wish to stop using the transitional measures.

We do not believe this should require supervisory approval (and it is not an empowerment in the Directive) but instead should be a discussion with firms’ normal supervisory contact.

Should a firm then subsequently starting using the transitional measures again, guidance on the PRA’s expectations is required.

Clarification on the requirements for firms that decide to stop (or re-start) the use of transitionals in the future will assist them this year in current assessments of whether and how to apply for these measures.

Process to apply to use transitional measure in the future

Our interpretation of the Solvency II Directive and this draft supervisory statement is there is no time limit to when a firm may apply for approval to use transitional arrangements for both risk-free interest rates and technical provisions (i.e. a firm need not apply for approval before Solvency II implementation on 01/01/16, nor within a specified period thereafter).

Confirmation from the PRA in the final supervisory statement, or in other firm communications, would be helpful.

Interaction between solo and group approval process

Our understanding is that a solo firms need to apply for approval to their supervisor to use transitional measures at the solo level; meanwhile groups need to apply for approval to their group supervisor to use transitional measures at the group level.

We do not believe approval is required at the group level for solo entities to use transition measures, when this will only be applied to the solo (i.e. not group) balance sheet.

Confirmation that this is the situation for UK firms and UK-based groups that the PRA supervises would be helpful.

Process for standard formula firms who subsequently move to internal model (and vice versa)

It would be helpful for the PRA to develop guidance on the process for applying transitional



measures for day 1 standard formula firms that apply to use an internal model within the 16 year transitional period (and vice versa). It would be appropriate to revisit the transitional arrangements in these situations.

Whilst clarification here would be helpful, this is not as high-priority as the other issues requiring clarification/confirmation in this section.

App 2.2

Supervisory Statement — Solvency II: the internal model treatment of participations

2.3 The legal basis for adjustments being made to the SCR according to paragraph 2.3 should be provided in the supervisory statement and it should be made clear that if any adjustments were to be made then these would not be expected to feed through to the calculation of the risk margin.

2.5 For the avoidance of doubt it would be helpful to clarify that the statement that “the solo SCR should not be replaced with a consolidated calculation as though the participating undertaking and its related undertaking were a Solvency II group” is without prejudice to paragraph 2.2.

Paragraph 2.2 allows firms to use their internal model to “examine the characteristics of the assets and liabilities of the undertaking in which the participation is held and the risks arising from these”, as well as the extent to which “the risks of the assets and liabilities of the participant might diversify with the risk of the participation”.