Table 1: Estimated relationship between annuity rates, risk-free rates and corporate bond spreads  (a)  𝐴𝑛𝑛𝑢𝑖𝑡𝑦𝑅𝑎𝑡𝑒 = 𝛼 ∙ 𝑅𝑖𝑠𝑘𝐹𝑟𝑒𝑒 + 𝛽 ∙ 𝑆𝑝𝑟𝑒𝑎𝑑 + 𝛾 Coefficients  p values  (b)  2  R  𝛼  𝛽  𝛾  𝛼  𝛽  𝛾  2007-15  0.753217  0.069835  0.035934  3.51E-50  0.007549  3.74E-58  0.890489  SII:  2016  0.630423  0.080868  0.03866  0.001673  0.785268  5.98E-07  0.786387  All:  2007-16  0.740991  0.068925  0.036442  9.18E-63  0.006131  5.02E-75  0.917595  Pre-SII:  Sources: Bank of America Merrill Lynch, Bloomberg, sharingpensions.co.uk and Bank calculations. (a) Estimated using ordinary least-squares. (b) p values below 0.05 are generally interpreted as being statistically significant – meaning all estimated coefficients in this table apart from the  of 0.785268 obtained using just 2016 data. 10  Using standard annuity rates for a 65 year old on average across males and females (sharingpensions.co.uk); 20-year sterling risk-free market interest rates (Bloomberg), to roughly match conditional life expectancy at age 65; and sterling-denominated option-adjusted corporate bond spreads (BoA-ML).
Even more important is how firms determine their capital resources. Reviewing the adequacy of reserving is a core element of our supervisory approach, particularly for general insurers. In the case of life insurers with significant annuity books, a key determinant of reserves is their use of the Matching Adjustment. Solvency II sets clear criteria for assets that can qualify for the Matching Adjustment. They must match the maturity of the underlying liabilities – so, for example, long-dated annuity liabilities require similarly long maturity assets – and they must have fixed cashflows. 8  These requirements are set by the Directive; they are not a feature of the PRA’s implementation. Indeed we have sought to interpret them in a purposive and proportionate way so that firms can back annuities with a wide range of assets, including illiquid assets, and still benefit from the Matching Adjustment. For example, we have allowed firms to restructure portfolios of illiquid assets, such as commercial real estate mortgages, infrastructure finance or equity release mortgages, using internal securitisations in order to create senior tranches that meet the Solvency II requirements. We have also allowed pairing and grouping of assets to meet the eligibility criteria - for example, combining a floating rate note with an interest swap, or a foreign currency-denominated bond with a cross currency swap. Restructuring of this kind has added complexity, operational risk and some costs for firms.