Conditions for long-term sustainable growth The recent history of the UK life sector has shown us conditions that were not supportive of sustainable growth – or indeed policyholder protection. We need only cast our minds back a couple of decades to the existential challenges faced by some with-profits firms and the impact this had on benefits paid to policyholders. These challenges resulted from the inadequate capital resources supporting the promises they had made (or were deemed to have made) to their policyholders. Whilst BPA balance sheets look very different, this nonetheless underlines our strong motivation for and expectations of effective governance, risk management and resilience, underpinned by a robust, transparent and risk-sensitive solvency system for long-term business. We see these elements as necessary conditions for success and for the purposes of today, I’ve boiled them down to four Rs: Responsibility of the Board  Page 4  Risk management Resilience; and Regulation Fundamentally, the PRA and BPA firms should be aligned in their interest in the growth of the sector happening in a sustainable way. And there is more agreement than not on the conditions needed for success. As we move from the fundamentals and start delving into the detail, differences of views emerge between BPA firms and the PRA on the extent, nature and relative importance of these conditions; not unexpected given our respective objectives.
Insurers may be sole or significant investors in specialised lending and will require a commensurate level of expertise to assess, maintain and potentially work-out such assets. Rationale for the MA Before discussing our supervisory analysis on MA portfolios, I will recap on the rationale for the MA. There are several schools of thought on whether illiquid liabilities should be discounted at a “risk-free” rate, or if it is appropriate in some cases to allow for some addition to the risk-free rate. The PRA accepts that a component of the credit spread represents an illiquidity premium, and that an allowance may be made for this where firms: hold debt-like instruments to back annuities; are able to hold those assets to maturity; and they closely match asset and liability cashflows. Solvency II has formalised the conditions for when that illiquidity premium can be recognised, often referred to as “eligibility”. Under Solvency II this increase to the discount rate is called the MA. The MA reduces the value of liabilities in the base balance sheet, and hence increases own funds [Chart 5]. The MA performed its expected function in 2020, allowing insurers to look through the sharp spike in credit spreads. And the MA also served broader financial stability as insurers did not behave in a procyclical way, as they did not need to sell assets as market prices fell [Chart 6]. Asset eligibility On the eligibility side, Solvency II requires that the assets backing MA eligible liabilities should be ‘fixed’.