TMTP: Another plot twist

The latest episode of the soap opera that is the Prudential Regulation Authority’s (PRA’s) evolving policy relating to the Transitional Measure on Technical Provisions (TMTP) was, in places, both predictable and surprising.

The main plotline in Policy Statement PS11/17, issued on 28 April 2017, was to bring into force a series of changes that had previously been consulted on. However, the subplot was more interesting: with some new requirements being introduced that were not in the consultation paper. In particular, we now have clarity that business written after the introduction of Solvency II should be included in the Financial Resources Requirement (FRR) test, as well as a requirement about how firms communicate the impact of TMTP to the market.

The proposals from CP47/16 remain intact

In Consultation Paper CP47/16, the PRA proposed to make a series of changes to its Supervisory Statement on the maintenance of the TMTP (SS6/16), the main ones being:

• Firms should understand and analyse the main drivers of the TMTP, with a view to improving the quality of their risk management practices;
• The PRA’s expectations relating to ensuring ongoing consistency between firms’ Solvency I and Solvency II valuation bases; and
• Clarification of the PRA’s expectations relating to the use of approximations.

At the time, we welcomed these changes as a helpful set of clarifications from the PRA – see our previous Solvency II Newsflash.

The PRA has now reviewed the responses it received to the consultation and PS11/17 brings these changes into force – in an almost identical form to the wording consulted on.

And now moving on from the predictable …

The FRR test SHOULD include business written after Solvency II came into force

Firms must restrict their use of TMTP to ensure that their total “financial resources requirement” (generally taken to mean the sum of the technical provisions, other liabilities and capital requirements) is no less under Solvency II than it would have been under the Solvency I rules. The PRA has now clarified that this test should take account of all the firm’s liabilities and capital requirements – rather than just those associated with the pre-2016 business.

This is likely to have come as a surprise to the industry. It is generally felt that including only pre-2016 business in the FRR test is more consistent with the objectives of the TMTP. However we think this is good news for firms:

• Firms might be in a position where the Solvency II liabilities and capital requirements for business written after 1 January 2016 are greater than what they would have been under Solvency I. This would therefore make it less likely that the FRR test would bite (even though this overlooks the fact that the premium the firm charged for the business presumably reflected the new, higher, regulatory liabilities and capital requirements).
• Including all of a firm’s business in the FRR test removes the need to address a number of practical challenges which might otherwise have the potential to complicate financial reporting processes. Examples include:

  • the need to split assets between those associated with business written before and after the commencement of Solvency II – especially challenging for a firm’s surplus assets and assets backing capital requirements;

  • the need to split accounting liabilities and deferred tax liabilities; and

  • whether diversification between pre and post 1 January 2016 business should be allowed for when determining the capital requirements.

Messaging to the market

The PRA has also introduced a new requirement relating to how firms communicate their solvency coverage ratio to the market. The ratio communicated should not include an allowance for TMTP that is greater than the amount for which the PRA has given approval.

When firms prepared their 2016 annual reports and accounts, some disclosed a solvency coverage ratio that included an allowance for TMTP based on the market conditions at the end of 2016 – rather than the amount approved by the PRA at the last recalculation date. This practice would seem to be in line with the PRA’s latest requirement, since the allowance made for TMTP was generally lower than at the last recalculation date – reflecting rises in long-term interest rates during the second half of 2016.

It will however, be more challenging for firms should they find themselves in a situation where rates have fallen since the last recalculation date. Should this happen, then the primary ratio they disclose to the market will need to reflect the TMTP at the last recalculation date. Firms will, however, have the option of providing supplementary information.

Other points

1. Two further changes have been made to the Supervisory Statement, above and beyond those proposed in the consultation paper:Greater detail on the timescales for obtaining approval for a recalculation. This includes a requirement that where the recalculation is triggered by an event that could not have been anticipated (such as market movements), the firm should submit its application to recalculate within 3 months of the change occurring.
2. Regular recalculation every 2 years following the start of Solvency II is generally mandatory, with the first such regular recalculation scheduled for the end of this year. However the PRA has now stated that firms will not be required to undertake this if they have recalculated their TMTP shortly before 31 December 2017 (although what the PRA means by “shortly” has not been defined).

We look forward to the next instalment

It seems certain we will hear more from the PRA on this subject. PS11/17 mentions that the PRA is currently engaging with stakeholders to identify possible simplifications for the TMTP recalculation process. And Sam Woods – the PRA’s CEO – has previously mentioned the possibility of another Supervisory Statement covering the first regular recalculation at 31 December 2017.

We will of course keep you updated as the drama unfolds! 

Contributing Authors: 

Ross Evans  Andrew Scott

The material and charts included herewith should not be considered a definitive analysis of the subjects covered, nor is it specific to circumstances of any person, scheme or organisation. It is not advice and should not be relied upon. Hymans Robertson LLP accepts no liability for any errors or omissions.