As Solvency II transforms
into 'Solvency UK', what does it mean for pension schemes considering buy-ins and buy-outs?

Our viewpoint

The final consultation proposals have now been published on the UK's transition from Solvency II, which determines the capital reserves insurers are required to hold. As this process nears its end after three years of debate, what are LCP’s expectations for the impact on the buy-in and buy-out market? Will it improve pricing and insurer capacity? Will it water down policyholder security?

In a nutshell:

  • The wider asset eligibility for insurers is subject to strict controls but should be beneficial for pricing and capacity when implemented next year, although the benefits could take time to fully materialise
  • The new attestation process strengthens policyholder security, but this could lead to some caution from insurers in the short term offsetting some of the benefit of the asset eligibility changes
  • The wider asset eligibility may help insurers take more illiquid assets from schemes but this is likely to be around the edges rather than wholesale change
  • The change to the risk margin comes into effect at the end of 2023 and has been benefiting buy-in pricing over recent months as the insurers fed it into their models


The Solvency II reform process for UK insurers kicked off following the UK's departure from the EU on 31 December 2020 and, once complete, Solvency II will be known as Solvency UK going forwards. The insurance regulator (the PRA) has published the final two consultation papers in recent months:

  1. At the end of June, a consultation paper on reforms to the Risk Margin and other technical areas (CP12/23) – this comes into effect at the end of 2023; and
  2. At the end of September, a consultation paper on reforms to the Matching Adjustment (CP19/23) which will widen the range of assets that insurers can invest in – this comes into effect in the second half of 2024.

Further background on the reforms is set out in our previous blog in July asking “How is the insurance regulator responding to the rapid growth in the bulk annuity market?”. In the rest of this blog we focus on the second consultation paper and the proposed changes to asset eligibility.

What is the Matching Adjustment?

The latest consultation (CP19/23) is focussed on changes to the Matching Adjustment (“MA”). The MA is an easement that was negotiated as part of the introduction of Solvency II and is used almost exclusively by UK insurers that write annuities. It is a reduction to the Best Estimate Liabilities (“BEL”) element of insurers’ reserves, giving rise to a “MA benefit” – the amount of the reduction in capital requirements.

The MA arises from the insurers holding to maturity a portfolio of assets with a closely matching cashflow profile to their long-term liabilities. The fact that these assets are held to maturity effectively eliminates market risk with the key remaining risk being default risk. The insurers are therefore permitted to calculate their BEL using a discount rate above risk-free – effectively adding on the additional yield on their assets after having made a deduction for defaults – this is the MA benefit. This approach of taking advance credit for investment returns not yet earned is not without its critics. The consultation makes clear that the PRA requires the “MA to be materially more certain than a 50th percentile or best estimate basis” (even though it is used to determine the Best Estimate Liabilities). On top of the BEL the insurers also hold the risk margin and “1-in-200” SCR risk capital and then excess assets above that.

The MA is a significant capital benefit meaning insurers can only price pension buy-ins competitively if the assets they will hold are MA eligible. So the MA eligibility rules have a significant bearing on the nature of assets the insurers invest in and their ability to price competitively.

What changes are proposed?

The latest consultation (CP19/23) proposes the following key changes to the MA:

1) Increased flexibility in the type of assets that can be held

  • Currently only assets with fixed contractual cash flows can be held (such as corporate bonds and similar long-term debt).
  • In future, assets with “Highly Predictable” (“HP”) cashflows can also be held, subject to strict controls. The cashflows need to have upper/lower bounds on the timing and amount.
  • The MA benefit from HP assets will be capped at 10% of the overall portfolio, so there will not be a wholesale change to the way insurers assets are invested.
  • It remains to be seen exactly what assets will meet the HP requirements, but the policy intention is for the changes to support investment in high-value initiatives such as strategic infrastructure and renewable energy (eg assets with construction phases or callable bonds).
  • The HP assets still need to be debt so the ability for insurers to take on illiquid assets from pension schemes will not be significantly changed. However, there may be some benefits around the edges (eg for illiquid credit assets which have optionality in the underlying cashflows so would not currently be eligible).

2) Removal of the penal treatment for Sub-Investment Grade (“SIG”) assets 

  • It is not expected that insurers will materially change their holdings of SIG assets but this easement will be beneficial when insurers calculate the risk capital they need under stress. 
  • The change may also facilitate insurers taking and holding more illiquid assets from schemes (ie where the assets aren’t of investment grade, which is relatively common for illiquid credit assets).

3) Recognition of ‘notched’ credit ratings (eg A+ or A- rather than just A), meaning a more granular assessment of credit risk in the reserves

  • This is likely to marginally increase capital requirements for most insurers (in the absence of rebalancing) as their existing portfolios are optimised for the current rating approach 

4) A new “attestation” process where the CFO (or other senior individual) has to personally sign off on the appropriateness of key elements of their reserving 

  • To date, certain elements of the reserves around default assumptions on key asset classes have been prescribed by the PRA and could be taken largely as read
  • Going forwards, the onus will be placed on the insurers that those key assumptions appropriately reflect the level of risk for their specific assets and circumstances
  • A new annual sign off will be required, with personal responsibility falling on a senior individual at the insurer, typically the CFO

5) Increased reporting requirements enabling improved PRA oversight, monitoring and intervention

  • This will give the PRA visibility on the insurers’ compliance with the new rules and ultimately assist the PRA with protecting policyholders.

6) A more streamlined approval process for seeking PRA approval for new asset classes

  • This should make insurers more agile investors when new types of asset opportunities arise

The proposals are under consultation until 5 January 2024, after which the PRA expects to bring them into force for 30 June 2024, with the first attestation due before the end of 2024. 

What are the implications for buy-ins and buy-outs?

The proposed changes in principle give the insurers the additional investment freedom that they have been pushing for. However, we suspect at least some insurers will be disappointed by the limitations in place and the extent of the hurdles and reporting that is required to benefit from the easements. 

The PRA states that it expects a “modest reduction” in buy-in pricing due to the asset eligibility changes but in practice we think the position is likely to be more nuanced. The increased asset flexibility will be beneficial but it may take time for the insurers to get to grips with the new rules and for the benefits to fully materialise. When Solvency II was originally introduced in 2016 it took the insurers (and reinsurers) several years to properly optimise their approach for the new regime, but it did lead to a steady improvement in pricing and appetite over time. The latest changes are not as fundamental, but the benefits may still take a while to fully implement. In the short term, the attestation process appears potentially onerous so could lead to some insurers being cautious in their approach until they have got familiar with how the attestation process operates in practice. This could potentially offset any benefits that would otherwise arise from the wider asset eligibility in the short term.

From a policyholder protection perspective, the changes arguably look quite positive. The wider asset flexibility does introduce new risk exposures, but it is subject to strict controls and the new attestation process places a significant level of additional personal responsibility on insurer management to set their reserving approach appropriately. Certainly, the PRA states that it believes the changes will improve the safety and soundness of insurers and will improve policyholder protection.

With the consultation only recently published, it remains too early to say definitively what the changes will mean for schemes exploring buy-ins. This will become clearer over time as the insurers digest the new rules. The PRA may make changes to the proposals following the consultation but, given the PRA’s expectation of the rules being in force by 30 June 2024, it would appear the PRA is not expecting to make wholesale changes ahead of finalisation.

In the meantime, the insurers will welcome the easements to the risk margin that come into force at the end of the year. Legal & General published figures with its half year results indicating this will reduce their capital requirements by nearly 1%. This change is relatively small but it is one of the factors that has been making buy-in pricing so attractive over recent months as the insurers fed it into their models.