My question on the matching adjustment comes from Q2(iii) of the Sept16 paper: Under the BEL for the guaranteed annuity option, no mention is made of a matching adjustment to the risk-free rate. Is that because the underlying assets are those in which the units are invested and so they're not necessarily assets which match the nature, term, currency of the liabilities (the annuities)? On the volatility adjustment, am I correct in saying that this adjustment may only be applied during times of general economic stress? So, in general, companies can't apply this adjustment?
They need to have a pra approval for using va. Do companies need to apply for approval for each valuation or annually?
As far as I am aware, firms can use the VA as much as they like once they get regulatory approval. Each month EIOPA publishes risk-free-rates with the volatility adjustment built in. The value of the volatility adjustment will change dependent on the general economic environment at the time, but this is already allowed for in the rates published by EIOPA.
You can only be granted a matching adjustment on predictable liabilities which are, at the valuation date, cashflow matched using corporate bonds which will be held to maturity. This is not the case for the unit-linked savings contract, nor is it the case for the guaranteed annuity option on a standalone basis, so the regulator would not have granted use of a matching adjustment within the BEL for this product.
Thanks, Lindsay. However, I'm struggling to understand why it's not the case for the guaranteed annuity option. In my mind, the insurer knows what the annuity value will be (for those who take up the option) so they should be able to match it with corporate bonds?
The insurer doesn't know how many will take up the option or the amount of annuity that would be payable if the option taken. The latter will depend on the performance of the unit fund from now until maturity: the guarantee is not of a minimum annuity amount, it is a minimum annuity rate at which the maturity fund is converted. So the liability is not sufficiently "predictable". The insurer does not hold assets now that match the future annuity benefits that may be payable under the option. (If it did decide to hold assets to attempt to hedge the guaranteed annuity option liability, these would be swaptions - as noted in Chapter 15.)
So, is this saying that all companies use the risk-free rate + volatility adjustment curve? And if so, everyone needs to get supervisory approval just to use the published rates (seems counterintuitive)?
Each month EIOPA publishes two sets of tables: one being just the risk-free rates and one being with the volatility adjustment included. Only companies which have been approved to use the volatility adjustment can use the latter tables.
Yes, my understanding is that the approval remains in place once given. However, if there are any material changes that could impact the company's ability to meet the original approval requirements (e.g. adjustment to assets held, in relation to the MA) then they are required to notify the PRA and may need to undertake a new approval process.
