Solvency II: Transitional measures on risk-free interest rates and technical provisions

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In this blog we will look at the proposal for the transition measures on interest rates and technical provisions as well as the proposed timescale and process for applications.

Transition Measure on Risk-Free Interest Rates

The transition measure on risk-free interest rates allows firms to apply for approval for transition from their current discount rate requirement to the corresponding Solvency II requirement.  The adjustment is calculated as a portion of the difference between the rate that applies under the current regime and the Solvency II discount rate and reduces linearly over the 16 year period. 

When applying for this transition measure firms are required to determine a single interest rate on the current regime so that the comparison with the Solvency II discount rate is meaningful.  Firms will be expected to explain and justify the method used as part of their application. 

Transition Measure on Technical Provisions

Similar to the transition measure on risk-free interest rates the transition measure for technical provisions applies for 16 years and is a deduction from the Solvency II technical provisions.  The deduction itself is calculated as the difference between the current technical provisions and the Solvency II technical provisions.  The deduction will decrease linearly over the 16 year period. 

The starting point for the current technical provisions depends upon which of the pillar 1 and pillar 2 technical provisions are higher.  Where a firm’s pillar 2 technical provisions are higher than pillar 1 they will be required to use the pillar 2 technical provisions as the starting point.  If pillar 1 is higher, firms have two options – either to use pillar 1 or to compare pillar 2 with the Solvency I (EU minimum) technical provisions requirements to make their own assessment of whether their pillar 2 technical provisions are at least as great as the EU minimum amount.  The conclusion of this assessment must be included within their transition measure application. 

Firms can apply the transition deduction at the level of selected homogeneous risk groups.  However in order to do this firms need to demonstrate that they can reliably calculate their existing technical provision amounts using the same homogeneous risk groups as are used for their Solvency II technical provisions. 

Application Process

Firms wishing to use transitional measures on the risk-free rate or on technical provisions are required to apply for approval to do so from the PRA.  Note that firms cannot use both transitional measures.  The timescales and key steps proposed are step out below.  

Our commentary

CP3/15 provides details of the proposals for the transition measures as well as the application process and details of the calculations firms will be required to perform.  We know that everyone is busy at this time of year but April isn’t that far away should you want to get your transitional measures application in early.  We would be delighted to discuss the proposed transitional measures with our clients as well as to discuss ways we could support you with the preparation of your application or indeed by providing an independent review prior to submission.