A thoughtful article in Lexology here.
The [Equitable] case is also interesting for Zacaroli J.’s discussion of Matching Adjustment in response to an objection raised by a policyholder with former experience in capital management at the Bank of England. Matching Adjustment allows insurers to seek regulatory approval to value certain long-term liabilities at a higher than risk-free discount rate where those liabilities are matched with eligible buy-to-hold assets, on the basis that insurers are not exposed to the risk of having to sell such assets before maturity. As this lowers the balance-sheet value of those liabilities, insurers are required to hold fewer assets to cover such liabilities, allowing them to price more competitively to insure them. Due to the long-term nature of the liabilities they insure, Matching Adjustment is a significant aspect of the balance sheet of many life insurers.
The policyholder objected that Matching Adjustment should not apply, on the basis that “if a liability is issued on the expectation or promise that it is risk-free, then it must be discounted at the risk free rate”, and doing otherwise artificially inflates the insurer’s capital position (since, in the absence of Matching Adjustment, more of its assets would be applied to cover the liabilities it insures). The policyholder argued that Utmost’s capital position, when judged without Matching Adjustment, should be considered to pose a solvency risk. Predictably, the judge dismissed the objection on the basis that the transfer should be assessed on the basis of the current applicable law, and the case was the inappropriate forum to challenge the introduction of the matching adjustment concept into legislation. Nevertheless, the discussion provides an interesting insight into competing views of this key element prudential regulation.
As I have pointed out elsewhere, the ‘current applicable law’ merely sets the framework under which a firm may assess its own solvency condition, primarily by means of separating the credit risky part of the spread, from the ‘safe’ part, the Matching Adjustment. To challenge the level of the Matching Adjustment is not in any way to challenge the framework itself.