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Optimising the unit matching process for efficient capital management for unit linked business
With Solvency II bedded down, life insurers have more choice about how to operate their unit matching business process. This article explores the role fund administration software and specifically box management technology can play in ensuring a successful and compliant capital management programme for life companies seeking to implement Solvency II unit matching.
The introduction of Solvency II back in 2016 has resulted in fundamental change to how life companies operate their unit-linked matching processes, because firms are no longer required by regulations to match to the full face-value of unit-linked liabilities. The regulatory criteria for unit matching are as per Article 132(3) of the Solvency II directive, which requires that the technical provisions for unit-linked contracts are matched by units. However under Solvency II, the investment policy for the amount representing the excess of the face value of the unit-linked liabilities over the Solvency II technical provisions is not prescribed by regulation.
Key considerations for life insurers:
- With Solvency II bedded down, life insurers have more choice about how to operate their unit matching business process.
- For life insurers with large unit-linked portfolios, choosing an appropriate unit matching process is an important part of their capital management programme as it can deliver capital efficiencies.
- Life companies use different criteria to select their optimal unit matching strategy and those vary by life insurer.
- From an operational level, life companies need to automate both the box management process and oversight and resilience in order to track algorithms from the actuarial department are correctly deployed and achieve the exact unit matching or underfunding program agreed.
Disruptive effects of Solvency II
Solvency II has been disruptive in that some existing business processes that have remained relatively unchanged for many years in the Solvency I world have required fundamental revisions to be fit for purpose in the Solvency II world. An example is unit matching where the old business process was based on matching exactly to the number of units allocated to customers, whereas the Solvency II business process requires the capability to match to a proportion of those amounts and therefore manage a special type of box position.
For firms yet to introduce unit matching programs the new unit matching process will be more complex than the existing business process. New systems capabilities are required to support the new unit matching process and while this might seem daunting, robust technology solutions are available. The technology solution must have good analytical functionality to display the size of the underfunding positions and the gains or losses on those positions, and to control and report on the revised business process.
The big picture perspective is that the benefits of the resultant capital outweigh the practical implementation challenges. The benefits of adopting a new unit matching business process include:
- Key capital efficiencies such as minimising volatility of Solvency II basis own funds, reducing market risk SCR and releasing cash from the unit-linked funds can be delivered.
- Elimination of unnecessary forced investment into the unit-funds – this is a very welcome development for finance directors of life insurers.
Maximising Capital Efficiencies: Box Management technology for unit matching
To maximise capital efficiencies, a new unit matching approach is required. Whilst the unit matching process would be more complex than the existing business process, it could be handled by an appropriately configured fund administration system with box management functionality.
The life insurer would operate unit matching based on proportions of the face value of units where the proportions vary by fund and over time. Rebalancing capabilities are thus also required because the required proportions vary over time.
The fund administration system needs to separately record the two components of the unit matching by firstly matching the face value of units and secondly the underfunding in respect of a proportion of the difference between the face value of the units and the Technical Provisions (the “underfunding position”) and then calculate the profit/loss on the underfunding position for IFRS reporting purposes. This means the life company fund administration systems must run a special type of negative box position to accurately account for this process in the Solvency II environment.
Good analytical functionality provides the ability to access the size of the underfunding positions and the gains or losses on those positions at any given time. Such reporting and analytical capabilities are a fundamental element of the system, for validation purposes and cross-reporting to the actuarial function.
Separately it is vital that the life company accurately tracks and knows the underfunding position by percentages and by amounts for the funds, this can be achieved by using software with automated box management functionality.
In summary, for life insurers with large unit-linked portfolios, the elimination of unnecessary forced investment into unit-funds, offers significant opportunity to release cash for other purposes. However it is crucial that the functionality and reporting capabilities of their fund administration system - for validation purposes and cross-reporting to the actuarial function – provide the ability to accurately manage the unit matching process and ensure a successful and compliant capital management programme.
For an in-depth look at the practical issues involved in Solvency II unit matching and capital management, and the systems required to operate the business processes with appropriate risk management and reporting, download the white paper here:
Solvency II Unit Matching & Capital Management for unit linked business