Where we continue to have concerns about the internal rating of particular assets, we may commission an opinion from an external credit rating agency in the form of a skilled person review. It should be no surprise that we are paying particular attention to the internal ratings of the securitised notes backed by equity release mortgages. These typically have a high matching adjustment, are complex and relatively large in value. They are subject to credit default and downgrade risks, like any other matching adjustment assets. But the drivers of default and downgrade risks are the risks on the underlying mortgages, such as prepayment, longevity or the exposure to long-term house prices arising from the 9  Article77c 1 (b), Directive 2009/138/EC Solvency II: Matching Adjustment, unrated, illiquid assets and equity release mortgages. Prudential Regulation Authority SS 3/17. 10  7  All speeches are available online at www.bankofengland.co.uk/speeches  7  no-negative-equity guarantee. The essential point of SS 3/17 is that compensation for the risks taken by the insurer, particularly providing a no-negative equity guarantee, should not translate into a matching adjustment benefit on the restructured notes. Moreover, the compensation for risks retained by a firm as a result of the no negative equity guarantee must comprise more than the best estimate cost of the no negative equity guarantee. A best estimate cost of the no negative equity guarantee might be based on assumptions about likely long-term house price growth in excess of risk-free rates, extrapolating for example from historical experience.

First, they do not have to hold capital against the full risk that credit spreads will move against them in the market; Second, they are allowed to discount their annuity liabilities at higher than risk-free rates, reducing their liabilities and therefore boosting their current available capital. For UK insurers, the Matching Adjustment currently amounts to a capital benefit of some £ billion, split roughly evenly between lower capital requirements and higher capital resources. The Bank of England supports the Matching Adjustment framework. Properly implemented, it does appropriately reflect the risks to which annuity writers are exposed. As the Financial Policy Committee 7  concluded , it also has important financial stability benefits. It allows insurers to ‘look through’ short-term  volatility in credit spreads, avoiding any undesirable incentives to act procyclically by selling risky assets as market prices fall. Under Solvency II, Matching Adjustment assets have to meet strict criteria. For example, they must match the liabilities and have fixed cashflows. Insurers are seeking illiquid assets that both offer attractive yields and qualify for the Matching Adjustment. The PRA has allowed insurers some scope to restructure assets in order to meet the requirements. For example, equity release mortgage portfolios may be a good maturity match for an annuity book as part of a diversified portfolio. But they do not have fixed cashflows. So  4  Housing Affordability in England and Wales: 2016, Office for National Statistics, 17 March 2017 Miles, D and J Sefton (2017), “Houses Across Time and Space”, CEPR Discussion Paper No.