INSPRU 1

Capital resources requirements and technical provisions for insurance business

INSPRU 1.1

Application

INSPRU 1.1.1

See Notes

handbook-rule
INSPRU 1.1 applies to an insurer unless it is:

INSPRU 1.1.2

See Notes

handbook-rule
(1) This section applies to a firm in relation to the whole of its business, except where a particular provision provides for a narrower scope.
(2) Where a firm carries on both long-term insurance business and general insurance business, this section applies separately to each type of business.

INSPRU 1.1.3

See Notes

handbook-rule
For a non-EEA insurer with a branch in the United Kingdom whose insurance business in the United Kingdom is not restricted to reinsurance (other than an EEA-deposit insurer, a Swiss general insurer or a UK-deposit insurer):
(1) the part of this section headed "Capital requirements for insurers" (INSPRU 1.1.43 G to INSPRU 1.1.92B G) applies to its world-wide activities;
(2) the parts of this section headed:
(a) "Establishing technical provisions" (INSPRU 1.1.12 R to INSPRU 1.1.19 G);
(b) "Reinsurance and analogous non-reinsurance financing agreements: risk transfer principle" (INSPRU 1.1.19A R to INSPRU 1.1.19F G);
(c) "Assets of a value sufficient to cover technical provisions and other liabilities" (INSPRU 1.1.20 R to INSPRU 1.1.29 G);
(d) "Matching of assets and liabilities" (INSPRU 1.1.34 R to INSPRU 1.1.40 G); and
(e) "Premiums for new business" (INSPRU 1.1.41 R to INSPRU 1.1.42 G);
apply separately in respect of its world-wide activities and its activities carried on from a branch in the United Kingdom; and
(3) the part of this section headed "Localisation" (INSPRU 1.1.30 R to INSPRU 1.1.33 R) does not apply (see INSPRU 1.5 (Internal contagion risk)).

INSPRU 1.1.4

See Notes

handbook-rule
For an EEA-deposit insurer or a Swiss general insurer:
(1) the parts of this section headed:
(a) "Establishing technical provisions" (INSPRU 1.1.12 R to INSPRU 1.1.19 G);
(b) "Reinsurance and analogous non-reinsurance financing agreements: risk transfer principle" (INSPRU 1.1.19A R to INSPRU 1.1.19F G);
(c) "Assets of a value sufficient to cover technical provisions and other liabilities" (INSPRU 1.1.20 R to INSPRU 1.1.29 G);
(d) "Matching of assets and liabilities" (INSPRU 1.1.34 R to INSPRU 1.1.40 G); and
(e) "Premiums for new business" (INSPRU 1.1.41 R to INSPRU 1.1.42 G);
apply in respect of the activities of the firm carried on from a branch in the United Kingdom; and
(2) the parts of this section headed "Capital requirements for insurers" (INSPRU 1.1.43 G to INSPRU 1.1.92B G) and "Localisation" (INSPRU 1.1.30 R to INSPRU 1.1.33 R) do not apply.

INSPRU 1.1.5

See Notes

handbook-rule
For a UK-deposit insurer:
(1) the part of this section headed "Capital requirements for insurers" (INSPRU 1.1.43 G to INSPRU 1.1.92B G) applies to its world-wide activities;
(2) the parts of this section headed:
(a) "Establishing technical provisions" (INSPRU 1.1.12 R to INSPRU 1.1.19 G);
(b) "Reinsurance and analogous non-reinsurance financing agreements: risk transfer principle" (INSPRU 1.1.19A R to INSPRU 1.1.19F G);
(c) "Assets of a value sufficient to cover technical provisions and other liabilities" (INSPRU 1.1.20 R to INSPRU 1.1.29 G);
(d) "Matching of assets and liabilities" (INSPRU 1.1.34 R to INSPRU 1.1.40 G); and
(e) "Premiums for new business" (INSPRU 1.1.41 R to INSPRU 1.1.42 G);
apply separately in respect of its world-wide activities and its activities carried on from branches in EEA States; and
(3) the part of this section headed "Localisation" (INSPRU 1.1.30 R to INSPRU 1.1.33 R) does not apply (see INSPRU 1.5 (Internal contagion risk)).

INSPRU 1.1.6

See Notes

handbook-guidance
This section may apply in cases where a firm has its head office in another EEA State but is neither an incoming EEA firm nor an incoming Treaty firm; this could arise in the case of a non-directive mutual.

Purpose

INSPRU 1.1.7

See Notes

handbook-guidance
INSPRU 1.1 has the aim of reducing the risk that a firm may fail to meet its liabilities to its policyholders as a result of insurance risk, that is, the risk that arises from the inherent uncertainties as to the occurrence, amount and timing of insurance liabilities.

INSPRU 1.1.8

See Notes

handbook-guidance
This section requires that the technical provisions that firms establish are adequate to meet their liabilities to policyholders under contracts of insurance. It also requires that firms hold assets of a value sufficient to cover their liabilities, including technical provisions, and that there is suitable matching of assets and liabilities. Technical provisions are the on-balance sheet provisions made by a firm in respect of liabilities arising under or in connection with contracts of insurance. There are different rules and guidance applicable to the calculation of technical provisions for general insurance business and for long-term insurance business.

INSPRU 1.1.9

See Notes

handbook-guidance
This section implements requirements of the Insurance Directives for both general insurance business and long-term insurance business with regard to the technical provisions. The relevant articles of the Directives include:
(1) article 15 of the First Non-Life Directive, as substituted by article 17 of the Third Non-Life Directive; and
(2) article 20 of the Consolidated Life Directive (this Directive consolidates the provisions of the previous First, Second and Third Life Directives).

INSPRU 1.1.10

See Notes

handbook-guidance
This section also sets out detailed rules and guidance on the calculation of the following elements of a firm'scapital resources requirement (CRR) (see GENPRU 2.1):

INSPRU 1.1.11

See Notes

handbook-guidance
These requirements are dealt with in the part of this section headed "Capital requirements for insurers" (see INSPRU 1.1.43 G to INSPRU 1.1.91 R). That part of this section also contains rules about the calculation of the enhanced capital requirement for firms carrying on general insurance business, including the calculation of the insurance-related capital requirement. The calculation of theasset-related capital requirement, which also forms part of the calculation of the ECR for firms carrying on general insurance business is set out in INSPRU 2.2.

Establishing technical provisions

INSPRU 1.1.12

See Notes

handbook-rule
For general insurance business, a firm must establish adequate technical provisions:
(1) in accordance with the rules in INSPRU 1.4 for equalisation provisions; and
(2) otherwise, in accordance with GENPRU 1.3.4 R.

INSPRU 1.1.13

See Notes

handbook-guidance
For general insurance business, the technical provisions include outstanding claims provisions, unearned premiums provisions, unexpired risk provisions and equalisation provisions. These provisions take into account the expected ultimate cost of claims, including those not yet incurred, related expenses and include an allowance for smoothing claims (the equalisation provision).

INSPRU 1.1.14

See Notes

handbook-guidance
Discounting (that is discounting for the time value of money) general insurance businesstechnical provisions may be carried out only in limited circumstances and on a prudent basis (see GENPRU 2.2.107 R and paragraph 48 of the insurance accounts rules). The fact that the expected liabilities are generally not discounted helps to protect against risk from inherent uncertainty in the timing, but not necessarily the amount, of claims.

INSPRU 1.1.15

See Notes

handbook-guidance
For some categories of general insurance business, equalisation provisions are required. These ensure that a firm retains additional assets to provide some extra protection against uncertainty as to the amount of claims. Equalisation provisions are particularly suitable for volatile business, where claims in any future year may be subject to significant adverse deviation from recent or average expected claims experience, or where trends in claims experience may be subject to change. Such volatile claims experience arises in a number of types of business, for example, property, marine and aviation, nuclear, certain non-proportional reinsurance treaty business, and credit insurance. The equalisation provisions help to equalise fluctuations in loss ratios in future years (see INSPRU 1.4 (Equalisation provisions)).

INSPRU 1.1.16

See Notes

handbook-rule
For long-term insurance business, a firm must establish adequate technical provisions in respect of its long-term insurance contracts as follows:
(1) mathematical reserves in accordance with the rules and guidance in INSPRU 1.2 relating to such reserves, and with due regard to generally accepted actuarial practice; and
(2) for liabilities in respect of such contracts that have fallen due, in accordance with GENPRU 1.3.4 R.

INSPRU 1.1.17

See Notes

handbook-guidance
Rules and guidance for calculating mathematical reserves are set out in INSPRU 1.2. Firms are advised by the actuarial function (see SUP 4) on the methods and assumptions to be used in calculating the mathematical reserves. The standards and guidance issued by the Board for Actuarial Standards to assist actuaries appointed to the actuarial function are important sources of evidence as to generally accepted actuarial practice, as referred to in INSPRU 1.1.16R (1).

INSPRU 1.1.18

See Notes

handbook-guidance
For long-term insurance business, the technical provisions include the mathematical reserves. These are actuarial estimates of a firm's liabilities in respect of future benefits due to policyholders, including bonuses already declared. The mathematical reserves may be reduced by the actuarial value of that component of future premiums attributable to meeting future liabilities (see INSPRU 1.2 (Mathematical reserves)).

INSPRU 1.1.19

See Notes

handbook-guidance
For long-term insurance business, the mathematical reserves are typically valued on a discounted basis but include valuation margins intended to provide protection against adverse deviations in experience (see INSPRU 1.2).

Reinsurance and analogous non-reinsurance financing agreements: risk transfer principle

INSPRU 1.1.19A

See Notes

handbook-rule
(1) A firm may only take credit for reinsurance if and to the extent that there has been an effective transfer of risk from the firm to a third party.
(2) In INSPRU 1.1.19A R to INSPRU 1.1.19F G, references to reinsurance and contracts of reinsurance include:
(a) all contracts of reinsurance with an ISPV; and
(b) analogous non-reinsurance financing agreements.

INSPRU 1.1.19B

See Notes

handbook-rule
For the purposes of INSPRU 1.1.19AR (2)(b), analogous non-reinsurance financing agreements include contingent loans, securitisations and any other arrangements in respect of contracts of insurance that are analogous to contracts of reinsurance in terms of the risks transferred and the finance provided.

INSPRU 1.1.19C

See Notes

handbook-guidance
There are a number of ways in which a firm may be able to take credit for reinsurance under the rules in GENPRU and INSPRU. Examples include:
(1) treating the reinsurer's share of technical provisions as an admissible asset in accordance with GENPRU 2 Annex 7;
(2) reducing its solvency requirements in accordance with the deduction for reinsurance allowed in the calculation of the general insurance capital requirement or the long-term insurance capital requirement under INSPRU 1.1; and
(3) bringing into account amounts receivable under the contract when valuing cash flows for the purpose of a prospective valuation of mathematical reserves under INSPRU 1.2. In particular, a contingent loan or other analogous non-reinsurance financing agreement may then give rise to an addition to capital resources as a positive valuation difference in accordance with GENPRU 2.2.105 R.

INSPRU 1.1.19D

See Notes

handbook-guidance
The amount of credit taken by a firm for a risk transferred should be measured by applying the standard methods for determining the regulatory balance sheet set out in INSPRU. For example, where credit is being taken so as to reduce technical provisions, the amount of that credit should reflect the difference in technical provisions that arises from changing the assumptions used to reflect the risk transferred.

INSPRU 1.1.19E

See Notes

handbook-guidance
For the purposes of INSPRU 1.1.19AR (1), the transfer of risk from the firm to the third party should be effective in all circumstances in which the firm may wish to rely upon the transfer. Examples of factors which the firm should take into account in assessing whether the transaction effectively transfers risk and the extent of that transfer include:
(1) whether the documentation associated with the reinsurance reflects the economic substance of the transaction;
(2) whether the extent of the risk transfer is clearly defined and incontrovertible;
(3) whether the transaction contains any terms or conditions the fulfilment of which is outside the direct control of the firm. Such terms or conditions may include those which:
(a) would allow the third party unilaterally to cancel the transaction, except for the non-payment of monies due from the firm to the third party under the contract; or
(b) would increase the effective cost of the transaction to the firm in response to an increased likelihood of the third party experiencing losses under the transaction; or
(c) would oblige the firm to alter the risk that had been transferred with the purpose of reducing the likelihood of the third party experiencing losses under the transaction; or
(d) would allow for the termination of the transaction due to an increased likelihood of the third party experiencing losses under the transaction; or
(e) could prevent the third party from being obliged to pay out in a timely manner any monies due under the transaction; or
(f) could allow the maturity of the transaction to be reduced;
(4) whether the transaction is legally effective and enforceable in all relevant jurisdictions.

INSPRU 1.1.19F

See Notes

handbook-guidance
A firm should also take into account circumstances in which the benefit to the firm of the transfer of risk could be undermined. For instance, where the firm, with a view to reducing potential or actual losses to third parties, provides support to the transaction, including support beyond its contractual obligations (implicit support). Another example of a situation where the firm should consider whether it should take reduced credit for a transaction is where it has invested in the bonds issued by an ISPV with which it has reinsured risks.

Assets of a value sufficient to cover technical provisions and other liabilities

INSPRU 1.1.20

See Notes

handbook-rule
A firm which is not a composite firm must hold admissible assets of a value at least equal to the amount of:
(1) the technical provisions that it is required to establish under INSPRU 1.1.12 R or INSPRU 1.1.16 R; and
but excluding property-linked liabilities and index-linked liabilities and the assets held to cover them under INSPRU 3.1.57 R and INSPRU 3.1.58 R.

INSPRU 1.1.21

See Notes

handbook-rule
A composite firm must ensure that:
(1) it holds admissible assets separately identified in accordance with INSPRU 1.5.18 R of a value at least equal to the amount of:
(a) the technical provisions that it is required to establish under INSPRU 1.1.16 R; and
but excluding property-linked liabilities and index-linked liabilities and the assets held to cover them under INSPRU 3.1.57 R and INSPRU 3.1.58 R; and
(2) it holds other admissible assets (other than those excluded under (1)) of a value at least equal to the amount of:
(a) the technical provisions that it is required to establish under INSPRU 1.1.12 R; and

INSPRU 1.1.22

See Notes

handbook-guidance
INSPRU 1.5 (Internal-contagion risk) sets out the rules and guidance on identifying and holding in a separate fund long-term insurance assets.

INSPRU 1.1.23

See Notes

handbook-guidance
When valuing assets for the purposes of INSPRU 1.1.20 R and INSPRU 1.1.21 R, a firm should bear in mind:
(2) the market and counterparty limits set out in INSPRU 2.1 (Credit risk in insurance). INSPRU 2.1 requires that a firm restrict to prudent levels its exposure to reinsurer and other counterparties, and, in particular, that for the purpose of its balance sheet, a firm must not take into account any exposure which exceeds the large exposure limits.

INSPRU 1.1.24

See Notes

handbook-guidance
Rules and guidance on the valuation of assets are set out in GENPRU 1.3 (Valuation), including the treatment of shares in, and debts due from, related undertakings in GENPRU 1.3.43 R to GENPRU 1.3.54 G. INSPRU 3.1 (Market risk in insurance) addresses market risk and sets out the matching requirements for linked assets and liabilities. INSPRU 3.1 also sets out rules and guidance on the matching by currency of assets and liabilities, to reduce a firm's exposure to currency market risk.

INSPRU 1.1.25

See Notes

handbook-rule
For the purpose of determining the value of assets available to meet technical provisions and other long-term insurance liabilities in accordance with INSPRU 1.1.20 R, INSPRU 1.1.21 R, INSPRU 1.1.27 R and INSPRU 1.1.28 R, no value is to be attributed to:
(1) debts owed by reinsurers; or
(2) claims; or
(3) tax recoveries; or
(4) claims against compensation funds;
to the extent already offset in the calculation of technical provisions.

INSPRU 1.1.26

See Notes

handbook-guidance
Certain debts and claims are excluded from INSPRU 1.1.20 R, INSPRU 1.1.21 R, INSPRU 1.1.27 R and INSPRU 1.1.28 R to avoid double-counting. The rules and guidance in INSPRU 1.2 (Mathematical reserves) set out how a firm may offset debts and claims against liabilities in calculating the mathematical reserves required for long-term insurance business.

INSPRU 1.1.27

See Notes

handbook-rule
A firm carrying on long-term insurance business must ensure that it has admissible assets in each of its with-profits funds of a value sufficient to cover:
(1) the technical provisions in respect of all the business written in that with-profits fund; and
(2) its other long-term insurance liabilities in respect of that with-profits fund.

INSPRU 1.1.28

See Notes

handbook-rule
In addition to complying with INSPRU 1.1.27 R, a realistic basis life firm must also ensure that the realistic value of assets for each of its with-profits funds is at least equal to the realistic value of liabilities of that fund.

INSPRU 1.1.29

See Notes

handbook-guidance
INSPRU 1.1.27 R and INSPRU 1.1.28 R support the funding of policyholder benefits by requiring firms to maintain admissible assets in with-profits funds to cover the technical provisions and other long-term insurance liabilities relating to all the business in that fund and, in the case of a realistic basis life firm, realistic assets to cover the realistic liabilities of the with-profits insurance contracts written in the fund.

Localisation (UK firms only)

INSPRU 1.1.30

See Notes

handbook-rule
(1) Subject to (2), a UK firm must hold admissible assets held pursuant to INSPRU 3.1.53 R:
(a) (where the admissible assets cover technical provisions in pounds sterling), in any EEA State; and
(b) (where the admissible assets cover technical provisions in any currency other than pounds sterling), in any EEA State or in the country of that currency.
(2) In the case of a community co-insurance operation and a relevant insurer, the admissible assets covering technical provisions must be held in any EEA State.

INSPRU 1.1.31

See Notes

handbook-guidance
INSPRU 1.5 (Internal contagion risk) sets out the rules and guidance on localisation for firms other than UK firms.

INSPRU 1.1.32

See Notes

handbook-rule
INSPRU 1.1.30 R does not apply to:
(1) a pure reinsurer; or
(2) debts owed by reinsurers; or
(3) insurance business carried on by a UK firm outside the EEA States; or
(4) general insurance business class groups 3 and 4 in IPRU(INS), Annex 11.2, Part II.

INSPRU 1.1.33

See Notes

handbook-rule
For the purposes of INSPRU 1.1.30 R:
(1) a tangible asset is to be treated as held in the country or territory where it is situated;
(2) an admissible asset consisting of a claim against a debtor is to be treated as held in any country or territory where it can be enforced by legal action;
(3) a listed security is to be treated as held in any country or territory where there is a regulated market on which the security is dealt; and
(4) a security which is not a listed security is to be treated as held in the country or territory in which the issuer has its head office.

Matching of assets and liabilities

INSPRU 1.1.34

See Notes

handbook-rule
(1) Subject to (4), the assets held by a firm to cover its technical provisions and other long-term insurance liabilities or general insurance liabilities (see INSPRU 1.1.20 R and INSPRU 1.1.21 R) must:
(a) have characteristics of safety, yield and marketability which are appropriate to the type of business carried on by the firm;
(b) be diversified and adequately spread; and
(c) comply with (2).
(2) The assets referred to in (1) must, in addition to meeting the criteria set out in (1)(a) and (b), be of a sufficient amount, and of an appropriate currency and term, to ensure that the cash inflows from those assets will meet the expected cash outflows from the firm's insurance liabilities as they become due.
(3) For the purpose of (2), a firm must take into consideration in determining expected cash outflows any options which exist in the firm'scontracts of insurance.
(4) (1) does not apply to:
(a) a pure reinsurer; or
(b) assets held to cover index-linked liabilities or property-linked liabilities, except that where the linked long-term contract of insurance in question includes a guarantee of investment performance or some other guaranteed benefit, (1) will nevertheless apply to assets held to cover that guaranteed element.

INSPRU 1.1.34A

See Notes

handbook-guidance
INSPRU 1.1.34 R is not applied to pure reinsurers because they are subject under INSPRU 3.1.61A R to the "prudent person" investment principles from the Reinsurance Directive.

INSPRU 1.1.35

See Notes

handbook-guidance
A firm should take account of the amount, currency and timing of its expected cash outflows in determining whether the assets it holds to cover its technical provisions and other long-term insurance liabilities or general insurance liabilities meet the requirements of INSPRU 1.1.34R (2).

INSPRU 1.1.36

See Notes

handbook-guidance
For the purpose of INSPRU 1.1.34R (2), the relevant cash inflows are those which the firm reasonably expects to receive from the admissible assets which it holds to cover its technical provisions and other long-term insurance liabilities or general insurance liabilities. A firm may receive cash inflows as a result of:
(1) selling assets or closing out transactions;
(2) holding assets that generate dividends, interest or other income; and
(3) receiving future premiums for existing business.

INSPRU 1.1.37

See Notes

handbook-guidance
Anticipated cash inflows from future new business should not be included, for example where the customer has not yet contracted to pay the premium, and where the associated liabilities and potential cash outflows should also not be included.

INSPRU 1.1.38

See Notes

handbook-guidance
A firm should compare cash inflows and outflows based on current expectations of amounts and timings. Current market expectations of future asset values, interest rates and currency exchange rates should be used. Where inflows are received in a currency different from that in which outflows are to be paid, account should be taken of the cost of converting the currency received.

INSPRU 1.1.39

See Notes

handbook-guidance
In considering the value and suitability of assets required to ensure that the firm's liabilities are met as they become due, a firm should take account of the risk of default on inflows from those assets, and other risks that may mean that future inflows are reduced relative to outflows.

INSPRU 1.1.40

See Notes

handbook-guidance
INSPRU 1.1.20 R lays down a general requirement for a firm that carries on long-term insurance business to hold admissible assets that are of a value sufficient to cover its technical provisions and other long-term insurance liabilities. The INSPRU 1.1.34R (2) requirement to match liabilities with assets that allow cash outflows to be met with suitable inflows as the outflows become due may mean that a firm has to hold assets of a value greater than would otherwise be required by the general rule in INSPRU 1.1.20 R.

Premiums for new business

INSPRU 1.1.41

See Notes

handbook-rule
A firm must not enter into a long-term insurance contract unless it is satisfied on reasonable actuarial assumptions that:
(1) the premiums receivable and the investment income expected to be earned from those premiums; and
(2) the reinsurance arrangements made in respect of the risk or risks covered by that new contract are sufficient to enable it, when taken together with the firm's other resources, to:
(a) establish adequate technical provisions as required by INSPRU 1.1.16 R;
(b) hold admissible assets of a value at least equal to the amount of the technical provisions and other long-term insurance liabilities as required by INSPRU 1.1.20 R to INSPRU 1.1.28 R; and
(c) maintain adequate overall financial resources as required by the overall financial adequacy rule.

INSPRU 1.1.42

See Notes

handbook-guidance
For the purposes of INSPRU 1.1.41 R, the adequacy of premiums may be assessed in the context of a firm's total portfolio of business and its other resources. It thus does not prevent a firm writing loss leaders nor writing contracts which might incur large losses, but only if the firm can meet the losses that might reasonably arise, including those that would arise from an event specifically insured against.

Capital requirements for insurers

INSPRU 1.1.43

See Notes

handbook-guidance
(1) GENPRU 2.1.13 R requires a firm to maintain capital resources equal to or in excess of its capital resources requirement (CRR). GENPRU 2.1 sets out the overall framework of the CRR; in particular, GENPRU 2.1.17 R requires that for a firm carrying on general insurance business the CRR is equal to the minimum capital requirement (MCR). GENPRU 2.1.18 R requires that for realistic basis life firms the CRR is the higher of the MCR and the ECR. GENPRU 2.1.23 R requires that for regulatory basis only life firms the CRR is equal to the MCR.
(2) For non-life firms the MCR represents the minimum capital requirement (or margin of solvency) prescribed by the Insurance Directives. GENPRU 2.1.24 R provides that, for a firm carrying on general insurance business, the MCR in respect of that business is the higher of the base capital resources requirement for general insurance business applicable to that firm and the general insurance capital requirement. GENPRU 2.1.24A R provides that, for a firm carrying on long-term insurance business which is a realistic basis life firm, the MCR in respect of that business is the higher of the base capital resources requirement for long-term insurance business applicable to that firm and the long-term insurance capital requirement.GENPRU 2.1.25 R provides that, for a firm carrying on long-term insurance business which is a regulatory basis only life firm, the MCR in respect of that business is the higher of the base capital resources requirement for long-term insurance business applicable to that firm and the sum of the long-term insurance capital requirement and the resilience capital requirement. As specified in GENPRU 2.1.14 R, a firm carrying on both general insurance business and long-term insurance business must apply GENPRU 2.1.13 R (referred to in paragraph (1) above) separately to its general insurance business and its long-term insurance business.
(3) The calculation of the general insurance capital requirement is set out in INSPRU 1.1.44 G to INSPRU 1.1.72 R below. INSPRU 1.1.73 to INSPRU 1.1.79 R set out the calculation of the insurance-related capital requirement for non-life firms. The calculation of the long-term insurance capital requirement is set out in INSPRU 1.1.80 G to INSPRU 1.1.91 R below.

General insurance capital requirement

INSPRU 1.1.44

See Notes

handbook-guidance
In relation to the MCR (see INSPRU 1.1.43 G), GENPRU 2.1.34 R requires a firm to calculate its general insurance capital requirement (GICR) as the highest of the premiums amount, the claims amount, and the brought forward amount. The elements for this computation are set out in INSPRU 1.1 as follows:

The premiums amount

INSPRU 1.1.45

See Notes

handbook-rule
The premiums amount is:
(1) 18% of the gross adjusted premiums amount; less 2% of the amount, if any, by which the gross adjusted premiums amount exceeds 53.1 million; multiplied by
(2) the reinsurance ratio set out in INSPRU 1.1.54 R.

INSPRU 1.1.46

See Notes

handbook-guidance
Rules and guidance as to how the gross adjusted premiums amount is to be calculated are set out in INSPRU 1.1.56 R to INSPRU 1.1.59 G.

The claims amount

INSPRU 1.1.47

See Notes

handbook-rule
The claims amount is:
(1) 26% of the gross adjusted claims amount; less 3% of the amount, if any, by which the gross adjusted claims amount exceeds 37.2 million; multiplied by
(2) the reinsurance ratio set out in INSPRU 1.1.54 R.

INSPRU 1.1.48

See Notes

handbook-guidance
Rules and guidance as to how the gross adjusted claims amount is to be calculated are set out in INSPRU 1.1.60 R to INSPRU 1.1.65 G.

INSPRU 1.1.49

See Notes

handbook-guidance
(1) Under the Insurance Directives the Euro amounts specified in INSPRU 1.1.45R (1) and INSPRU 1.1.47R (1) are subject to annual review. The relevant amounts will be increased by the percentage change in the European index of consumer prices (comprising all EU member states, as published by Eurostat) from 20 March 2002, to the relevant review date, rounded up to a multiple of 100,000, provided that where the percentage change since the last increase is less than 5%, no increase will take place.
(2) No provision for the index-linking of these amounts is made by the Reinsurance Directive. However, to ensure consistency as between pure reinsurers, mixed insurers and other insurers, the FSA intends to amend the Euro amounts specified in INSPRU 1.1.45R (1) and INSPRU 1.1.47R (1) for all such firms when an index-linked increase is required by the Insurance Directives.

INSPRU 1.1.50

See Notes

handbook-rule
For the purposes of INSPRU 1.1.45R (1) and INSPRU 1.1.47R (1), the exchange rate from the Euro to the pound sterling for each year beginning on 31 December is the rate applicable on the last day of the preceding October for which the exchange rates for the currencies of all the European Union member states were published in the Official Journal of the European Union.

The brought forward amount

INSPRU 1.1.51

See Notes

handbook-rule
The brought forward amount is the general insurance capital requirement (GICR) for the prior financial year, multiplied, if the ratio is less than one, by the ratio (expressed as a percentage) of:
(1) the technical provisions (calculated net of reinsurance) for claims outstanding at the end of the prior financial year, determined in accordance with INSPRU 1.1.12 R; to
(2) the technical provisions (calculated net of reinsurance) for claims outstanding at the beginning of the prior financial year, determined in accordance with INSPRU 1.1.12 R.

INSPRU 1.1.52

See Notes

handbook-guidance
The brought forward amount is the same as the GICR for the prior financial year, except where claims outstanding have fallen during that financial year. If they have fallen, the brought forward amount is itself reduced by the same percentage fall.

INSPRU 1.1.53

See Notes

handbook-guidance
If the GICR for the prior financial year is less than the premiums amount or the claims amount, then a brought forward amount is not required to be calculated.

Reinsurance ratio used in calculating the premiums amount and the claims amount

INSPRU 1.1.54

See Notes

handbook-rule
The reinsurance ratio referred to in INSPRU 1.1.45R (2) and INSPRU 1.1.47R (2) is:
(1) if the ratio lies between 50% and 100%, the ratio (expressed as a percentage) of:
(a) the claims incurred (net of reinsurance) in the financial year in question and the two previous financial years; to
(b) the gross claims incurred in that three-year period;
(2) 50%, if the ratio calculated in (a) and (b) of (1) is 50% or less; and
(3) 100%, if the ratio calculated in (a) and (b) of (1) is 100% or more.

INSPRU 1.1.54A

See Notes

handbook-guidance
For the treatment of amounts recoverable from ISPVs when calculating the reinsurance ratio, see INSPRU 1.1.92A R and INSPRU 1.1.92B G.

INSPRU 1.1.55

See Notes

handbook-guidance
Rules and guidance as to how the net and gross claims are to be calculated are set out in INSPRU 1.1.66 R to INSPRU 1.1.71 R.

Gross adjusted premiums amount used in calculating the premiums amount

INSPRU 1.1.56

See Notes

handbook-rule
For the purpose of INSPRU 1.1.45 R, the gross adjusted premiums amount is the higher of the gross written premiums and gross earned premiums (as adjusted in accordance with INSPRU 1.1.66 R) for the financial year in question, adjusted by:
(1) except for a pure reinsurer which became a firm in run-off before 31 December 2006 and whose Part IV permission has not subsequently been varied to add back the regulated activity of effecting contracts of insurance, increasing by 50% the amount included in respect of the premiums for general insurance businessclasses 11, 12 and 13;
(2) deducting 66.7% of the premiums for actuarial health insurance that meets the conditions set out in INSPRU 1.1.72 R; and
(3) multiplying the resulting figure by 12 and dividing by the number of months in the financial year. For the purposes of this calculation, the number of months in the financial year is the number of complete calendar months in the financial year plus any fractions of a month at the beginning and the end of the financial year.

INSPRU 1.1.57

See Notes

handbook-guidance
A firm may use statistical methods in order to allocate premiums in respect of the classes 11, 12 and 13 for the purposes of INSPRU 1.1.56 R.

INSPRU 1.1.58

See Notes

handbook-guidance
General insurance business classes 11, 12 and 13 are, respectively, the marine liability, aviation liability and general liability insurance classes.

INSPRU 1.1.59

See Notes

handbook-guidance
Where the firm did not carry on insurance business in the financial year in question, the gross adjusted premiums amount, and therefore the premiums amount, is nil.

Gross adjusted claims amount used in calculating the claims amount

INSPRU 1.1.60

See Notes

handbook-rule
For the purpose of INSPRU 1.1.47 R and subject to INSPRU 1.1.62 R, the gross adjusted claims amount is the amount of gross claims incurred (as determined in accordance with INSPRU 1.1.66 R) over the reference period (as specified in INSPRU 1.1.63 R) and adjusted by:
(1) except for a pure reinsurer which became a firm in run-off before 31 December 2006 and whose Part IV permission has not subsequently been varied to add back the regulated activity of effecting contracts of insurance, increasing by 50% the amount included in respect of the claims incurred for 11, 12 and 13;
(2) deducting 66.7% of the claims for actuarial health insurance that meets the conditions set out in INSPRU 1.1.72 R; and
(3) multiplying the resulting figure by 12 and dividing by the number of months in the reference period. For the purposes of this calculation, the number of months in the reference period is the number of complete calendar months in the reference period plus any fractions of a month at the beginning and the end of the reference period.

INSPRU 1.1.61

See Notes

handbook-guidance
A firm may use statistical methods in order to allocate claims in respect of classes 11, 12 and 13 for the purposes of INSPRU 1.1.60 R.

INSPRU 1.1.62

See Notes

handbook-rule
For the purposes of INSPRU 1.1.47 R, in relation to general insurance businessclass 18, the amount of claims incurred used to calculate the gross adjusted claims amount must be the amount of costs recorded in the firm's books in the reference period as borne by the firm (whether or not borne in the reference period) in respect of the assistance given.

INSPRU 1.1.63

See Notes

handbook-rule
(1) Except in those cases where paragraph (2) applies, the reference period to be used in INSPRU 1.1.60 R and INSPRU 1.1.62 R must be:
(a) the financial year in question and the two previous financial years; or
(b) the period the firm had been in existence at the end of the financial year in question, if shorter.
(2) In the case of a firm which underwrites only one or more of the general insurance business risks of credit, storm, hail or frost (including other business written in connection with such risks), the reference period to be used must be:
(a) the financial year in question and the six previous financial years; or
(b) the period the firm had been in existence at the end of the financial year in question, if shorter.

INSPRU 1.1.64

See Notes

handbook-guidance
The classification of the risks referred to in INSPRU 1.1.63R (2) is as follows: credit - as included in general insurance businessclass 14; storm - as included in general insurance businessclass 8; hail - as included in general insurance businessclass 9; and frost - as included in general insurance businessclass 9.

INSPRU 1.1.65

See Notes

handbook-guidance
Where the firm did not carry on insurance business in the reference period, the gross adjusted claims amount, and therefore the claims amount, is nil.

Accounting for premiums and claims

INSPRU 1.1.66

See Notes

handbook-rule
For the purposes of INSPRU 1.1.54 R, INSPRU 1.1.56 R, INSPRU 1.1.60 R and INSPRU 1.1.62 R, amounts of premiums and claims must be:
(1) determined in accordance with the insurance accounts rules or the Friendly Societies (Accounts and Related Provisions) Regulations 1994, as appropriate; and
(2) adjusted for transfers that were approved by the relevant authority (or became effective where approval by an authority was not required) before the end of the financial year in question:
(a) to exclude any amount included in, or adjustment made to, premiums and claims to reflect the consideration for a transfer of contracts of insurance to or from the firm;
(b) to exclude premiums and claims which arose from contracts of insurance that have been transferred by the firm to another body; and
(c) to account for premiums and claims which arose from contracts of insurance that have been transferred to the firm from another body as if they were receivable by or payable by the firm.

INSPRU 1.1.67

See Notes

handbook-guidance
To ensure that all rights and obligations under a contract of insurance are transferred, a number of alternative mechanisms could be used. These are: an insurance business transfer under Part VII of the Act; under earlier United Kingdom insurance legislation; under equivalent foreign legislation; or by novation of contracts. The term "relevant authority" in paragraph (2) of INSPRU 1.1.66 R may refer to whatever body has responsibility in a country, whether within or outside the EEA, for the approval of transfers of portfolios of contracts of insurance; the body may be a supervisory authority for financial services as such or it may be a judicial authority which has the necessary responsibility.

INSPRU 1.1.68

See Notes

handbook-guidance
INSPRU 1.1.66R (2)(b) requires a firm, for the purpose of calculating its GICR, to account for contracts of insurance transferred by it to another body as if it had never written those contracts. All amounts of premiums and claims arising in respect of those contracts are excluded, including amounts that arose in the financial year in question or previous financial years.

INSPRU 1.1.69

See Notes

handbook-guidance
Conversely, INSPRU 1.1.66R (2)(c) requires a firm, for the purpose of calculating its GICR, to account for contracts of insurance transferred to it by another body as if it had been responsible for those contracts from inception and not merely from the date of transfer. All amounts of premiums and claims that arose from those contracts are included even where they arose prior to the date of transfer and were, in fact, receivable by or payable by the other body.

INSPRU 1.1.70

See Notes

handbook-guidance
For both transfers to and from the firm, the consideration receivable or payable in respect of the transfer is excluded from premiums and claims in order to avoid double counting.

INSPRU 1.1.71

See Notes

handbook-rule
Where there has been a significant change in the business portfolio of the firm since the end of the financial year in question, for example, a line of business has been transferred to another firm, or the firm no longer carries on a particular class of insurance business, the gross adjusted premiums amount and the gross adjusted claims amount must both be recalculated to take into account the impact of this change. The recalculation must take into account the requirements of the insurance accounts rules or the Friendly Societies (Accounts and Related Provisions) Regulations 1994, as appropriate.

Actuarial health insurance

INSPRU 1.1.72

See Notes

handbook-rule
The conditions referred to in INSPRU 1.1.56R (2) and INSPRU 1.1.60R (2) are that:
(1) the health insurance is underwritten on a similar technical basis to that of life insurance;
(2) the premiums paid are calculated on the basis of sickness tables according to the mathematical method applied in insurance;
(3) a provision is set up for increasing age;
(4) an additional premium is collected in order to set up a safety margin of an appropriate amount;
(5) it is not possible for the firm to cancel the contract after the end of the third year of insurance; and
(6) the contract provides for the possibility of increasing premiums or reducing payments even for current contracts.

Enhanced capital requirement for general insurance business

INSPRU 1.1.72A

See Notes

handbook-guidance
This section sets out the requirement for firms carrying on general insurance business, other than non-directive insurers, to calculate their ECR. The ECR for firms carrying on general insurance business is an indicative measure of the capital resources that a firm may need to hold based on risk sensitive calculations applied to its business profile. For firms carrying on general insurance business, the FSA will use the ECR as a benchmark for its consideration of the appropriateness of the firm's own capital assessment. For firms where an ECR is not calculated, the MCR will provide a benchmark for the firm's own capital assessment.

INSPRU 1.1.72B

See Notes

handbook-rule
A firm carrying on general insurance business, other than a non-directive insurer, must calculate the amount of its ECR.

INSPRU 1.1.72C

See Notes

handbook-rule
A firm to which INSPRU 1.1.72B R applies must calculate its ECR in respect of its general insurance business as the sum of:

INSPRU 1.1.72D

See Notes

handbook-guidance
Details of the calculation of the asset-related capital requirement are set out in INSPRU 2.2.10 R to INSPRU 2.2.16 R. Details of the calculation of the insurance-related capital requirement are set out in INSPRU 1.1.76 R to INSPRU 1.1.79 R.

Insurance-related capital requirement

INSPRU 1.1.73

See Notes

handbook-guidance
[intentionally blank]

INSPRU 1.1.74

See Notes

handbook-guidance
The insurance-related capital requirement is a measure of the capital that a firm should hold against the risk of:
(1) an adverse movement in the value of a firm's liabilities, to recognise that there may be substantial volatility in claims and other technical provisions made by the firm. Such variations may be due to inflationary increases, interest rate changes, movements in the underlying provisions themselves, changes in expense costs, inadequate rate pricing or premium collections (or both) from intermediaries differing from projected assumptions; and
(2) the premiums a firm charges in respect of particular business not being adequate to fund future liabilities arising from that business.

INSPRU 1.1.75

See Notes

handbook-guidance
The insurance-related capital requirement is calculated by applying capital charge factors, expressed as a percentage, to the value of the net written premiums and the technical provisions in respect of different classes of business. Firms should refer to GENPRU 1.3.4 R which sets out how a firm must recognise and value assets and liabilities.

Calculation of the insurance-related capital requirement

INSPRU 1.1.76

See Notes

handbook-rule
A firm must calculate its insurance-related capital requirement in accordance with INSPRU 1.1.77 R.

INSPRU 1.1.77

See Notes

handbook-rule
(1) The value of:in respect of each class of business listed in the table in INSPRU 1.1.79 R must be multiplied by the corresponding capital charge factor.
(2) If any amount which is to be multiplied by a capital charge factor is a negative amount, that amount shall be treated as zero.
(3) The amounts resulting from multiplying the net written premiums in respect of each such class of business by the corresponding capital charge factor must be aggregated.
(4) The amounts resulting from multiplying the technical provisions in respect of each such class of business by the corresponding capital charge factor must be aggregated.
(5) The insurance-related capital requirement is the sum of the amounts calculated in accordance with (3) and (4).

INSPRU 1.1.78

See Notes

handbook-rule
In INSPRU 1.1.77 R references to technical provisions comprise:
(1) outstanding claims;
(2) provisions for incurred but not reported (IBNR) claims;
(3) provisions for incurred but not enough reported (IBNER) claims;
(5) unexpired risk reserves;
in each case net of reinsurance receivables.

INSPRU 1.1.79

See Notes

handbook-rule
Table: Insurance-related Capital Charge Factors

Long-term insurance capital requirement

Insurance death risk capital component

INSPRU 1.1.81

See Notes

handbook-rule
The insurance death risk capital component is the aggregate of the amounts which represent the fractions specified by INSPRU 1.1.82 R of the capital at risk, defined in INSPRU 1.1.83 R, for each category of contracts of insurance (as specified in INSPRU 1.1.81A R), in respect of those contracts where the capital at risk is not a negative figure, multiplied by the higher of:
(1) 50%; and
(2) the ratio as at the end of the financial year in question of:
(a) the aggregate capital at risk in respect of that category of contracts net of reinsurance cessions; to
(b) the aggregate capital at risk in respect of that category of contracts gross of reinsurance cessions.

INSPRU 1.1.81A

See Notes

handbook-rule
For the purpose of INSPRU 1.1.81 R, the categories of contracts of insurance are as follows:
(1) contracts which fall in long-term insurance businessclasses I, II or IX; and
(2) contracts which fall in long-term insurance businessclasses III, VII or VIII.

INSPRU 1.1.82

See Notes

handbook-rule
For the purpose of INSPRU 1.1.81 R, the fraction is:
(1) for long-term insurance businessclasses I, II and IX, except for a pure reinsurer:
(a) 0.1% for temporary insurance on death where the original term of the contract is three years or less;
(b) 0.15% for temporary insurance on death where the original term of the contract is five years or less but more than three years; and
(c) 0.3% in any other case;
(2) 0.3% for long-term insurance businessclasses III, VII and VIII, except for a pure reinsurer; and
(3) 0.1% for a pure reinsurer.

INSPRU 1.1.83

See Notes

handbook-rule
For the purpose of INSPRU 1.1.81 R, the capital at risk is:
(1) where the benefit under a contract of insurance payable as a result of death includes periodic or deferred payments, the present value of the benefits payable; and
(2) in any other case, the amount payable as a result of death;
less, in either case, the mathematical reserves for the contract.

INSPRU 1.1.83A

See Notes

handbook-rule
INSPRU 1.1.81 R does not apply to:
(1) a pure reinsurer; or
in respect of life protection reinsurance business.

INSPRU 1.1.84

See Notes

handbook-guidance
The insurance death risk capital component only relates to the risk of death. There is a separate risk component for insured health risks (class IV) which also applies to the risk of death covered in the life protection reinsurance business of pure reinsurers and mixed insurers. Tontines (class V) and capital redemption operations (class VI) also have separate risk components. There is no specified risk margin for other insured risks.

INSPRU 1.1.84A

See Notes

handbook-guidance
For the treatment of amounts recoverable from ISPVs when calculating the insurance death risk capital component in accordance with INSPRU 1.1.81 R, see INSPRU 1.1.92A R and INSPRU 1.1.92B G.

Insurance health risk and life protection reinsurance capital component

INSPRU 1.1.85

See Notes

handbook-rule
The insurance health risk and life protection reinsurance capital component is the highest of:
(1) the premiums amount (determined in accordance with INSPRU 1.1.45 R);
(2) the claims amount (determined in accordance with INSPRU 1.1.47 R); and
(3) the brought forward amount (determined in accordance with INSPRU 1.1.51 R); in respect of:
(b) risks falling in general insurance businessclasses 1 or 2 that are written as part of a long-term insurance contract; and

INSPRU 1.1.86

See Notes

handbook-rule
For the purposes of INSPRU 1.1.85 R, in the case of contracts of insurance falling in long-term insurance businessclass IV, condition (3) as set out in INSPRU 1.1.72 R (actuarial health insurance) is modified to: "either the reserves include a provision for increasing age, or the business is conducted on a group basis.".

Insurance expense risk capital component

INSPRU 1.1.88

See Notes

handbook-rule
The insurance expense risk capital component is:
(1) in respect of long-term insurance businessclasses III, VII and VIII, an amount equivalent to 25% of the net administrative expenses in the financial year in question relevant to the business of each of those classes, in so far as the firm bears no investment risk and the allocation to cover management expenses in the contract of insurance does not have a fixed upper limit which is effective as a limit for a period exceeding 5 years from the commencement of the contract;
(2) in respect of any tontine (long-term insurance businessclass V), 1% of the assets of the tontine;
(3) in the case of any other long-term insurance business, 1% of the "adjusted mathematical reserves" (as defined in INSPRU 1.1.89A R).

INSPRU 1.1.88A

See Notes

handbook-rule

Insurance market risk capital component

INSPRU 1.1.89

See Notes

handbook-rule
The insurance market risk capital component is 3% of the "adjusted mathematical reserves" (as defined in INSPRU 1.1.89A R) for all insurance liabilities except those of a kind which:
(1) arise from contracts of insurance falling in long-term insurance businessclasses III, VII or VIII to the extent that the firm does not bear any investment risk; or

Adjusted mathematical reserves

INSPRU 1.1.89A

See Notes

handbook-rule
(1) For the purpose of INSPRU 1.1.88 R and INSPRU 1.1.89 R, the "adjusted mathematical reserves" is the aggregate of the amounts which result from the performance of the calculation in INSPRU 1.1.90 R for each category of insurance liability specified in (2).
(2) The categories of insurance liability referred to in (1) are:
(a) for the purpose of INSPRU 1.1.88 R, those categories described in INSPRU 1.1.91R (1), (2), (3), (4) and (5); and
(b) for the purpose of INSPRU 1.1.89 R, those categories described in INSPRU 1.1.91R (1), (2), (4) and (5).

INSPRU 1.1.90

See Notes

handbook-rule
The calculation referred to in INSPRU 1.1.89AR (1) is the multiplication of the amount of the mathematical reserves (gross of reinsurance cessions) in respect of a category of insurance liability by the higher of:
(1) 85% or, in the case of a pure reinsurer, 50%; and
(2) the ratio as at the end of the financial year in question of:
(a) the mathematical reserves in respect of that category of insurance liability net of reinsurance cessions; to
(b) the mathematical reserves in respect of that category of insurance liability gross of reinsurance cessions.

INSPRU 1.1.91

See Notes

handbook-rule
For the purpose of INSPRU 1.1.89A R and INSPRU 1.1.90 R, the categories of insurance liability are as follows:
(1) liabilities of a kind which arise from contracts of insurance falling in long-term insurance businessclasses I, II or IX;
(2) liabilities of a kind which arise from contracts of insurance falling in long-term insurance businessclasses III, VII or VIII to the extent that the firm bears an investment risk;
(3) liabilities of a kind which arise from contracts of insurance falling in long-term insurance businessclasses III, VII or VIII to the extent that the firm bears no investment risk and where the allocation to cover management expenses in the contract of insurance has a fixed upper limit which is effective as a limit for a period exceeding 5 years from the commencement of the contract;
(4) liabilities of a kind which arise from contracts of insurance falling in long-term insurance businessclass IV; and
(5) liabilities of a kind which arise from contracts of insurance falling in long-term insurance businessclass VI.

INSPRU 1.1.92

See Notes

handbook-guidance
Where a firm has written a unit-linked contract, the firm's liability under the contract may consist of a unit liability, where the firm bears no investment risk, and other liabilities for which the firm bears an investment risk, and for which a separate reserve is held. INSPRU 1.1.91R (2) and (3) require a firm to analyse its liabilities under unit-linked contracts between those for which it bears an investment risk and those for which it does not. INSPRU 1.1.88 R and INSPRU 1.1.89 R taken together result in a capital requirement for any liabilities for which the firm bears an investment risk of 4% of "adjusted mathematical reserves" (1% for expense risk and 3% for market risk).

Insurance special purpose vehicles

INSPRU 1.1.92A

See Notes

handbook-rule
A firm must not treat any amounts recoverable from an ISPV as reinsurance for the purposes of the calculation of:
(1) the reinsurance ratio in accordance with INSPRU 1.1.54 R; or
(3) the "adjusted mathematical reserves" in accordance with INSPRU 1.1.90 R.

INSPRU 1.1.92B

See Notes

handbook-guidance
A firm may treat amounts recoverable from an ISPV as reinsurance for these purposes if it obtains a waiver of INSPRU 1.1.92A R under section 148 of the Act. The conditions that will need to be met, in addition to the statutory tests under section 148(4) of the Act, before the FSA will consider granting such a waiver are set out in INSPRU 1.6.13 G to INSPRU 1.6.18 G

Application of INSPRU 1.1 to Lloyd's

INSPRU 1.1.93

See Notes

handbook-rule
INSPRU 1.1 applies to the Society in accordance with INSPRU 8.1.2 R.

INSPRU 1.1.94

See Notes

handbook-rule
The following rules and guidance apply to managing agents in accordance with INSPRU 8.1.4 R:
(1) INSPRU 1.1.13 G to INSPRU 1.1.20 R (except INSPRU 1.1.13R(1));

INSPRU 1.1.95

See Notes

handbook-rule
The Society must calculate the brought forward amount for the members in aggregate in accordance with INSPRU 1.1.51 R, using the result of GENPRU 2.3.6 R for the prior financial year and the aggregate of all members'technical provisions for the relevant periods.

INSPRU 1.1.96

See Notes

handbook-rule
For the purposes of INSPRU 1.1.66 R and further to that rule, in the case of Lloyd's members, amounts of premiums and claims must be adjusted for approved reinsurance to close to exclude any amount included in, or adjustment made to, premiums and claims to reflect the consideration for an approved reinsurance to close.

INSPRU 1.2

Mathematical reserves

Application

INSPRU 1.2.1

See Notes

handbook-rule

Purpose

INSPRU 1.2.2

See Notes

handbook-guidance
This section follows on from the overall requirement on firms to establish adequate technical provisions (see INSPRU 1.1.16 R). The mathematical reserves form the main component of technical provisions for long-term insurance business. INSPRU 1.2 sets out rules and guidance as to the methods and assumptions to be used in calculating the mathematical reserves. The rules and guidance set out the minimum basis for mathematical reserves. Methods and assumptions that produce reserves that are demonstrably equal to or greater than the minimum basis may also be used, though they must meet the basic requirements for methods and assumptions set out in INSPRU 1.2.7 R to INSPRU 1.2.27 G.

INSPRU 1.2.3

See Notes

handbook-guidance
This section applies to all firms carrying on long-term insurance business and implements some of the requirements contained in article 20 of the Consolidated Life Directive. The implementation is designed to ensure that a firm'smathematical reserves in respect of long-term insurance contracts meet the minimum requirements set by the Consolidated Life Directive. A firm may use a prospective or a retrospective method to value its mathematical reserves (see INSPRU 1.2.7 R).

INSPRU 1.2.4

See Notes

handbook-guidance
The required procedures are summarised in the flowchart in INSPRU 1 Annex 1.

INSPRU 1.2.5

See Notes

handbook-guidance
Firms to which GENPRU 2.1.18 R applies are required to calculate a with-profits insurance capital component (see GENPRU 2.1.38 R). In order to calculate its with-profits insurance capital component, such a firm is required to carry out additional calculations of its liabilities on a realistic basis (see INSPRU 1.3), which it is required to report to the FSA (see Forms 18,19). A firm that reports its liabilities on a realistic basis is referred to in PRU as a realistic basis life firm. Such firms are subject to different rules relating to the calculation of mathematical reserves (see INSPRU 1.2.46 R and INSPRU 1.2.76 R) compared with those that apply to firms that report on a regulatory basis only (regulatory basis only life firms).

INSPRU 1.2.6

See Notes

handbook-guidance
A number of the rules in this section require a firm to take into account its regulatory duty to treat customers fairly. In this section, references to such a duty are to a firm's dutyto pay due regard to the interests of its customers and to treat them fairly (see Principle 6 in PRIN). This duty is owed to both policyholders and potential policyholders.

Basic valuation method

INSPRU 1.2.7

See Notes

handbook-rule
(1) Subject to (2), a firm must establish its mathematical reserves using a prospective actuarial valuation on prudent assumptions of all future cash flows expected to arise under, or in respect of, each of its long-term insurance contracts.
(2) But a firm may use a retrospective actuarial valuation where:
(a) a prospective method cannot be applied to a particular type of contract; or
(b) the firm can demonstrate that the resulting amount of the mathematical reserves would be no lower than would be required by a prudent prospective actuarial valuation.

INSPRU 1.2.8

See Notes

handbook-guidance
A prospective valuation sets the mathematical reserves at the present value of future net cash flows. A retrospective method typically sets the mathematical reserves at the level of premiums received (and accumulated with investment return), less claims and expenses paid. A prospective valuation is preferred because it takes account of circumstances that might have arisen since the premium rate was set and of changes in the perception of future experience. Circumstances in which a retrospective valuation might be appropriate include:
(1) where the assumptions initially made in determining the premium rate were sufficiently prudent at inception and have not been overtaken by subsequent events; and
(2) where the liability depends on the emerging experience.

INSPRU 1.2.9

See Notes

handbook-rule
Except in INSPRU 1.2.71R (1), INSPRU 1.2 does not apply to final bonuses. In addition, for realistic basis life firms only, INSPRU 1.2 does not apply to other discretionary benefits, including future annual bonuses.

Methods and assumptions

INSPRU 1.2.10

See Notes

handbook-rule
In the actuarial valuation under INSPRU 1.2.7 R, a firm must use methods and prudent assumptions which:
(1) are appropriate to the business of the firm;
(2) are consistent from year to year without arbitrary changes (see INSPRU 1.2.11 G);
(3) are consistent with the method of valuing assets (see GENPRU 1.3);
(4) include appropriate margins for adverse deviation of relevant factors (see INSPRU 1.2.12 G);
(5) recognise the distribution of profits (that is, emerging surplus) in an appropriate way over the duration of each contract of insurance;
(6) take into account its regulatory duty to treat its customers fairly (see Principle 6); and
(7) are in accordance with generally accepted actuarial practice.

INSPRU 1.2.11

See Notes

handbook-guidance
INSPRU 1.2.10R (2) prohibits only arbitrary changes in methods and assumptions, that is, changes made without adequate reasons. Any such changes would hinder comparisons over time as to the amount of the mathematical reserves and so obscure trends in solvency and the emergence of surplus.

INSPRU 1.2.12

See Notes

handbook-guidance
The relevant factors referred to in INSPRU 1.2.10R (4) may include, but are not limited to, factors such as future investment returns, expenses, mortality, morbidity, options, persistency and reinsurance (see also INSPRU 1.2.13 R to INSPRU 1.2.19 G).

Margins for adverse deviation

INSPRU 1.2.13

See Notes

handbook-rule
The appropriate margins for adverse deviation required by INSPRU 1.2.10R (4) must be sufficiently prudent to ensure that there is no significant foreseeable risk that liabilities to policyholders in respect of long-term insurance contracts will not be met as they fall due.

INSPRU 1.2.14

See Notes

handbook-guidance
The margins for adverse deviation are a prudential margin in respect of the risks that arise under a long-term insurance contract.

INSPRU 1.2.15

See Notes

handbook-guidance
INSPRU 1.2.13 R sets the normal standard of prudence required for margins. INSPRU 1.2.16 G suggests benchmarks against which a firm should compare the margins it has set in accordance with INSPRU 1.2.10R (4) and INSPRU 1.2.13 R. INSPRU 1.2.17 G gives guidance where a market risk premium is not readily obtainable.

INSPRU 1.2.16

See Notes

handbook-guidance
When setting the margins for adverse deviation required by INSPRU 1.2.10R (4) in relation to a particular contract, a firm should consider, where appropriate:
(1) the margin for adverse deviation included in the premium for similar long-term insurance contracts, if any, newly issued by the firm; and
(2) where a sufficiently developed and diversified market for transferring a risk exists, the risk premium that would be required by an unconnected party to assume the risk in respect of the contract.
The margin for adverse deviation of a risk should generally be greater than or equal to the relevant market price for that risk.

INSPRU 1.2.17

See Notes

handbook-guidance
Where a risk premium is not readily available, or cannot be determined, an external proxy for the risk should be used, such as adjusted industry mortality tables. Where there is a considerable range of possible outcomes, the PRA FSA expects firms to use stochastic techniques to evaluate these risks. In time, for example, longevity risk, where this constitutes a significant risk for the firm, may fall into this category.

INSPRU 1.2.18

See Notes

handbook-guidance
The margins for adverse deviation should be recognised as profit only as the firm itself is released from risk over the duration of the contract.

INSPRU 1.2.19

See Notes

handbook-guidance
Further detailed rules and guidance on margins for adverse deviation are included in INSPRU 1.2.32 G to INSPRU 1.2.89 G. In particular, the cross-references for the different assumptions used in calculating the mathematical reserves are as follows:
(1) expenses (INSPRU 1.2.50 R to INSPRU 1.2.58 G);
(2) mortality and morbidity (INSPRU 1.2.59 R to INSPRU 1.2.61 G);
(4) persistency (INSPRU 1.2.76 R andINSPRU 1.2.77 G); and

The rules and guidance on margins for adverse deviation in respect of future investment returns, which are also required in the calculation of mathematical reserves, are set out in INSPRU 3.1.28 R to INSPRU 3.1.48 G.

Record keeping

INSPRU 1.2.20

See Notes

handbook-rule
A firm must make, and retain for an appropriate period, a record of:
(1) the methods and assumptions used in establishing its mathematical reserves, including the margins for adverse deviation, and the reasons for their use; and
(2) the nature of, reasons for, and effect of, any change in approach, including the amount by which the change in approach increases or decreases its mathematical reserves.

INSPRU 1.2.21

See Notes

handbook-guidance
SYSC 14.1.53 R requires firms to maintain accounting and other records for a minimum of three years, or longer as appropriate. For the purposes of INSPRU 1.2.20 R, a period of longer than three years will be appropriate for a firm'slong-term insurance business. In determining an appropriate period, a firm should have regard to:
(1) the detailed rules and guidance on record keeping in SYSC 14.1.51 G - SYSC 14.1.64 G;
(2) the nature and term of the firm's long-term insurance business; and
(3) any additional provisions or statutory requirements applicable to the firm or its records.

Valuation of individual contracts

INSPRU 1.2.22

See Notes

handbook-rule
(1) Subject to (2) and (3), a firm must determine the amount of the mathematical reserves separately for each long-term insurance contract.
(2) Approximations or generalisations may be made:
(a) in the case of non-attributable expenses, in relation to a group of contracts with the same or similar expense risk characteristics, provided that the mathematical reserves in respect of such expenses established by the firm in relation to that group of contracts have a minimum value of at least zero; and
(b) in any other case, where they are likely to provide the same, or a higher, result than a determination made in accordance with (1).
(3) A firm must set up additional mathematical reserves on an aggregated basis for general risks that are not specific to individual contracts.
(4) For the purpose of (2), non-attributable expenses are expenses which are not directly attributable to a particular long-term insurance contract.

INSPRU 1.2.23

See Notes

handbook-guidance
INSPRU 1.2.22 R to INSPRU 1.2.89 G set out rules and guidance for the separate prospective valuation of each contract. These may be applied instead to groups of contracts where the conditions set out in INSPRU 1.2.22R (2)(a) or (b) are satisfied. Guidance on non-attributable expenses and the application of INSPRU 1.2.22R (2)(a) is provided in INSPRU 1.2.54A G.

Negative mathematical reserves

INSPRU 1.2.24

See Notes

handbook-rule
A firm may calculate a negative value for the mathematical reserves in respect of a long-term insurance contract provided that:
(1) this is based on assumptions which meet the general requirements for prudent assumptions as set out in INSPRU 1.2.10 R and INSPRU 1.2.13 R;
(2) the contract does not have a surrender value which at the actuarial valuation date is guaranteed; and
(3) the total mathematical reserves established by the firm have a minimum value of at least:
(a) where the firm's long-term insurance contracts include linked long-term contracts, the sum of the surrender values of all its linked long-term contracts at the actuarial valuation date; and
(b) in any other case, zero.

INSPRU 1.2.25

See Notes

handbook-guidance
A separate prospective valuation for each contract may identify contracts for which the value of future cash inflows under and in respect of the contract exceeds that of outflows. In these circumstances, the firm may calculate the mathematical reserves for that contract as having a negative value and that value is available to off-set mathematical reserves for other contracts which have a positive value when establishing the overall mathematical reserves. However, the Consolidated Life Directive requires that no contract should be valued at less than its guaranteed surrender value (see INSPRU 1.2.62A G). As a result, no contract with a guaranteed surrender value to which the Consolidated Life Directive applies should be valued as if it were an asset. Although the Reinsurance Directive does not require this treatment of contracts with guaranteed surrender values to be applied to pure reinsurers, the FSA's policy is that there should be equal treatment in this respect. INSPRU 1.2.62 R makes further provision relating to the mathematical reserves to be established in respect of such contracts. When considering the impact that the amount payable on surrender may have on the valuation of a contract, a firm should have regard to INSPRU 1.2.71 R.

Avoidance of future valuation strain

INSPRU 1.2.26

See Notes

handbook-rule
(1) A firm must establish mathematical reserves for a contract of insurance which are sufficient to ensure that, at any subsequent date, the mathematical reserves then required are covered solely by:
(a) the assets covering the current mathematical reserves; and
(b) the resources arising from those assets and from the contract itself.
(2) For the purposes of (1), the firm must assume that:
(a) the assumptions adopted for the current valuation of liabilities remain unaltered and are met; and
(b) discretionary benefits and charges will be set so as to fulfil its regulatory duty to treat its customers fairly.
(3) Subject to (4), (1) may be applied to a group of similar contracts instead of to the individual contracts within that group.
(4) (1) must be applied to a group of contracts in relation to which mathematical reserves in respect of non-attributable expenses are established for that group of contracts in accordance with INSPRU 1.2.22R (2)(a), instead of to the individual contracts within that group.

INSPRU 1.2.27

See Notes

handbook-guidance
The valuation of each contract, or group of similar contracts, should allow for the possibility, where it exists, that contracts may be surrendered (wholly or in part), lapsed or made paid-up at any time. The valuation assumptions include margins for adverse deviation (see INSPRU 1.2.13 R). INSPRU 1.2.26 R requires mathematical reserves to be established such that, if future experience is in line with the valuation assumptions, there would be no future valuation strain.

Cash flows to be valued

INSPRU 1.2.28

See Notes

handbook-rule
In a prospective valuation, a firm must:
(1) include in the cash flows to be valued the following:
(b) expenses, including commissions (see INSPRU 1.2.50 R to INSPRU 1.2.58 G);
(c) benefits payable (see INSPRU 1.2.29 R); and
(d) subject to (2), amounts to be received or paid in respect of the long-term insurance contracts under contracts of reinsurance or analogous non-reinsurance financing agreements (see INSPRU 1.2.77A R to INSPRU 1.2.89 G); but
(2) exclude from those cash flows amounts recoverable from an ISPV.

INSPRU 1.2.28A

See Notes

handbook-guidance
A firm may include amounts recoverable from an ISPV in the cash flows to be valued in a prospective valuation if it obtains a waiver of INSPRU 1.2.28 R under section 148 of the Act. The conditions that will need to be met, in addition to the statutory tests under section 148(4) of the Act, before the FSA will consider granting such a waiver are set out in INSPRU 1.6.13 G to INSPRU 1.6.18 G.

INSPRU 1.2.29

See Notes

handbook-rule
For the purpose of INSPRU 1.2.28R (1), benefits payable include:
(1) all guaranteed benefits including guaranteed surrender values and paid-up values;
(2) vested, declared and allotted bonuses to which the policyholder is entitled;
(3) all options available to the policyholder under the terms of the contract; and
(4) discretionary benefits payable in accordance with the firm's regulatory duty to treat its customers fairly.

INSPRU 1.2.30

See Notes

handbook-guidance
All cash flows are to be valued using prudent assumptions in accordance with generally accepted actuarial practice. Cash flows may be omitted from the valuation calculations provided the reserves obtained as a result of leaving those cash flows out of the calculation are not less than would have resulted had all cash flows been included (see INSPRU 1.2.22R (2)(b)). Provision for future expenses in respect of with-profits insurance contracts (excluding accumulating with-profits policies) may be made implicitly, using the net premium method of valuation (see INSPRU 1.2.43 R below). For the purposes of INSPRU 1.2.28R (2) , any charges included in expenses should be determined in accordance with the firm's regulatory duty to treat its customers fairly.

INSPRU 1.2.31

See Notes

handbook-guidance
INSPRU 1.2.29R (4) requires regulatory basis only life firms to make allowance for any future annual bonus that a firm would expect to grant, assuming future experience is in line with the assumptions used in the calculation of the mathematical reserves. final bonuses do not have to be taken into consideration in these calculations except in relation to accumulating with-profits policies (see INSPRU 1.2.9 R). The calculations required for accumulating with-profits policies are set out in INSPRU 1.2.71R (1). For realistic basis life firms, except for accumulating with-profits policies, the mathematical reserves may be calculated without taking into account discretionary benefits, including both annual bonuses and final bonuses. For such firms full allowance for discretionary benefits is made in the calculation of the realistic value of liabilities (see INSPRU 1.3.105R (5)).

Valuation assumptions: detailed rules and guidance

INSPRU 1.2.32

See Notes

handbook-guidance
More detailed rules and guidance about the valuation of cash flows are set out in INSPRU 1.2.33 R to INSPRU 1.2.89 G.

Valuation rates of interest

INSPRU 1.2.33

See Notes

handbook-rule
In calculating the present value of future net cash flows, a firm must determine the rates of interest to be used in accordance with INSPRU 3.1.28 R to INSPRU 3.1.47 R.

INSPRU 1.2.34

See Notes

handbook-guidance
The rules in INSPRU 3.1.28 R to INSPRU 3.1.47 R set out the approach firms must take in setting margins for adverse deviation in the interest rates assumed in calculating the mathematical reserves. This includes a margin to allow for adverse deviation in market risk and, where relevant, credit risk. The requirements set out in INSPRU 3.1.28 R to INSPRU 3.1.47 R protect against the market risk that the return actually achieved on assets may fall below the market yields on assets at the actuarial valuation date.

Future premiums

INSPRU 1.2.36

See Notes

handbook-guidance
For non-profit insurance contracts no specific method of valuation for future premiums is required by INSPRU. However, the method of valuation used should be sufficiently prudent taking into account, in particular, the risk of voluntary discontinuance by the policyholder.

Future premiums: firms reporting only on a regulatory basis

INSPRU 1.2.37

See Notes

handbook-rule

INSPRU 1.2.38

See Notes

handbook-rule
(1) This rule applies to with-profits insurance contracts except accumulating with-profits policies written on a recurring single premium basis.
(2) The value attributed to a premium due in any future financial year (a future premium) must not exceed the lower of the value of:
(a) the actual premium payable under the contract; and
(b) the net premium.
(3) The net premium may be increased for deferred acquisition costs in accordance with INSPRU 1.2.43 R.

INSPRU 1.2.39

See Notes

handbook-guidance
The valuation method for future premiums in INSPRU 1.2.38 R retains the difference, if any, between the gross premium and the net premium as an implicit margin available to finance future bonuses, expenses and other costs. It thus helps to protect against the risk that adequate resources may not be available in the future to meet those costs. Where expenses are not directly attributable to a particular contract, a firm may establish mathematical reserves in respect of such expenses in relation to a group of contracts with the same or similar expense risk characteristics in accordance with INSPRU 1.2.22R (2)(a).

INSPRU 1.2.40

See Notes

handbook-rule
Where the terms of a contract of insurance have changed since it was first entered into, a firm must apply one of the methods in INSPRU 1.2.41 R in determining the net premium for the purpose of INSPRU 1.2.38R (2)(b).

INSPRU 1.2.41

See Notes

handbook-rule
A firm must treat the change referred to in INSPRU 1.2.40 R as if either:
(1) it had been included in the original contract but came into effect from the time the change became effective; or
(2) the original contract were cancelled and replaced by a new contract (with an initial premium paid on the new contract equal to the liability under the original contract immediately prior to the change); or
(3) it gave rise to two separate contracts where:
(a) all premiums are payable under the first contract and that contract provides only for such benefits as those premiums could have purchased from the firm at the date the change became effective; and
(b) no premiums are payable under the second contract and that contract provides for all the other benefits.

INSPRU 1.2.42

See Notes

handbook-guidance
INSPRU 1.2.41 R permits three alternative methods. However, the third method is only possible where a meaningful comparison can be made between the terms of the contract (as changed) and the terms upon which the firm was effecting its new contracts of insurance at the time the contract was changed.

Future net premiums: adjustment for deferred acquisition costs

INSPRU 1.2.43

See Notes

handbook-rule
(1) The amount of any increase to the net premium for deferred acquisition costs must not exceed the equivalent of the recoverable acquisition expenses spread over the period of premium payments and calculated in accordance with the rates of interest, mortality and morbidity assumed in calculating the mathematical reserves.
(2) For the purpose of (1), recoverable acquisition expenses means the amount of expenses, after allowing for the effects of taxation, which it is reasonable to expect will be recovered from future premiums payable under the contract.
(3) The recoverable acquisition expenses in (1) must not exceed the lower of:
(a) the value of the excess of actual premiums over net premiums; and
(b) 3.5% of the relevant capital sum.
(4) Recoverable acquisition expenses may be calculated as the average for a group of similar contracts weighted by the relevant capital sum for each contract.

INSPRU 1.2.44

See Notes

handbook-guidance
INSPRU 1.2.43 R allows a firm to spread acquisition costs over the lifetime of a contract of insurance, but only if it is reasonable to expect those costs to be recoverable from future premium income from that contract. Further prudence is provided by the limitation of recoverable acquisition expenses to 3.5% of the relevant capital sum. This adjustment for acquisition costs is sometimes termed a Zillmer adjustment.

INSPRU 1.2.45

See Notes

handbook-guidance
In determining the extent, if any, to which it is reasonable to expect acquisition costs to be recoverable from future premium income, the firm should make prudent assumptions as to levels of voluntary discontinuance by policyholders.

Future premiums: firms also reporting with-profits insurance liabilities on a realistic basis

INSPRU 1.2.46

See Notes

handbook-rule
(1) Subject to (2), for a realistic basis life firm, the future premiums to be valued in the calculation of the mathematical reserves for its with-profits insurance contracts must not be greater than the gross premiums payable by the policyholder.
(2) This rule does not apply to accumulating with-profits policies written on a recurring single premium basis (see INSPRU 1.2.48 R).

INSPRU 1.2.47

See Notes

handbook-guidance
The gross premium is the full amount of premium payable by the policyholder to the firm. The gross premium method contrasts with the net premium method which is required from regulatory basis only life firms (see INSPRU 1.2.37 R to INSPRU 1.2.45 G).

Future premiums: accumulating with-profits policies

INSPRU 1.2.48

See Notes

handbook-rule
(1) This rule applies to accumulating with-profits policies written on a recurring single premium basis.
(2) A firm must not attribute any value to a future premium under the contract.
(3) Any liability arising only upon the payment of that premium may be ignored except to the extent that the value of that liability upon payment would exceed the amount of that premium.

INSPRU 1.2.49

See Notes

handbook-guidance
INSPRU 1.2.48 R prohibits a firm from taking credit for recurring single premiums under accumulating with-profits policies. As there is no contractual commitment to pay any future premiums the amount and timing of which are uncertain, the recognition of any potential margins would not be prudent. Where the payment of a future premium would give rise to a liability in excess of the premium a provision should be established.

Expenses

INSPRU 1.2.50

See Notes

handbook-rule
(1) A firm must make provision for expenses, either implicitly or explicitly, in its mathematical reserves of an amount which is not less than the amount expected, on prudent assumptions, to be incurred in fulfilling its long-term insurance contracts.
(2) For the purpose of (1), expenses must be valued:
(a) after taking account of the effect of taxation;
(b) having regard to the firm's actual expenses in the last 12 months before the actuarial valuation date and any increases in expenses expected to occur in the future;
(c) after making prudent assumptions as to the effects of inflation on future increases in prices and earnings; and
(d) at no less than the level that would be incurred if the firm were to cease to transact new business 12 months after the actuarial valuation date.
(3) A firm must not rely upon an implicit provision arising from the method of valuing future premiums except to the extent that:
(a) it is reasonable to assume that expenses will be recoverable from future premiums; and
(b) the expenses would only arise if the future premiums were received.

INSPRU 1.2.51

See Notes

handbook-guidance
For with-profits insurance contracts where the net premium valuation method applies, an implicit provision arises because the future premiums valued are limited to the net premium adjusted as permitted by INSPRU 1.2.43 R. This excludes the allowance within the gross premium for expenses (other than recoverable acquisition expenses). It also excludes other margins within the actual premium that are a prudential margin in respect of the risks that arise under the contract or that are needed to provide for future discretionary benefits. To the extent that these other margins are not needed for the purpose for which they were originally established, they may also constitute an implicit provision for expenses.

INSPRU 1.2.52

See Notes

handbook-guidance
An implicit provision may also arise for other types of long-term insurance contract where, for example, no value is attributed to future premiums, but the firm is entitled to make deductions from future regular premiums before allocating them to secure policyholder benefits.

INSPRU 1.2.53

See Notes

handbook-guidance
A firm should only reduce the provision for future expenses to take account of expected taxation recoveries related to those expenses where recovery is reasonably certain, and after taking into account the assumption that the firm ceases to transact new business 12 months after the actuarial valuation date. An appropriate adjustment for discounting should be made where receipt of the taxation recoveries is not expected until significantly after the expenses are incurred.

INSPRU 1.2.54

See Notes

handbook-guidance
The firm's actual expenses in the 12 months prior to the actuarial valuation date may serve as a guide to the assumptions for future expenses, taking into consideration the mix of acquisition and renewal expenses. The expense assumptions should not be reduced to account for expected future improvements in efficiency until such efficiency improvements result in a reduced level of actual expenditure. However, the assumptions should take account of all factors which might increase costs including earnings and price inflation.

INSPRU 1.2.54A

See Notes

handbook-guidance
(1) A firm should attribute to an individual contract at least those expenses which are directly attributable to that contract including expenses which vary with the volume of business for that type of contract. Commission payments, charges to a fund on a 'per policy' basis and investment management fees are generally directly attributable. For expenses of the fund which are calculated directly based on actual expenses (and not calculated in accordance with a management services agreement), the attributable expenses will also include those costs which vary with the volume of business for that product, for example, salaries and accommodation costs of staff in a processing centre, printing and postage of communications to policyholders and associated computer services.
(2) Non-attributable expenses may include overheads which are relatively insensitive to the volume of business for the type of contract in question and an apportionment of group overheads. Examples of expenses that firms may consider non-attributable include salaries of head office staff involved in monitoring products and drafting standard communications to policyholders and allocated overheads for centralised functions such as human resources, finance and IT. Where non-attributable expenses arise in relation to a homogeneous risk group of contracts sharing the same or similar expense risk characteristics, a firm may determine the reserve for those expenses at the level of that risk group, provided that the reserve so established has a minimum value of at least zero (see INSPRU 1.2.22R (2)(a)). In identifying its homogeneous risk groups, a firm should consider all risks that impact on the level of expenses borne by contracts including persistency risk and expense inflation risk. For example, business that is subject to bulk lapse risk, such as any large group contract that would give rise to a reduction in surplus on lapse, should be considered as forming a homogeneous risk group of its own. A firm must document and justify its approach to identifying homogeneous risk groups in accordance with the record-keeping requirements of INSPRU 1.2.20 R. This approach to reserving for expenses ensures that prudent reserves are established in respect of both directly attributable and non-attributable expenses arising in relation to the firm'slong-term insurance business.

INSPRU 1.2.54B

See Notes

handbook-guidance
In valuing cash flows in respect of commissions, a firm may wish to take into account any contractual arrangements for the "clawback" or repayment of commissions already paid in the event of voluntary discontinuance of a contract of insurance. In deciding how to treat such arrangements in determining the mathematical reserves for a contract of insurance, the firm must use assumptions which meet the general requirements for prudent assumptions as set out in INSPRU 1.2.10 R and INSPRU 1.2.13 R. For example, the firm should establish prudent margins for adverse deviation in respect of the credit risk of the intermediary by whom the commission would be repayable.

INSPRU 1.2.55

See Notes

handbook-rule
The provisions for expenses (whether implicit or explicit) required by INSPRU 1.2.50 R must be sufficient to cover all the expenses of running off the firm's existing long-term insurance business including:
(1) all discontinuance costs (for example, redundancy costs and closure costs) that would arise if the firm were to cease transacting new business 12 months after the actuarial valuation date in circumstances where (and to the extent that) the discontinuance costs exceed the projected surplus available to meet such costs;
(2) all costs of continuing to service the existing business taking into account the loss of economies of scale from, and any other likely consequences of, ceasing to transact new business at that time; and
(3) the lower of:
(a) any projected valuation strain from writing new business for the 12 months following the actuarial valuation date to the extent the actual amount of that strain exceeds the projected surplus on prudent assumptions from existing business in the 12 months following the actuarial valuation date; and
(b) any projected new business expense overrun from writing new business for the 12 months following the actuarial valuation date to the extent the projected expenses exceed the expenses that the new business can support on a prudent basis.

INSPRU 1.2.56

See Notes

handbook-guidance
The provision for future expenses, whether implicit or explicit, should include a prudent margin for adverse deviation in the level and timing of expenses (see INSPRU 1.2.13 R to INSPRU 1.2.19 G). The margin should cover the risk of underestimating expenses whether due to, for example, initial under-calculation or subsequent increases in the amount of expenses. In setting the amount of the margin, the firm should take into account the extent to which:
(1) an appropriately validated method based on reliable data is used to allocate expenses as between attributable and non-attributable expenses or between acquisition and non-acquisition expenses and by product type, by distribution channel or by homogeneous risk group, as appropriate;
(2) the volume of existing and new business and its distribution by product type or distribution channel is stable or predictable;
(3) costs vary in the short, medium or long term dependent upon the volume of existing or new business and its distribution by product type or distribution channel; and
(4) cost control is well-managed.

INSPRU 1.2.57

See Notes

handbook-guidance
In setting the margin, the firm should also take into account:
(1) the length of the period over which it is necessary to project costs;
(2) the extent to which it is reasonable to expect inflation to be stable or predictable over that period; and
(3) whether, if inflation is higher than expected, it is reasonable to expect that the excess would be offset by increases in investment returns.

INSPRU 1.2.58

See Notes

handbook-guidance
Where a firm has entered into an agreement with any other person for the sharing or reimbursement of costs, in setting the margin it should take into account the potential impact of that agreement and of its discontinuance.

Mortality and Morbidity

INSPRU 1.2.59

See Notes

handbook-rule
A firm must set the assumptions for mortality and morbidity using prudent rates of mortality and morbidity that are appropriate to the country or territory of residence of the person whose life or health is insured.

INSPRU 1.2.60

See Notes

handbook-guidance
The rates of mortality or morbidity should contain prudent margins for adverse deviation (see INSPRU 1.2.13 R to INSPRU 1.2.19 G). In setting those rates, a firm should take account of:
(1) the systems and controls applied in underwriting long-term insurance contracts and whether they provide adequate protection against anti-selection (that is, selection against the firm) including:
(a) adequately defining and identifying non-standard risks; and
(b) where such risks are underwritten, allocating to them an appropriate weighting;
(2) the nature of the contractual exposure to mortality or morbidity risk including:
(a) whether lower mortality increases or decreases the firm's liability;
(b) the period of cover and whether risk charges can be varied during that period and, if so, how quickly; and
(c) whether the options in the contract give rise to a significant risk of anti-selection (for example, opportunities for voluntary discontinuance, guaranteed renewal at the option of the policyholder and rights for conversion of benefits);
(3) the credibility of the firm's actual experience as a basis for projecting future experience including:
(a) whether there is sufficient data (especially for medical or financial risks and for new types of benefit or new methods of distribution); and
(b) whether the data is reliable and has been appropriately validated;
(4) the availability and reliability of:
(a) any published tables of mortality or morbidity for the country or territory of residence of the person whose life or health is insured; and
(b) any other information as to the industry-wide insurance experience for that country or territory;
(5) anticipated or possible future trends in experience including, but only where they increase the liability:
(a) anticipated improvements in mortality;
(b) changes arising from improved detection of morbidity (including critical illnesses);
(c) diseases the impact of which may not yet be reflected fully in current experience; and
(d) changes in market segmentation (such as impaired life annuities) which, in the light of developing experience, may require different assumptions for different parts of the policy class.

INSPRU 1.2.61

See Notes

handbook-guidance
An additional provision for diseases covered by INSPRU 1.2.60G (5)(c) may be needed, in particular for unit-linked policies. In determining whether such a provision is needed a firm may take into consideration any ability to increase product charges commensurately (provided that such increase does not infringe on its regulatory duty to treat its customers fairly), but a provision would still be required for the period until such an increase could be brought into effect.

Options

INSPRU 1.2.62

See Notes

handbook-rule
When a firm establishes its mathematical reserves in respect of a long-term insurance contract, the firm must include an amount to cover any increase in liabilities which might be the direct result of its policyholder exercising an option under, or by virtue of, that contract of insurance. Where the surrender value of a contract is guaranteed, the amount of the mathematical reserves for that contract at any time must be at least as great as the value guaranteed at that time.

INSPRU 1.2.62A

See Notes

handbook-guidance
A contract has a guaranteed surrender value where the policy wording states that a surrender value is payable and either provides for a minimum amount payable on surrender or sets out a method for calculating such an amount. For example, where a unit-linked contract provides for a surrender value equal to the value of the units allocated to the contract, the firm must establish mathematical reserves for that contract greater than or equal to the value of the units allocated at the valuation date.

INSPRU 1.2.63

See Notes

handbook-guidance
An option exists where a policyholder is given a choice between alternative forms of benefit, for example, a choice between receiving a cash benefit upon maturity or an annuity at a guaranteed rate. In some cases, the contract may designate one or other of these alternatives as the principal benefit and any other as an option. This designation, in itself, is not one of substance in the context of reserving since it does not affect the policyholder's choices. Other forms of option include:
(1) the right to convert to a different contract on guaranteed terms;
(2) the right to increase cover on guaranteed terms;
(3) the right to a specified amount on surrender; and
(4) the right to a paid up value.

INSPRU 1.2.64

See Notes

handbook-guidance
The firm should provide for the benefit which the firm anticipates the policyholder is most likely to choose. Past experience may be used as a guide, but only if this is likely to give a reasonable estimate of future experience. For example, past experience of the take-up of a cash payment option instead of an annuity would not be a reliable guide, if, in the past, market rates exceeded those guaranteed in the annuity but no longer do so. Similarly, past experience on the take-up of options may not be relevant in the light of the assumptions made in respect of future interest rates and mortality rates in the valuation of the benefits.

INSPRU 1.2.65

See Notes

handbook-guidance
Many options are long-term and need careful consideration. Improving longevity, for example, can increase the value of guaranteed annuity options vesting further in the future. firms also need to have regard to the fact that policyholder behaviour can change in the future as policyholders become more aware of the value of their options. The impact on policyholder behaviour of possible changes in taxation should also be considered.

INSPRU 1.2.66

See Notes

handbook-guidance
In accordance with INSPRU 1.2.7 R and INSPRU 1.2.13 R, take-up rates for guaranteed annuity options should be assessed on a prudent basis with assumptions that include margins for adverse deviation (see INSPRU 1.2.13 R to INSPRU 1.2.19 G) that take account of current experience and the potential for future change. The firm should reserve for option take-up at least at a prudent margin over current experience for options shortly to vest. For longer term options where the option becomes increasingly valuable in the future due to projected mortality improvements, increased take-up rates should be assumed. In view of the growing uncertainty over take-up rates for projections further in the future, for guaranteed annuity option dates 20 years or more ahead at least a 95% take-up rate assumption should be made.

INSPRU 1.2.67

See Notes

handbook-guidance
Where there is considerable variation in the cost of the option depending on conditions at the time the option is exercised, and where that variation constitutes a material risk for the firm, it will generally be appropriate to use stochastic modelling. In this case prices from the asset model used in the stochastic approach should be benchmarked to relevant market asset prices before determining the value of the option. Where stochastic modelling is not undertaken, market option prices should be used to determine suitable assumptions for the valuation of the option. If no market exists for a particular option, a firm should take the value of the nearest equivalent benefit or right for which a market exists and document the way in which it has adjusted that valuation to reflect the original option.

INSPRU 1.2.68

See Notes

handbook-guidance
Where the option offers a choice between two non-discretionary financial benefits (such as between a guaranteed cash sum or a guaranteed annuity value, or between a unit value and a maturity guarantee) and where there is a wide range of possible outcomes, the firm should normally model such liabilities stochastically. In carrying out such modelling firms should take into account the likely choices to be made by policyholders in each scenario. Firms should make and retain a record of the development and application of the model.

INSPRU 1.2.69

See Notes

handbook-guidance
The value of a contract with an option is greater than the value of a similar contract without the option, that is, the option has value whether it is expected to be exercised or not. Although in theory a firm can rebalance its investments to match the expected cost of the option to the firm (including the time value of the option), this takes time to achieve and the market may move more quickly than the firm is able to respond. Also, there are likely to be transaction costs. Firms should take these aspects into consideration in setting up mathematical reserves.

INSPRU 1.2.70

See Notes

handbook-rule
(1) Where a policyholder may opt to be paid a cash amount, or a series of cash payments, the mathematical reserves for the contract of insurance established under INSPRU 1.2.7 R must be sufficient to ensure that the payment or payments could be made solely from:
(a) the assets covering those mathematical reserves; and
(b) the resources arising from those assets and from the contract itself.
(2) In (1) references to a cash amount or a series of cash payments include the amount or amounts likely to be paid on a voluntary discontinuance.
(3) For the purposes of (1), the firm must assume that:
(a) the assumptions adopted for the current valuation remain unaltered and are met; and
(b) discretionary benefits and charges will be set so as to fulfil the firm's regulatory duty to treat its customers fairly.
(4) (1) may be applied to a group of similar contracts instead of to the individual contracts within that group except where the cash amount or series of cash payments is the amount or amounts likely to be paid on a voluntary discontinuance.

INSPRU 1.2.71

See Notes

handbook-rule
For the purposes of INSPRU 1.2.70 R, a firm must assume that the amount of a cash payment secured by the exercise of an option is:
(1) in the case of an accumulating with-profits policy, the lower of:
(a) the amount which the policyholder would reasonably expect to be paid if the option were exercised, having regard to the representations made by the firm and including any expectations of a final bonus; and
(b) that amount, disregarding all discretionary adjustments;
(2) in the case of any other policy, the amount which the policyholder would reasonably expect to be paid if the option were exercised, having regard to the representations made by the firm, without taking into account any expectations regarding future distributions of profits or the granting of discretionary additions in respect of an established surplus.

INSPRU 1.2.72

See Notes

handbook-guidance
INSPRU 1.2.71R (1) applies only to accumulating with-profits policies; INSPRU 1.2.71R (2) applies to any other type of policy, including non-profit insurance contracts. In INSPRU 1.2.71R (1)(a) a firm must take into consideration, for example, a market value adjustment where such an adjustment has been described in representations made to policyholders by the firm. However, any discretionary adjustment, such as a market value adjustment, must not be included in the amount calculated in INSPRU 1.2.71R (1)(b).

Persistency assumptions

INSPRU 1.2.73

See Notes

handbook-guidance
[intentionally blank]

INSPRU 1.2.74

See Notes

handbook-rule
[intentionally blank]

INSPRU 1.2.75

See Notes

handbook-guidance
[intentionally blank]

INSPRU 1.2.76

See Notes

handbook-rule
A firm may make assumptions about voluntary discontinuance rates in the calculation of the mathematical reserves provided that those assumptions meet the general requirements for prudent assumptions as set out in INSPRU 1.2.10 R and INSPRU 1.2.13 R.

INSPRU 1.2.77

See Notes

handbook-guidance
The prudential margin in respect of assumptions of voluntary discontinuance should be validated both in relation to recent experience and to variations in future experience that might arise as a result of reasonably foreseeable changes in conditions. In particular, where estimates of experience are being made well into the future, the assumptions should contain margins that take into account the increased risk of adverse experience arising from changed circumstances. firms should also consider the possibility of anti-selection by policyholders and of variations in persistency experience for different classes and cohorts of business.

Reinsurance

INSPRU 1.2.77A

See Notes

handbook-rule
In INSPRU 1.2.78 G to INSPRU 1.2.89 G references to:
(1) reinsurance and contracts of reinsurance include analogous non-reinsurance financing agreements, including contingent loans, securitisations and any other arrangements in respect of contracts of insurance that are analogous to contracts of reinsurance in terms of the risks transferred and the finance provided;
(2) reinsured risks, in relation to a contract of reinsurance entered into by a firm, means that part of:
(a) the risks insured by the firm under long-term insurance contracts entered into by it; and
(b) the other risks arising directly from the firm'slong-term insurance business;
that have been transferred to the reinsurer under that contract of reinsurance; and
(3) reinsurance cash outflows include any reduction in policy liabilities recognised as covered under a contract of reinsurance or any reduction of any debt to the firm under or in respect of a contract of reinsurance.

INSPRU 1.2.78

See Notes

handbook-guidance
The prospective valuation of future cash flows to determine the amount of the mathematical reserves includes amounts to be received or paid under contracts of reinsurance in respect of long-term insurance business (see INSPRU 1.2.28R(4)). This applies even where those cash flows cannot be identified as related to particular long-term insurance contracts (see INSPRU 1.2.22R (3)).

INSPRU 1.2.79

See Notes

handbook-rule
A firm must value reinsurance cash flows using methods and assumptions which are at least as prudent as the methods and assumptions used to value the underlying contracts of insurance which have been reinsured. In particular:
(1) reinsurance recoveries must not be recognised unless the underlying liabilities to which they relate have also been recognised;
(2) reinsurance cash outflows that are unambiguously linked to the emergence as surplus of margins included in the valuation of existing contracts of insurance or to the exercise by a reinsurer of its rights under a termination clause need not be valued (see INSPRU 1.2.85 R); and
(3) reinsurance cash inflows that are contingent on factors or conditions other than the reinsured risks must not be valued.

INSPRU 1.2.80

See Notes

handbook-guidance
In valuing reinsurance cash flows, a firm should establish prudent margins for adverse deviation (see INSPRU 1.2.13 R to INSPRU 1.2.19 G) including margins in respect of:
(1) any uncertainty as to the amount or timing of amounts to be paid or received; and
(2) the risk of credit default by the reinsurer.

INSPRU 1.2.81

See Notes

handbook-guidance
In assessing the risk of credit default, the firm should take into account the rules and guidance in INSPRU 2.1 (Credit risk in insurance).

INSPRU 1.2.82

See Notes

handbook-guidance
It will not necessarily be appropriate to use the same assumptions in INSPRU 1.2.79 R as for the underlying contracts. For example, if only a subgroup of the original contracts is reinsured, it may be appropriate to use different mortality rates.

INSPRU 1.2.83

See Notes

handbook-guidance
Only reinsurance cash inflows that are triggered unambiguously by the reinsured risks may be valued. Reinsurance cash inflows that depend on other contingencies where the outcome does not form part of the valuation basis should not be given credit.

INSPRU 1.2.84

See Notes

handbook-guidance
Firms should assess the extent of margins in the valuation of the existing contracts of insurance where these provide implicit provision for the reinsurance cash outflows in INSPRU 1.2.79 R. Where the reinsurance asset exceeds the estimated value of the future surplus under reinsured contracts firms should assess their credit risk exposure to the reinsurer.

INSPRU 1.2.85

See Notes

handbook-rule
For the purposes of INSPRU 1.2.79R (2), the "link" must be such that a contingent liability to pay or repay the amount to the reinsurer could not arise except when, and to the extent that, the margins in the valuation of the existing contracts of insurance emerge as surplus, or the reinsurer exercises its rights under a termination clause in the contract of reinsurance as a result of:
(1) fraudulent conduct by the firm under or in relation to the contract of reinsurance; or
(2) a representation as to the existence, at or before the time the contract of reinsurance is entered into, of a state of affairs which is within the knowledge or control of the firm and which is material to the reinsurer's decision to enter into the contract being discovered to be false; or
(3) the non-payment of reinsurancepremiums by the firm; or
(4) a transfer by the firm of the whole or a specified part of its business without the agreement of the reinsurer, except where that agreement has been unreasonably withheld.

INSPRU 1.2.86

See Notes

handbook-rule
For the purposes of INSPRU 1.2.79R (2) and INSPRU 1.2.85 R, future surplus may only be offset against future reinsurance cash outflow in respect of surplus on non-profit insurance contracts and the charges or shareholder transfers arising as surplus from with-profits insurance contracts. Such charges and transfers may only be allowed for to the extent consistent with the regulatory duty of the firm to treat its customers fairly.

INSPRU 1.2.87

See Notes

handbook-guidance
For the purposes of INSPRU 1.2.85 R, a contingent liability means a liability that would only arise upon the happening of a particular contingency, even where that contingency is not expected to occur. For example, if the firm has a reinsurance arrangement in force that in the event the firm were wound up would give rise to repayments other than out of surplus emerging, the reinsurance cash outflows should be valued as a liability.

INSPRU 1.2.88

See Notes

handbook-guidance
INSPRU 1.2.85 R allows a firm not to value reinsurance cash outflows provided the contingencies in which the reinsurance would require repayment other than out of future surpluses are limited to termination clauses concerning fraud, material misrepresentation, non-payment of reinsurancepremiums by the firm or a transfer of business by the firm without the agreement of the reinsurer, except if unreasonably withheld.

INSPRU 1.2.89

See Notes

handbook-guidance
Where the reinsurance cash outflow is payable by a fund or sub-fund that generates such profits, charges or transfers, the firm need make no provision for such payments provided that repayment to the reinsurer is linked unambiguously (as defined in INSPRU 1.2.85 R) to the emergence of future surplus. Where the profits, charges or transfers arising under a block of business are payable by a fund or sub-fund to another part of the firm then only where the firm has committed to remit such profits, charges or transfers directly to the reinsurer would it be acceptable for no provision for payments to the reinsurer to be made.

Application of INSPRU 1.2 to Lloyd's

INSPRU 1.2.92

See Notes

handbook-rule
INSPRU 1.2 applies to managing agents in accordance with INSPRU 8.1.4 R.

Approved reinsurance to close

INSPRU 1.2.93

See Notes

handbook-rule
In respect of business that has been subject to an approved reinsurance to close, managing agents must calculate mathematical reserves (before and after deduction of reinsurance cessions) for the reinsuring and not for the reinsured member.

INSPRU 1.3

With-profits insurance capital component

Application

INSPRU 1.3.1

See Notes

handbook-rule

INSPRU 1.3.2

See Notes

handbook-guidance
A realistic basis life firm means a firm to which GENPRU 2.1.18 R applies. The application of GENPRU 2.1.18 R is set out in GENPRU 2.1.19 R and GENPRU 2.1.20 R. GENPRU 2.1.13 R requires that a firm must maintain at all times capital resources equal to or in excess of its capital resources requirement. The enhanced capital requirement forms part of the capital resources requirement for a realistic basis life firm. The with-profits insurance capital component forms part of the enhanced capital requirement which a realistic basis life firm is required to calculate in accordance with GENPRU 2.1.38 R.

Purpose

INSPRU 1.3.3

See Notes

handbook-guidance
This section sets out rules and guidance as to the methods and assumptions to be used in calculating the with-profits insurance capital component.

INSPRU 1.3.4

See Notes

handbook-guidance
The purpose of the with-profits insurance capital component is to supplement the mathematical reserves so as to ensure that a firm holds adequate financial resources for the conduct of its with-profits insurance business. In particular, capital in excess of the mathematical reserves may be needed to ensure that adequate final bonuses can be awarded to policyholders. That is, adequate in the sense that in setting bonuses payable to policyholders the firm pays due regard to the interests of its policyholders and treats them fairly. The mathematical reserves for a realistic basis life firm are not required to include provision for future annual bonuses or final bonuses (INSPRU 1.2.9 R).

INSPRU 1.3.5

See Notes

handbook-guidance
The required procedures are summarised in the flowchart in INSPRU 1 Annex 1.

Main requirements

INSPRU 1.3.6

See Notes

handbook-rule
A firm must calculate the with-profits insurance capital component in accordance with INSPRU 1.3.7 R.

INSPRU 1.3.7

See Notes

handbook-rule
(1) The with-profits insurance capital component for a firm is the aggregate of any amounts that:
(a) result from the calculations specified in (2) and (3); and
(b) are greater than zero.
(2) Subject to (3), in relation to each with-profits fund within the firm, the firm must deduct B from A, where:
(a) A is the amount of the regulatory excess capital for that fund (see INSPRU 1.3.23 R); and
(b) B is the sum of:
(i) the realistic excess capital for that fund (see INSPRU 1.3.32 R):
(ii) the value, in the most adverse scenario required by INSPRU 1.3.43R (3), of future internal transfers from the fund to shareholders or another of the firm's funds in respect of the future distribution of surplus between policyholders and shareholders; and
(iii) an amount not exceeding the value, in the most adverse scenario required by INSPRU 1.3.43R (3), of any other future internal transfers from the fund to a non-profit fund in respect of expense-related charges to the extent that the future receipt of the amount transferred is not already taken into account in the calculation of the firm'scapital resources or in establishing its technical provisions.
(3) Where a capital instrument that can be included in the firm'scapital resources in accordance with GENPRU 2.2 has been attributed wholly or partly to a with-profits fund and that instrument meets the requirements of GENPRU 2.2.271 R, the firm must add to the amount calculated under (2) for that fund the result, subject to a minimum of zero, of deducting D from C where:
(a) C is the outstanding face amount of the instrument to the extent attributed to the fund; and
(b) D is the realistic value of the instrument to the extent attributed to the fund in the single event that determines the risk capital margin under INSPRU 1.3.43 R.

INSPRU 1.3.7A

See Notes

handbook-guidance
Future internal transfers from a with-profits fund are included in the realistic value of liabilities (see INSPRU 1.3.105 R, INSPRU 1.3.119 R, INSPRU 1.3.128 R and INSPRU 1.3.165 R). INSPRU 1.1.27 R ensures that sufficient assets are maintained in a with-profits fund to meet those future internal transfers. In calculating the WPICC, the economic value to the firm of those future transfers in the most adverse scenario required in calculating the risk capital margin (see INSPRU 1.3.43 R) should be recognised. In the case of internal transfers to a non-profit fund in respect of expense-related charges, those transfers may only be recognised to the extent that those cash flows have not already been taken into account in calculating the firm'scapital resources or technical provisions. In effect, the future asset of the shareholders or another of the firm's funds is available to offset the corresponding liability of the with-profits fund and should, therefore, subject to the limitation in INSPRU 1.3.7R (2)(b)(iii), be treated as capital arising from that fund which is available to reduce the amount of the WPICC.

INSPRU 1.3.8

See Notes

handbook-guidance
Subordinated debt which is subordinated to policyholder interests (see GENPRU 2.2.271 R) is an example of the sort of capital instrument that may give rise to a component of the WPICC under INSPRU 1.3.7R (3). Such instruments are treated as capital under GENPRU 2.2, subject to the requirements of GENPRU 2.2.271 R. Under realistic reserving the capital instrument is valued as a realistic liability (INSPRU 1.3.40 R) and in calculating the risk capital margin such an instrument would be valued at its realistic value in the single event outlined in INSPRU 1.3.43 R (see also INSPRU 1.3.162 R). Overall, the effect of GENPRU 2.2, INSPRU 1.3.7R (3) and INSPRU 1.3.43 R is to enable a firm that obtains subordinated debt to benefit from additional capital resources equal to the face amount of that debt.

INSPRU 1.3.9

See Notes

handbook-guidance
SUP 4 (Actuaries) sets out the role and responsibilities of the actuarial function and of the with-profits actuary.
(1) As part of his duties under SUP 4.3.13 R, the actuary appointed by the firm to perform the actuarial function must calculate the firm'smathematical reserves and, in the context of the calculation of the with-profits insurance capital component, must also:
(a) advise the firm's governing body on the methods and assumptions to be used in the calculation of the firm's with-profits insurance capital component;
(b) perform that calculation in accordance with the methods and assumptions determined by the firm'sgoverning body; and
(c) report to the firm'sgoverning body on the results of that calculation.
(2) As part of his duties under SUP 4.3.16G, the with-profits actuary must advise the firm'sgoverning body on the discretion exercised by the firm. In the context of the calculation of the with-profits insurance capital component, the with-profits actuary must also advise the firm'sgoverning body as to whether the methods and assumptions (including the allowance for management actions) used for that calculation are consistent with the firm'sPrinciples and Practices of Financial Management (PPFM - see COB 6.10 ) and with its regulatory duty to treat its customers fairly.

General


Definitions

INSPRU 1.3.10

See Notes

handbook-rule
In this section, real estate means an interest in land, buildings or other immovable property.

INSPRU 1.3.11

See Notes

handbook-rule
In this section, the long-term gilt yield is the annualised equivalent of the yield on the 15-year index for United Kingdom Government fixed-interest securities jointly compiled by the Financial Times, the Institute of Actuaries and the Faculty of Actuaries.

INSPRU 1.3.12

See Notes

handbook-rule
For the purposes of this section, a firm has an exposure to an asset or liability where the firm's valuation of its assets or liabilities changes when the value of the asset or liability changes.

INSPRU 1.3.13

See Notes

handbook-rule
Unless the context otherwise requires, all references (however expressed) in this section to realistic liabilities, or to liabilities which are included in the calculation of realistic liabilities, include discretionary benefits payable by the firm in accordance with the firm's regulatory duty to treat its customers fairly.

INSPRU 1.3.14

See Notes

handbook-guidance
In this section, any reference to a firm's regulatory duty to treat its customers fairly is a reference to the firm's dutyunder Principle 6 (Customers' interests). This states that a firm must pay due regard to the interests of its customers and treat them fairly.

INSPRU 1.3.15

See Notes

handbook-guidance
In this section, any reference to the Principles and Practices of Financial Management (PPFM) is a reference to the requirements in COB 6.10 (Principles and Practices of Financial Management) for firms to establish, maintain and record the principles and practices of financial management according to which the business of its with-profits funds is conducted.

INSPRU 1.3.16

See Notes

handbook-guidance
The extent to which a firm requires a separate PPFM for each of its with-profits funds will depend on the firm's circumstances and any relevant representations made by the firm to its with-profits policyholders. In this section, any reference to a firm'sPPFM refers to the PPFM which relate to the with-profits fund or the with-profits insurance contracts in question.

Record keeping

INSPRU 1.3.17

See Notes

handbook-rule
A firm must make, and retain for an appropriate period of time, a record of:
(1) the methods and assumptions used in making any calculation required for the purposes of this section (and any subsequent changes) and the reasons for their use; and
(2) any change in practice and the nature of, reasons for, and effect of, any change in approach with respect to those methods and assumptions.

INSPRU 1.3.18

See Notes

handbook-guidance
SYSC 14.1.53 R requires firms to maintain accounting and other records for a minimum of three years, or longer as appropriate. For the purposes of INSPRU 1.3.17 R, a period of longer than three years will be appropriate for a firm'slong-term insurance business. In determining an appropriate time period, a firm should have regard to:
(1) the detailed guidance on record keeping in SYSC 14.1.51 G to SYSC 14.1.64 G;
(2) the nature and term of the firm's long-term insurance contracts; and
(3) any additional provisions or statutory requirements applicable to the firm or its records.

INSPRU 1.3.19

See Notes

handbook-rule
A firm must also identify in the record required to be kept by INSPRU 1.3.17 R changes in practice, in particular changes in those items which will or may be significant in relation to the eventual claim values.

INSPRU 1.3.20

See Notes

handbook-guidance
Some of the changes identified in accordance with INSPRU 1.3.19 R may have to be notified to the firm'spolicyholders in accordance with the firm'sPPFM.

General principles for allocating aggregate amounts

INSPRU 1.3.21

See Notes

handbook-rule
Where any calculation is required under this section which:
(1) is to be made in respect of any with-profits fund of a firm; and
(2) covers an amount that is otherwise calculated in relation to the firm as a whole;
the firm must make an allocation of that amount as between all of its funds (including funds which are not with-profits funds).

INSPRU 1.3.22

See Notes

handbook-rule
In any case where:
(1) non-profit insurance contracts are written in any with-profits fund of a firm; and
(2) any calculation is required under this section which:
(a) is to be made in respect of the regulatory excess capital or realistic excess capital for the fund; and
(b) covers an amount that is otherwise calculated or allocated in relation to the fund as a whole;
the firm must make an allocation of the amount in (2)(b) as between the with-profits insurance contracts and non-profit insurance contracts written in the fund.

Calculation of regulatory excess capital

INSPRU 1.3.23

See Notes

handbook-rule
A firm must calculate the regulatory excess capital for each of its with-profits funds by deducting B from A, where:
(1) A is the regulatory value of assets of the fund (INSPRU 1.3.24 R; and
(2) B is the sum of:

Regulatory value of assets

INSPRU 1.3.24

See Notes

handbook-rule
(1) For the purposes of INSPRU 1.3.23R (1), the regulatory value of assets of a with-profits fund is equal to the sum of:
(a) the amount of the fund's long-term admissible assets; and
(b) the amount of any implicit items allocated to that fund;
less an amount, representing any non-profit insurance contracts written in that fund, determined in accordance with (2).
(2) Where non-profit insurance contracts are written in a with-profits fund, the amount representing those contracts is the sum of:
(a) the mathematical reserves in respect of the non-profit insurance contracts written in the fund; and
(b) an amount in respect of the non-profit insurance contracts written in the fund which represents an appropriate allocation of the firm's resilience capital requirement, to the extent that it is covered by the fund's long-term admissible assets.

INSPRU 1.3.25

See Notes

handbook-rule
For the purpose of determining the value of a fund's long-term admissible assets in accordance with INSPRU 1.3.24R (1)(a), no value is to be attributed to:
(1) debts owed by reinsurers; or
(2) claims; or
(3) tax recoveries; or
(4) claims against compensation funds;
to the extent already offset in the calculation of technical provisions.

INSPRU 1.3.26

See Notes

handbook-rule
In making a determination in accordance with INSPRU 1.3.24R (2), a firm must allocate long-term admissible assets of an appropriate nature and term to any non-profit insurance contracts written in the with-profits fund.

INSPRU 1.3.27

See Notes

handbook-guidance
[intentionally blank]

INSPRU 1.3.28

See Notes

handbook-guidance
A firm needs to obtain an implicit item waiver from the FSA in order to bring in an amount under INSPRU 1.3.24R (1)(b). For guidance on applying for an implicit item waiver in respect of future surpluses relating to with-profits funds see GENPRU 2 Annex 8. The amount of any implicit item allocated to a with-profits fund may be defined in the terms of any waiver granted.

Regulatory value of liabilities

INSPRU 1.3.29

See Notes

handbook-rule
For the purposes of INSPRU 1.3.23R (2)(a), the regulatory value of liabilities of a with-profits fund is equal to the sum of:
(1) the mathematical reserves, in respect of the fund's with-profits insurance contracts, including the value of any provisions reflecting bonuses allocated at the actuarial valuation date; and

INSPRU 1.3.30

See Notes

handbook-rule
For the purposes of INSPRU 1.3.29R (2), the regulatory current liabilities of a with-profits fund are equal to the sum of the following amounts to the extent that they relate to that fund:
(1) accounting liabilities (including long-term insurance liabilities which have fallen due before the end of the financial year);
(2) liabilities from deposit back arrangements; and
(3) any provision for adverse variations (determined in accordance with INSPRU 3.2.17 R).

INSPRU 1.3.31

See Notes

handbook-guidance
The amount of regulatory current liabilities for a with-profits fund refers to the sum of the amounts in (1) and (2) in respect of the fund:
(1) the amount of 'Total other insurance and non-insurance liabilities'; and
(2) the amount of 'Cash bonuses which had not been paid to policyholders prior to the end of the financial year';

as disclosed at lines 49 and 12 respectively of the appropriate Form 14 ('Long-term business liabilities and margins') for that fund as part of the Annual Returns required to be deposited with the FSA under IPRU(INS) rule 9.6R(1).

Calculation of realistic excess capital

INSPRU 1.3.32

See Notes

handbook-rule
A firm must calculate the realistic excess capital for each of its with-profits funds by deducting B from A, where:
(1) A is the realistic value of assets of the fund (see INSPRU 1.3.33 R); and
(2) B is the sum of:
(a) the realistic value of liabilities of the fund (see INSPRU 1.3.40 R); and
(b) the risk capital margin for the fund (see INSPRU 1.3.43 R).

Realistic value of assets

INSPRU 1.3.33

See Notes

handbook-rule
(1) For the purposes of INSPRU 1.3.32R (1), the realistic value of assets of a with-profits fund is the sum of:
(a) the amount of the fund's regulatory value of assets determined in accordance with INSPRU 1.3.24 R, but with no value given to any implicit items and excluding the regulatory value of any shares in a related undertaking which carries on long-term insurance business;
(b) the amount of the fund's excess admissible assets (see INSPRU 1.3.36 R);
(c) the present value of future profits (or losses) on any non-profit insurance contracts written in the with-profits fund (see INSPRU 1.3.37 R);
(d) the value of any derivative or quasi-derivative held in the fund (see GENPRU 1.3.41 R) to the extent its value is not reflected in (a), (b) or (c);
(e) any amount determined under (2); and
(f) the amount of any prepayments made from the fund.
(2) Where any equity shares held (directly or indirectly) by a firm (A):
(a) are shares in a related undertaking (B) which carries on long-term insurance business; and
(b) have been identified by A under INSPRU 1.3.21 R as long-term insurance assets which are held in the with-profits fund for which the realistic value is to be determined under (1);
the amount required under (1)(e) is the relevant proportion of the value of all B's equity shares as determined in (3).
(3) For the purposes of (2):
(a) the relevant proportion is the proportion of the total number of equity shares issued by B which are held (directly or indirectly) by A;
(b) the value of all B's equity shares must be taken as D deducted from C, where C is equal to the sum of:
(i) the shareholder net assets of B;
(ii) any surplus assets in the non-profit funds of B;
(iii) any additional amount arising from the present value of future profits (or losses) on any non-profit insurance contracts written by B (calculated on a basis consistent with INSPRU 1.3.37 R), excluding any amount arising from business that is written in a with-profits fund; and
(iv) where B has any with-profits funds, the present value of projected future transfers out of those funds to shareholder funds of B;
and D is equal to the sum of:
(vi) where B is a regulatory basis only life firm, the amount of the resilience capital requirement in respect of any non-profit insurance contracts written in a non-profit fund of B;
(vii) any part of the with-profits insurance capital component of B, or of B's long-term insurance capital requirement, where B is a regulatory basis only life firm, or resilience capital requirement in respect of B's with-profits insurance contracts, that is not covered from the assets of the with-profits fund from which it arises after deducting from those assets the amount calculated under (iv); and
(viii) any assets of B that back its regulatory capital requirements and that are valued in (iii) in the calculation of the present value of future profits of non-profit insurance business written by B.
(4) The methods and assumptions used in the calculations under (3)(b)(iii) and (iv) must follow a consistent approach to that set out in INSPRU 1.3.37 R.

INSPRU 1.3.34

See Notes

handbook-guidance
In INSPRU 1.3.33R (1)(d), where a derivative or quasi-derivative has a positive asset value, credit should be given within the realistic value of assets. If the derivative or quasi-derivative has a negative asset value it should be valued within realistic liabilities as an element of realistic current liabilities (see INSPRU 1.3.40R (3)).

INSPRU 1.3.35

See Notes

handbook-guidance
Where a firm identifies shares in a related undertaking which carries on long-term insurance business as shares held in one of its with-profits funds, INSPRU 1.3.33R (1)(e), INSPRU 1.3.33R (2) and INSPRU 1.3.33R (3) bring in a realistic valuation of the related undertaking equal to its net assets plus the present value of future profits, less its regulatory capital requirements (see INSPRU 1.3.33R (3)(b)(v), INSPRU 1.3.33R (3)(b)(vi) and INSPRU 1.3.33R (3)(b)(vii)). Where the related undertaking has taken the present value of future profits arising from its contracts into consideration in covering its regulatory capital requirements (for example, its risk capital margin, under INSPRU 1.3.45R (2)(c), INSPRU 1.3.33R (3)(b)(iii) requires a firm to exclude those future profits in valuing the related undertaking. The subtraction of the capital requirements in the calculation provides a straightforward method of allowing for the change in the related undertaking's value in stress conditions, as the value of the related undertaking is not subject to the realistic stress tests of the risk capital margin. In calculating the present value of future profits on non-profit insurance business written in the related undertaking under INSPRU 1.3.33R (3)(b)(iii), a firm may value the release of capital requirements as the business runs off (see INSPRU 1.3.38 G). INSPRU 1.3.33R (3)(b)(viii) ensures that any such capital is not double-counted.

INSPRU 1.3.36

See Notes

handbook-rule
Excess admissible assets of a with-profits fund means admissible assets which exceed any of the percentage limits referred to in INSPRU 2.1.22 R.

INSPRU 1.3.37

See Notes

handbook-rule
A firm must calculate the present value of future profits (or losses) on non-profit insurance contracts written in the with-profits fund using methodology and assumptions which:
(1) are based on current estimates of future experience;
(2) involve reasonable (but not excessively prudent) adjustments to reflect risk and uncertainty;
(3) allow for a market-consistent valuation of any guarantees or options within the contracts valued;
(4) are derived from current market yields, having regard to International Financial Reporting Standard 4: Insurance Contracts, as if it were being applied to determine the value under that standard for the first time;
(5) have regard to generally accepted actuarial practice and generally accepted industry standards appropriate for firms carrying on long-term insurance business;
(6) are consistent with the allocation, made in accordance with INSPRU 1.3.22 R, of any aggregate amounts as between the with-profits insurance contracts and the non-profit insurance contracts written in the fund;
(7) allow for any tax that would be payable out of the with-profits fund in respect of the contracts valued; and
(8) are consistent with the allocation, made in accordance with INSPRU 1.3.26 R, of long-term admissible assets as between the with-profits insurance contracts and any non-profit insurance contracts written in the fund.

INSPRU 1.3.38

See Notes

handbook-guidance
In calculating the present value of future profits (or losses) for non-profit insurance business required by INSPRU 1.3.33R (1)(c), to the extent that the long-term insurance capital requirement is covered by the with-profits fund'slong-term admissible assets, a firm may take into consideration any release of this item as the relevant policies go off the books.

INSPRU 1.3.39

See Notes

handbook-guidance
Annuities do not typically fall to be valued on a market-consistent basis under INSPRU 1.3.37R (3) as they are not "options and guarantees" as defined for accounting purposes. This is because they do not have "time value" in the option-pricing meaning of that term. However where, atypically, annuities do fall to be valued on a market-consistent basis under INSPRU 1.3.37R (3), the discount rate used should be appropriate to the characteristics of the liability, including its illiquidity. The appropriate interest rate, therefore, would not typically be the risk-free rate. Where illiquid assets are used to closely match similar illiquid liabilities, as could be the case in annuities business, it would be appropriate to look at the liquidity premium that is implicit in the market value of the assets as a proxy for the liquidity premium that should be included in a market consistent valuation of the liabilities. However, care should be exercised in doing this. Assets and liabilities are rarely perfectly matched and an appropriate margin needs to be included in the valuation to cover the risk of unexpected mismatch.

INSPRU 1.3.39A

See Notes

handbook-guidance
In view of INSPRU 1.3.39 G, it is likely that the discount rate to be applied to the market-consistent valuation of those annuities that fall within the scope of INSPRU 1.3.37R (3) would not be significantly different from that which applies to other annuities (to which a discount rate based on the return on the matching assets less an allowance for risk which is reasonable but not excessively prudent, in accordance with INSPRU 1.3.37R (2), might be applied).

INSPRU 1.3.39B

See Notes

handbook-guidance
In determining current market yields for the purpose of INSPRU 1.3.37R (4), a firm is required to have regard to IFRS 4 as if it were being applied to determine the value under that standard for the first time, that is, without reference to existing practices. Paragraph 27 of the standard is likely to be of particular relevance. In general, afirm should only include an allowance for future investment margins if its assumptions are limited to no more than a risk-free rate and the discount rate is set consistently. However, this does not preclude a firm from using a replicating portfolio of assets to determine the discount rate for the liability with suitable adjustments for differences in their characteristics (for the example of annuity business, see INSPRU 1.3.39 G). In setting assumptions for future investment returns, a firm should also consider sections BC134 to BC144 of the Basis for Conclusions in IFRS 4.

Realistic value of liabilities: general

INSPRU 1.3.40

See Notes

handbook-rule
For the purposes of INSPRU 1.3.32R (2)(a), the realistic value of liabilities of a with-profits fund is the sum of:
(1) the with-profits benefits reserve of the fund;
(2) the future policy related liabilities of the fund; and
(3) the realistic current liabilities of the fund.

INSPRU 1.3.41

See Notes

handbook-guidance
All liabilities arising under, or in connection with, with-profits insurance contracts written in the fund should be included in the realistic value of liabilities referred to in INSPRU 1.3.40 R, including those in respect of guarantees and the value of options.

INSPRU 1.3.42

See Notes

handbook-guidance
Detailed rules and guidance for the calculation of the three elements referred to in INSPRU 1.3.40 R are contained below in this section:

Risk capital margin

INSPRU 1.3.43

See Notes

handbook-rule
(1) A firm must calculate a risk capital margin for each of its with-profits funds in accordance with (2) to (6).
(2) The firm must identify relevant assets (INSPRU 1.3.45 R) which, in the most adverse scenario, will have a value (INSPRU 1.3.46 R) which is equal to the realistic value of liabilities of the fund under that scenario.
(3) The most adverse scenario means the single event comprising that combination of the scenarios in INSPRU 1.3.44 R which gives rise to the largest positive value that results from deducting B from A, where:
(a) A is the value of relevant assets which will produce the result described in (2); and
(b) B is the realistic value of liabilities of the fund.
(4) The risk capital margin for the fund is the result of deducting C from A, where C is the sum of:
(a) B; and
(b) any amount included within relevant assets under INSPRU 1.3.45R (2)(c).
(5) In calculating the value of relevant assets for the purpose of determining the most adverse scenario in (3), a firm must not adjust the valuation of any asset taken into consideration under INSPRU 1.3.33R (1)(e) (related undertakings carrying on long-term insurance business) or INSPRU 1.3.45R (2)(c) (present value of future profits arising from insurance contracts written outside the with-profits fund).
(6) In calculating the realistic value of liabilities of a fund under any scenario, a firm is not required to adjust the best estimate provision made under INSPRU 1.3.190R (1) in respect of a defined benefits pension scheme in accordance with INSPRU 1.3.191 R .

INSPRU 1.3.44

See Notes

handbook-rule
For the purposes of INSPRU 1.3.43R (3), the scenarios are one scenario selected from each of the following:
(1) in respect of UK and other assets within INSPRU 1.3.62R (1)(a):
(a) the range of market risk scenarios identified in accordance with INSPRU 1.3.68R (1) (equities);
(b) the range of market risk scenarios identified in accordance with INSPRU 1.3.68R (2) (real estate); and
(c) the range of market risk scenarios identified in accordance with INSPRU 1.3.68R (3) (fixed interest securities);
(2) in respect of non-UK assets within INSPRU 1.3.62R (1)(b):
(a) the range of market risk scenarios identified in accordance with INSPRU 1.3.73R (1) (equities);
(b) the range of market risk scenarios identified in accordance with INSPRU 1.3.73R (2) (real estate); and
(c) the range of market risk scenarios identified in accordance with INSPRU 1.3.73R (3) (fixed interest securities);
(3) the range of credit risk scenarios identified in accordance with INSPRU 1.3.78R (1) (bond or debt items);
(4) the range of credit risk scenarios identified in accordance with INSPRU 1.3.78R (2) (reinsurance items or analogous non-reinsurance financing agreements);
(5) the range of credit risk scenarios identified in accordance with INSPRU 1.3.78R (3) (other items including derivatives and quasi-derivatives); and
(6) the persistency risk scenario identified in accordance with INSPRU 1.3.100 R.

INSPRU 1.3.45

See Notes

handbook-rule
(1) In INSPRU 1.3.43 R, in relation to a with-profits fund, the relevant assets means a range of assets which meets the following conditions:
(a) the range is selected on a basis which is consistent with the firm's regulatory duty to treat its customers fairly;
(b) the range must include assets from within the with-profits fund the value of which is greater than or equal to the realistic value of liabilities of the fund;
(c) the range is selected in accordance with (2); and
(d) no asset of the firm may be allocated to the range of assets identified in respect of more than one with-profits fund.
(2) The range of assets must be selected from the assets specified in (a) to (c), in the order specified:
(a) assets that have a realistic value under INSPRU 1.3.33 R;
(b) where a firm has selected all the assets within (a), any admissible assets that are not identified as held within the with-profits fund; and
(c) where a firm has selected all the assets within (a) and (b), any additional assets.
(3) But a firm must not bring any amounts into account under (2)(b) or (2)(c) in respect of any with-profits fund if that would result in the firm exceeding its overall maximum limit (determined according to whether the firm has only one with-profits fund or more than one such fund).
(4) A firm exceeds its overall maximum limit for amounts brought into account under (2)(b) where:
(a) in the case of a firm with a single with-profits fund, the amount the firm brings into account in respect of that fund;
(b) in the case of a firm with two or more with-profits funds, the aggregate of the amounts the firm brings into account in respect of each of those funds;
exceeds the sum of the firm's shareholder net assets and the surplus assets in the firm'snon-profits funds, less any regulatory capital requirements in respect of business written outside its with-profits funds.
(5) A firm exceeds its overall maximum limit for amounts brought into account under (2)(c) where:
(a) in the case of a firm with a single with-profits fund, the amount the firm brings into account in respect of that fund;
(b) in the case of a firm with two or more with-profits funds, the aggregate of the amounts the firm brings into account in respect of each of those funds;
exceeds 50% of the present value of future profits arising from insurance contracts written by the firm outside its with-profits funds.

INSPRU 1.3.46

See Notes

handbook-rule
In valuing the relevant assets identified under INSPRU 1.3.43R (2), a firm must use the same methods of valuation as in INSPRU 1.3.33 R, except that:
(1) the value of any admissible assets not identified as held within the with-profits fund (INSPRU 1.3.45R (2)(b)) must be as determined under GENPRU 1.3; and
(2) the value of any asset which forms part of the range of assets as a result of INSPRU 1.3.45R (2)(c) must be determined on a basis consistent with that described in INSPRU 1.3.37 R.

INSPRU 1.3.47

See Notes

handbook-guidance
The purpose of the risk capital margin for a with-profits fund is to cover adverse deviation from:
(2) the value of assets identified, in accordance with INSPRU 1.3.43R (2), to cover the amount in (1) and the fund's risk capital margin;

arising from the effects of market risk, credit risk and persistency risk. Other risks are not explicitly addressed by the risk capital margin.

INSPRU 1.3.48

See Notes

handbook-guidance
The amount of the risk capital margin calculated by the firm for a with-profits fund will depend on the firm's choice of assets held to cover the fund's realistic value of liabilities and the margin. INSPRU 1.3.43 R requires the relevant assets to be sufficient, in the most adverse scenario, to cover the realistic value of liabilities in the event that scenario was to arise.

INSPRU 1.3.49

See Notes

handbook-guidance
INSPRU 1.3.45R (2)(c) allows firms to bring the economic value of non-profit insurance business written outside a with-profits fund into the assets available to cover the risk capital margin. To place a prudent limit on the amount of future profits taken into consideration a maximum of 50% of the present value of non-profit insurance business can be taken into the calculation (INSPRU 1.3.45R (5)). Where a contract is written in a non-profit fund but the assets arising from that contract are invested in a with-profits fund which is subject to charges for investment management or other services which benefit the non-profit fund, such charges can be taken into consideration in calculating the present value of future profits of the non-profit insurance business. Where a proportion of the present value of future profits on non-profit insurance business written outside a with-profits fund is brought in as an asset, no stress tests apply to this asset (see INSPRU 1.3.43R (5)) as the amount taken into consideration is limited to 50% of the total present value.

INSPRU 1.3.50

See Notes

handbook-guidance
A firm using a stochastic approach in INSPRU 1.3.169R (1) should keep recalibration in the post-stress scenarios to the minimum required to reflect any change in the underlying risk-free yields. A firm using the market costs of hedging approach, as in INSPRU 1.3.169R (2), may assume in estimating the market cost of hedging in the post-stress scenarios that market volatilities are unchanged.

INSPRU 1.3.51

See Notes

handbook-guidance
In the scenario tests set out in INSPRU 1.3.62 R to INSPRU 1.3.103 G, firms are required to test for worst case scenarios across a range of assumptions. The tests are, with the exception of the credit risk test, two-sided, requiring both increases and decreases in the assumptions. The FSA does not expect a firm to investigate every possible stress, but a firm should be able to demonstrate that it is reasonable to assume that it has successfully identified the single event that determines the risk capital margin for the firm's business, as required by INSPRU 1.3.43R (3).

INSPRU 1.3.51A

See Notes

handbook-guidance
In the scenario tests set out in INSPRU 1.3.62 R to INSPRU 1.3.103 G, a firm is required to assess the changed value of its assets and liabilities in the economic conditions of the most adverse scenario. A firm is required to assess the changed value of each relevant asset (as defined in INSPRU 1.3.45 R), notwithstanding any uncertainty about the appropriate valuation basis for that asset. In valuing an asset in the most adverse scenario, a firm should have regard to the economic substance of the asset, rather than its legal form, and assess its value accordingly. Consider, for example, a convertible bond that is close to its conversion date and where the conversion option has value. The value of the convertible bond in the most adverse scenario is likely to be sensitive primarily to equity market scenarios and to a lesser extent to interest rate scenarios. The firm should value the asset according to its expected market value in the economic conditions underlying the most adverse scenario.

Management actions

INSPRU 1.3.52

See Notes

handbook-rule
In calculating the risk capital margin for a with-profits fund, a firm may reflect, in its projections of the value of assets and liabilities under the scenarios in INSPRU 1.3.44 R, the firm's prospective management actions (INSPRU 1.3.53 R).

INSPRU 1.3.53

See Notes

handbook-rule
Prospective management actions refer to the foreseeable actions that would be taken by the firm's management, taking into account:
(1) an appropriately realistic period of time for the management actions to take effect; and
(2) the firm'sPPFM and its regulatory duty to treat its customers fairly.

INSPRU 1.3.54

See Notes

handbook-guidance
The management actions in INSPRU 1.3.53 R may include, but are not limited to, changes in future bonus rates, reductions in surrender values, changes in asset dispositions (taking into account the associated selling costs) and changes in the amount of charges deducted from asset shares for with-profits insurance contracts.

INSPRU 1.3.55

See Notes

handbook-guidance
A firm should use reasonable assumptions in incorporating management actions into its projections of claims such that the mitigating effects of the management actions are not overstated. In modelling management actions, a firm should ensure consistency with its PPFM and take into account its regulatory duty to treat its customers fairly.

INSPRU 1.3.56

See Notes

handbook-guidance
In accordance with INSPRU 1.3.17 R, a firm should make and retain a record of the approach used, in particular the nature and effect of anticipated management actions (including, where practicable, the amount by which the actions would serve to reduce the projected values of assets and liabilities).

INSPRU 1.3.57

See Notes

handbook-guidance
A firm which deducts charges in respect of any adverse experience or cost of capital to with-profits insurance contracts should keep a record under INSPRU 1.3.17 R of the amount of any such charges to its customers and of how it has ensured their fair treatment.

Policyholder actions

INSPRU 1.3.58

See Notes

handbook-rule
In calculating the risk capital margin for a with-profits fund, a firm must reflect, in its projections of the value of assets and liabilities under the scenarios in INSPRU 1.3.44 R, a realistic assessment of the actions of its policyholders (see INSPRU 1.3.59 R).

INSPRU 1.3.59

See Notes

handbook-rule
Policyholder actions refer to the foreseeable actions that would be taken by the firm'spolicyholders, taking into account:
(1) the experience of the firm in the past; and
(2) the changes that may occur in the future if options and guarantees become more valuable to policyholders than in the past.

INSPRU 1.3.60

See Notes

handbook-guidance
A firm should use realistic assumptions in incorporating policyholder actions into its projections of claims such that any mitigating effects of policyholder actions are not overstated and any exacerbating effects of policyholder actions are not understated. In modelling policyholder actions, a firm should ensure consistency with its PPFM and take into account its regulatory duty to treat its customers fairly in determining the options and information that would be available to policyholders.

INSPRU 1.3.61

See Notes

handbook-guidance
In calculating the persistency scenario in INSPRU 1.3.100 R, a firm needs to make assumptions regarding the future termination rates exhibited by policies, at points described in particular in INSPRU 1.3.101 R. Such assumptions should be realistic. However, the firm must have regard to the economic scenarios being projected. For example, if the value of an option became significantly greater in a future scenario than in the recent past, then the behaviour of policyholders in taking up the option is likely to differ in this future scenario compared with the recent past.

Market risk scenario

INSPRU 1.3.62

See Notes

handbook-rule
(1) For the purposes of INSPRU 1.3.44 R, the ranges of market risk scenarios that a firm must assume are:
(a) for exposures to UK assets and for exposures to non-UK assets within (2), the ranges of scenarios set out in INSPRU 1.3.68 R; and
(b) for exposures to other non-UK assets, the ranges of scenarios set out in INSPRU 1.3.73 R.
(2) The exposures to non-UK assets within this paragraph are:
(a) exposures which do not arise from a significant territory outside the United Kingdom (INSPRU 1.3.63 R); or
(b) exposures which do arise from a significant territory outside the United Kingdom but which represent less than 0.5% of the realistic value of assets of the with-profits fund, measured by market value.

INSPRU 1.3.63

See Notes

handbook-rule
For the purposes of this section in relation to a with-profits fund, a significant territory is any country or territory in which more than 2.5% of the fund's realistic value of assets (by market value) are invested.

INSPRU 1.3.63A

See Notes

handbook-guidance
Guidance on how a firm should determine where particular assets are invested is provided in INSPRU 3.1.13B G.

INSPRU 1.3.64

See Notes

handbook-guidance
In determining its most adverse scenario, a firm applying INSPRU 1.3.68 R and INSPRU 1.3.73 R should consider separately possible movements in UK and non-UK markets. It should not assume that market prices in different markets move in a similar way at the same time. A firm should also allow for the effect of the other components of the single event comprising the combination of scenarios applicable under INSPRU 1.3.43 R.

INSPRU 1.3.65

See Notes

handbook-guidance
In relation to the market risk scenarios in INSPRU 1.3.68 R and INSPRU 1.3.73 R, the effect of INSPRU 1.3.52 R and INSPRU 1.3.58 R is that a firm may reflect management actions and must make a realistic assessment of policyholder actions in projecting the assets and liabilities in its calculation of the risk capital margin for a with-profits fund within the firm.

INSPRU 1.3.67

See Notes

handbook-guidance
The relevant assets identified under INSPRU 1.3.43R (2) to calculate the risk capital margin may, in certain circumstances, include up to 50% of the present value of future profits arising from insurance contracts written by the firm outside its with-profits funds. INSPRU 1.3.43R (5) exempts such an asset from the market risk stress tests.

Market risk scenario for exposures to UK assets and certain non-UK assets

INSPRU 1.3.68

See Notes

handbook-rule
The range of market risk scenarios referred to in INSPRU 1.3.62R (1)(a) is:
(1) a rise or fall in the market value of equities of up to the greater of:
(a) 10%; and
(2) a rise or fall in real estate values of up to 12.5%; and
(3) a rise or fall in yields on all fixed interest securities of up to 17.5% of the long-term gilt yield.

INSPRU 1.3.69

See Notes

handbook-rule
For the purposes of INSPRU 1.3.68 R, a firm must:
(1) assume that yields on equities and real estate remain unchanged from those applicable at market levels before applying each scenario; and
(2) model a rise or fall in equity, real estate and fixed interest markets as if the movement occurred instantaneously.

INSPRU 1.3.70

See Notes

handbook-guidance
For example, where the long-term gilt yield is 6%, a change of 17.5% in that yield would amount to a change of 1.05 percentage points. For the purpose of the scenarios in INSPRU 1.3.68R (3), the firm would assume a fall or rise of up to 1.05 percentage points in yields on all fixed interest securities.

Equity market adjustment ratio

INSPRU 1.3.71

See Notes

handbook-rule
The equity market adjustment ratio referred to in INSPRU 1.3.68R (1)(b) is:
(1) if the ratio calculated in (a) and (b) lies between 80% and 100%, the result of 100% less the ratio (expressed as a percentage) of:
(a) the current value of the FTSE Actuaries All Share Index; to
(b) the average value of the FTSE Actuaries All Share Index over the preceding 90 calendar days;
(2) 0%, if the ratio calculated in (1)(a) and (b) is more than 100%; and
(3) 20%, if the ratio calculated in (1)(a) and (b) is less than 80%.

INSPRU 1.3.72

See Notes

handbook-rule
In INSPRU 1.3.71R (1)(b), the average value of the FTSE Actuaries All Share Index over any period of 90 calendar days means the arithmetic mean based on levels at the close of business on each of the days in that period on which the London Stock Exchange was open for trading.

Market risk scenario for exposures to other non-UK assets

INSPRU 1.3.73

See Notes

handbook-rule
The range of market risk scenarios referred to in INSPRU 1.3.62R (1)(b) is:
(1) an appropriate rise or fall in the market value of equities listed in that territory (INSPRU 1.3.75 G), which must be at least equal to the percentage determined in INSPRU 1.3.68R (1);
(2) a rise or fall in real estate values in that territory of up to 12.5%; and
(3) a rise or fall in yields on all fixed interest securities of up to 17.5% of the nearest equivalent (in respect of the method of calculation) of the long-term gilt yield.

INSPRU 1.3.74

See Notes

handbook-rule
For the purposes of INSPRU 1.3.73 R, a firm must:
(1) assume that yields on equities and real estate remain unchanged from those applicable at market levels before applying each scenario; and
(2) model a rise or fall in equity, real estate and fixed interest markets as if the movement occurred instantaneously.

INSPRU 1.3.75

See Notes

handbook-guidance
For the purposes of INSPRU 1.3.73R (1), an appropriate rise or fall in the market value of equities to which a firm has exposure in a significant territory must be determined having regard to:
(1) an appropriate equity market index (or indices) for that territory; and
(2) the historical volatility of the equity market index (or indices) selected in (1).

INSPRU 1.3.76

See Notes

handbook-guidance
For the purpose of INSPRU 1.3.75G (1), an appropriate equity market index (or indices) for a territory should be such that:
(1) the constituents of the index (or indices) are reasonably representative of the nature of the equities to which the firm is exposed in that territory which are included in the relevant assets identified in accordance with INSPRU 1.3.43R (2); and
(2) the frequency of, and historical data relating to, published values of the index (or indices) are sufficient to enable an average value(s) and historical volatility of the index (or indices) to be calculated over at least the three preceding financial years.

Credit risk scenarios


General

INSPRU 1.3.77

See Notes

handbook-guidance
(1) The purpose of the credit risk scenarios in INSPRU 1.3.78 R to INSPRU 1.3.99 G is to show the financial effect of specified changes in the general credit risk environment on a firm's direct (counterparty) and indirect credit risk exposures. The scenarios apply in relation to corporate bonds, debt, reinsurance and other exposures, including derivatives and quasi-derivatives. This is thus quite separate from any reference to allowance for credit risk in INSPRU 3.1.
(2) In the case of bonds and debts, the scenarios are described in terms of an assumed credit rating dependent on the widening of credit spreads - changes in bond and debt credit spreads will have a direct impact on the value of bond and debt assets. Credit ratings are intended to give an indication of the security of the income and capital payments for a bond - the higher the credit rating, the more secure the payments. The reaction of credit spreads to developments in markets for credit risk varies by credit rating and so the scenarios to be assumed for bonds and debts depend on their ratings. The credit spreads on bonds and debt represent compensation to the investor for the risk of default and downgrade, but also for illiquidity, price volatility and the uncertainty of recovery rates relative to government bonds. Credit spreads on bonds tend to widen during an economic recession to reflect the increased expectations that corporate borrowers may default on their obligations or be subject to rating downgrades.
(3) Changes in bond and debt credit spreads will also be indicative of a change in direct counterparty exposure in relation to reinsurance and other exposures including derivatives and quasi-derivatives.
(4) In addition, changes in bond and debt credit spreads may indirectly impact on credit exposures, for example by affecting the payments anticipated under credit derivative instruments.
(5) A firm will also need to allow for the effect of other components of the single event comprising the combination of scenarios applicable under INSPRU 1.3.43 R in assessing exposure to credit risk. For example, in the case of an equity put option and a fall in equity market values, the resulting increase in the level of exposure to the firm'scounterparty for the option combined with a change in the quality of the counterparty should be allowed for.

INSPRU 1.3.78

See Notes

handbook-rule
For the purposes of INSPRU 1.3.44 R, the range of credit risk scenarios that a firm must assume is:
(1) changes in value resulting from an increase in credit spreads by an amount of up to the spread stress determined according to INSPRU 1.3.84 R in respect of any bond or debt item;
(2) changes in value determined according to INSPRU 1.3.94 R in respect of any reinsurance item or any analogous non-reinsurance financing agreement item; and
(3) changes in value determined according to INSPRU 1.3.98 R for any other item (including any derivative or quasi-derivative).

INSPRU 1.3.79

See Notes

handbook-rule
For the purposes of INSPRU 1.3.78 R, a firm must make appropriate allowance for any loss mitigation techniques to the extent that they are loss mitigation techniques relied on for the purpose of INSPRU 2.1.8 R in accordance with INSPRU 2.1.16 R and INSPRU 2.1.18 R.

INSPRU 1.3.80

See Notes

handbook-guidance
The change in asset or liability values to be determined in relation to a credit risk scenario for the purposes of INSPRU 1.3.43 R and INSPRU 1.3.44 R is the change in value which would arise on the occurrence of the relevant credit risk scenario as a result of bond, debt, reinsurance or other exposures whether or not there is a direct counterparty exposure.

INSPRU 1.3.81

See Notes

handbook-rule
Where a bond or a debt item or reinsurance asset is currently in default, it may be ignored by a firm for the purpose of applying INSPRU 1.3.78 R.

INSPRU 1.3.82

See Notes

handbook-guidance
Where a bond or a debt item or a reinsurance asset is currently in default and has been specifically provisioned, in accordance with relevant accounting standards, a firm is not required to increase the existing default provisions to reflect a worsening of recovery rates.

INSPRU 1.3.83

See Notes

handbook-rule
Where the credit risk scenarios in INSPRU 1.3.78 R to INSPRU 1.3.99 G require a firm to assume a change in current credit spread, or a direct change in market value, the firm must not change the risk-free yields used to discount future cash flows in calculating the revised realistic value of liabilities and realistic value of assets (INSPRU 1.3.43R (2)) resulting from those credit risk scenarios.

Spread stresses to be assumed for bonds and debt

INSPRU 1.3.84

See Notes

handbook-rule
(1) In INSPRU 1.3.78R (1) the spread stress which a firm must assume for any bond or debt item is:
(a) for any bond or debt item issued or guaranteed by an organisation which is in accordance with INSPRU 1.3.87 R a credit risk scenario exempt organisation in respect of that item, zero basis points; and
(b) for any other bond or debt item:
(i) Y if the credit rating description of that other bond or debt item determined by reference to INSPRU 1.3.89 R is not "Highly speculative or very vulnerable"; and
(ii) otherwise the larger of Y and Z.
(2) For the purpose of (1)(b):
(a) Y is the product of the spread factor for that bond or debt item and the square root of S, where:
(i) the spread factor for a bond or debt item is the spread factor shown in the final column of Table INSPRU 1.3.90 R, in the row of that Table corresponding to the credit rating description of the bond or debt item determined for the purpose of this rule by reference to INSPRU 1.3.89 R; and
(ii) subject to (3), S is the current credit spread for a bond or debt item, expressed as a number of basis points, which the firm must determine as the current yield on that bond or debt item in excess of the current gross redemption yield on the government bond most similar to that bond or debt item in terms of currency of denomination and equivalent term; and
(b) Z is the change in credit spread expressed as a number of basis points that would result in the current market value of the bond or debt falling by 5%.
(3) Where, for the purposes of (2)(a)(ii), there is no suitable government bond, the firm must use its best estimate of the gross redemption yield that would apply for a notional government bond similar to the bond or debt item in terms of currency of denomination and equivalent term.

INSPRU 1.3.85

See Notes

handbook-rule
For the purpose of INSPRU 1.3.84R (1)(a), a guarantee must be direct, explicit, unconditional and irrevocable.

INSPRU 1.3.86

See Notes

handbook-guidance
(1) As an example, a bond item has the credit rating description "exceptional or extremely strong" and currently yields 49 basis points in excess of the most similar government bond. The spread factor for that bond item is 3.00 by reference to Table INSPRU 1.3.90 R. Since S is 49, the square root of S is 7 and the spread stress for that item is 3 times 7, that is, 21 basis points. The firm must consider the impact of an increase in spreads by up to 21 basis points for that item.
(2) As a further example, a bond item has the credit rating description "highly speculative or very vulnerable". For this bond, S is 400, being the current spread for that bond expressed as a number of basis points. The spread factor for the bond is 24.00. So the firm must consider the impact of an increase in spreads by up to 24.00 times 20 i.e. 480 basis points for that item. The bond is however of short duration and the reduction in market value resulting from an additional spread of 480 basis points is less than 5 per cent of its current market value. A 5 per cent reduction in its market value would result from a spread widening of 525 basis points. The firm must consider the impact of an increase in spreads by up to 525 basis points for that item by virtue of its credit rating description.
(3) The calculation of the credit spread on commercial floating rate notes warrants particular consideration. Suppose, for example, that a notional floating rate note guaranteed by the UK government would have a market consistent price of X. This price can be estimated based on an assumed distribution of future payments under the floating rate note, and the current forward gilt curve. Suppose further that the market price of the commercial floating rate note is Y, where Y is less than X. A firm could calculate what parallel upward shift in the forward gilt curve would result in the notional government-backed floating rate note having a market price of Y for an unchanged assumed distribution of future payments. The size of the resulting shift could then be taken as the credit spread on the commercial floating rate note.
(4) In arriving at the estimated gross redemption yield in INSPRU 1.3.84R (3), the firm may have regard to any appropriate swap rates for the currency of denomination of the bond or debt item, adjusted to take appropriate account of observed differences between swap rates and the yields on government bonds.

INSPRU 1.3.87

See Notes

handbook-rule
For the purposes of this section:
(1) an organisation is a credit risk scenario exempt organisation in respect of an item if the organisation is:
(a) the European Central Bank; or
(b) any central government or central bank which, in relation to that item, satisfies the conditions in (2); or
(c) a multilateral development bank which is listed in (3); or
(d) an international organisation which is listed in (4);
(2) the conditions in (1)(b) are that, for any claim against the central government or central bank denominated in the currency in which the item is denominated:
(a) a credit rating is available from at least one listed rating agency nominated in accordance with INSPRU 1.3.92 R; and
(b) the credit rating description in the first column of Table INSPRU 1.3.90 R corresponding to the lowest such credit rating is either "exceptionally or extremely strong" or "very strong";
(3) for the purposes of (1)(c) the listed multilateral development banks are:
(a) the International Bank for Reconstruction and Development;
(b) the International Finance Corporation;
(c) the Inter-American Development Bank;
(d) the Asian Development Bank;
(e) the African Development Bank;
(f) the Council of Europe Development Bank;
(g) the Nordic Investment Bank;
(h) the Caribbean Development Bank;
(i) the European Bank for Reconstruction and Development;
(j) the European Investment Bank;
(k) the European Investment Fund; and
(l) the Multilateral Investment Guarantee Agency;
(4) for the purposes of (1)(d) the listed international organisations are:
(a) the European Community;
(b) the International Monetary Fund; and
(c) the Bank for International Settlements.

INSPRU 1.3.88

See Notes

handbook-guidance
Under INSPRU 1.3.87R (2), a firm needs to take account of the currency in which the claim is denominated when it is considering claims on or guaranteed by a central government or central bank. It is possible, for example, that a given central bank would be a credit risk scenario exempt organisation in respect of claims on it denominated in its domestic currency, while not being a credit risk scenario exempt organisation in respect of claims on it denominated in a currency other than its domestic currency - the central government or central bank may have been assigned different credit assessments depending on the currency in which the claim on it is denominated.

INSPRU 1.3.89

See Notes

handbook-rule
(1) For the purposes of this section, the credit rating description of a bond or debt item is to be determined in accordance with (2) and (3).
(2) If the item has at least one credit rating nominated in accordance with INSPRU 1.3.92 R ("a rated item"), its credit rating description is:
(a) where it has only one nominated credit rating, the general description given in the first column of Table INSPRU 1.3.90 R corresponding to that rating; or
(b) where it has two or more nominated credit ratings and the two highest nominated ratings fall within the same general description given in the first column of that Table, that description; or
(c) where it has two or more nominated credit ratings and the two highest nominated ratings do not fall within the same general description given in the first column of that Table, the second highest of those two descriptions.
(3) If the item is not a rated item, its credit rating description is the general description given in the first column of Table INSPRU 1.3.90 R that most closely corresponds to the firm's own assessment of the item's credit quality.
(4) An assessment under (3) must be made by the firm for the purposes of the credit risk scenario having due regard to the seniority of the bond or debt and the credit quality of the bond or debt issuer.

Table : Listed rating agencies, credit rating descriptions, spread factors

INSPRU 1.3.90

See Notes

handbook-rule

INSPRU 1.3.91

See Notes

handbook-guidance
Where listed rating agencies provide ratings by sub-category then all ratings should be allocated to the main ratings category (e.g. ratings sub-category A+ or A- would be allocated to the assigned ratings category "Strong").

INSPRU 1.3.92

See Notes

handbook-rule
For the purposes of INSPRU 1.3.87 R and INSPRU 1.3.89 R, a firm may, subject to (1) to (5), nominate for use credit ratings produced by one or more of the rating agencies listed in INSPRU 1.3.93 R:
(1) if the firm decides to nominate for use for an item the credit rating produced by one or more rating agencies, it must do so consistently for all similar items;
(2) the firm must use credit ratings in a continuous and consistent way over time;
(3) the firm must nominate for use only credit ratings that take into account both principal and interest;
(4) if the firm nominates for use credit ratings produced by one of the listed rating agencies then the firm must use solicited credit ratings produced by that listed rating agency; and
(5) the firm may nominate for use unsolicited credit ratings produced by one or more of the listed rating agencies except where there are reasonable grounds for believing that any unsolicited credit ratings produced by the agency are used so as to obtain inappropriate advantages in the relationship with rated parties.

INSPRU 1.3.93

See Notes

handbook-rule
In this section, a listed rating agency is:
(1) A.M. Best Company; or
(2) Fitch Ratings; or
(3) Moody's Investors Service; or
(4) Standard & Poor's Corporation.

Credit risk scenario for reinsurance

INSPRU 1.3.94

See Notes

handbook-rule
(1) The contracts of reinsurance or analogous non-reinsurance financing agreements to which INSPRU 1.3.78R (2) applies are those:
(a) into which the firm has entered;
(b) which represent an economic asset under the single event applicable under INSPRU 1.3.43R (3); and
(c) which are material (individually or in aggregate).
(2) For the purposes of (1), no account is to be taken of reinsurance or analogous non-reinsurance financing arrangements between undertakings in the same group where:
(a) the ceding and accepting undertakings are regulated by the FSA or a regulatory body in a designated State or territory for insurance (including reinsurance);
(b) no subsequent cessions of the ceded risk which are material (individually or in aggregate) are made to subsequent accepting undertakings by accepting undertakings (including subsequent accepting undertakings) other than to subsequent accepting undertakings which are in the same group; and
(c) for any subsequent cession or cessions of the ceded risk which are material (individually or in aggregate) each of the ceding and accepting undertakings (including subsequent accepting undertakings) is regulated by the FSA or a regulatory body in a designated State or territory for insurance (including reinsurance).
(3) The change in value which a firm must determine for a contract of reinsurance or an analogous non-reinsurance financing agreement is the firm's best estimate of the change in realistic value which would result from changes in credit risk market conditions consistent, subject to (4), with the changes in credit spreads determined in accordance with INSPRU 1.3.78R (1).
(4) For the purpose of (3), 5% should be replaced by 10% in INSPRU 1.3.84R (2)(b).

INSPRU 1.3.95

See Notes

handbook-guidance
(1) Reinsurance and analogous non-reinsurance financing agreements entered into by the firm, either with or acting as a reinsurer, must be included within the scope of the scenario. The combined rights and obligations under a contract of reinsurance or an analogous non-reinsurance financing agreement may represent an economic asset or liability. The value placed by the firm on the reinsurance item or non-reinsurance financing item should allow for a realistic assessment of the risks transferred and the risks of counterparty default associated with the item. In the case of analogous non-reinsurance financing agreements, references to terms such as "reinsurer", "ceding undertakings" and "accepting undertakings" include undertakings which by analogy are reinsurers, ceding or accepting undertakings. Analogous non-reinsurance financing agreements include contingent loans, securitisations and any other arrangements in respect of contracts of insurance that are analogous to contracts of reinsurance in terms of the risks transferred and the finance provided.
(2) In assessing values in accordance with INSPRU 1.3.94 R, a firm may consider it appropriate to determine values by drawing an analogy with the approach in respect of bond and debt items set out in INSPRU 1.3.84 R. (This might be the case if, in economic terms, the item being valued sufficiently resembles a bond or debt item - an alternative approach might otherwise be preferred). If the firm does consider it appropriate to draw an analogy, the "credit spread" assumed should be consistent with the assumed default probabilities and the values placed on the reinsurance asset for the purposes of determining the realistic values of assets and liabilities. A firm may regard it as appropriate to have regard to any financial strength ratings applicable to the reinsurer, but if so should apply the same principles set out in INSPRU 1.3.92 R for the nomination of financial strength ratings. Table INSPRU 1.3.97 G provides guidance as to the allocation of spread factors which a firm may, by analogy, deem appropriate to apply. Appropriate allowance should be made for any change in the extent of the counterparty exposure under the assumed scenario.
(3) The changes in credit risk spreads determined for bond and debt items in accordance with INSPRU 1.3.78R (1) are required to result in a reduction in market value for some items of 5% of their current value through the operation of INSPRU 1.3.84R (2)(b). For reinsurance contracts and analogous non-reinsurance financing agreements, determining the change in value by reference to INSPRU 1.3.94R (3) requires a firm to consider the possibility of counterparty default in changed credit risk market conditions. Where in the changed credit risk market conditions assumed to apply the firm's assessment of the counterparty risk would result in the asset being considered equivalent to "Highly speculative or very vulnerable", the reduction in value required is at least 10% of its current value. INSPRU 1.3.94R (4) relates to this requirement.

INSPRU 1.3.96

See Notes

handbook-guidance
A financial strength rating of a reinsurer refers to a current assessment of the financial security characteristics of the reinsurer with respect to its ability to pay claims under its reinsurance contracts and treaties in accordance with their terms.

INSPRU 1.3.97

See Notes

handbook-guidance
Table: Listed rating agencies, financial strength descriptions and spread factors

Credit risk scenario for other exposures (including any derivative or quasi-derivative)

INSPRU 1.3.98

See Notes

handbook-rule
For the purposes of INSPRU 1.3.78R (3), the change in value which must be determined for any other item (including any derivative or quasi-derivative) which represents an economic asset under the single event applicable under INSPRU 1.3.43R (3) is the firm's best estimate of the change in the realistic value of that item which would result from changes in credit risk market conditions consistent with the changes in credit spreads determined in accordance with INSPRU 1.3.78R (1) and the changes in value determined in accordance with INSPRU 1.3.78R (2).

INSPRU 1.3.99

See Notes

handbook-guidance
In applying INSPRU 1.3.98 R, a firm should assess the total impact on the value of the item resulting from the assumed changed credit risk market conditions. The total change in value may result from the interaction of a number of separate influences. For example, a widening of credit spreads may imply an impact on the amount exposed to counterparty default as well as on the likelihood of that default. Each factor influencing the change in value needs separate consideration. It should be assumed, both for determining amounts exposed to counterparty default and the likelihood of such default that there will be no change in the likelihood of default in relation to an item issued by or guaranteed by an organisation which is in respect of that item a credit risk scenario exempt organisation (INSPRU 1.3.87 R. INSPRU 1.3.77G (5) is also relevant in this context.

Persistency risk scenario

INSPRU 1.3.100

See Notes

handbook-rule
For the purposes of the persistency risk scenario in INSPRU 1.3.44R (6), a firm must allow for the effects of an increase or a decrease in persistency experience of its with-profits insurance contract by adjusting the termination rates in each year of projection by 32.5% of the termination rates assumed in the calculation of the realistic value of liabilities in INSPRU 1.3.40 R.

INSPRU 1.3.101

See Notes

handbook-rule
The termination rates referred to in INSPRU 1.3.100 R are the rates of termination (including the paying-up of policies, but excluding deaths, maturities and retirements) other than on dates specified by the firm where:
(1) a guaranteed amount applies as the minimum amount which will be paid on claim; or
(2) any payments to the policyholder cannot be reduced at the discretion of the firm by its applying a market value adjustment.

INSPRU 1.3.102

See Notes

handbook-rule
For the purposes of INSPRU 1.3.100 R, the increase or decrease in termination rates must be applied to the projection of terminations up to policy guarantee dates and between policy guarantee dates, but not to the assumptions as to the proportion of policyholders taking up the guarantees at policy guarantee dates.

INSPRU 1.3.103

See Notes

handbook-guidance
INSPRU 1.3.100 R to INSPRU 1.3.102 R require firms to apply a persistency stress test to the realistic value of liabilities. Where a firm brings the present value of non-profit insurance business in a with-profits fund into the calculation of the realistic value of assets (see INSPRU 1.3.33 R) there is no requirement to stress this asset for changes in persistency assumptions.

Realistic value of liabilities: detailed provisions

INSPRU 1.3.104

See Notes

handbook-guidance
INSPRU 1.3.40 R sets out the three elements comprising the realistic value of liabilities for a with-profits fund. The remainder of this section contains general rules and guidance on determining the realistic value of liabilities plus further detail relating to each of those elements separately, as follows:

Methods and assumptions: general

INSPRU 1.3.105

See Notes

handbook-rule
In calculating the realistic value of liabilities for a with-profits fund, a firm must use methods and assumptions which:
(1) are appropriate to the business of the firm;
(2) are consistent from year to year without arbitrary changes (that is, changes without adequate reasons);
(3) are consistent with the method of valuing assets (GENPRU 1.3);
(4) make full provision for tax payable out of the with-profits fund, based on current legislation and practice, together with any known future changes, and on a consistent basis with the other methods and assumptions used;
(5) take into account discretionary benefits which are at least equal to, and charges which are no more than, the levels required for the firm to fulfil its regulatory duty to treat its customers fairly;
(6) take into account prospective management actions (INSPRU 1.3.53 R) and policyholder actions (INSPRU 1.3.59 R);
(7) provide for shareholder transfers out of the with-profits fund as a liability of the fund;
(8) have regard to generally accepted actuarial practice; and
(9) are consistent with the firm'sPPFM.

INSPRU 1.3.106

See Notes

handbook-guidance
More specific rules and guidance are set out below on some aspects of the methods and assumptions to be used in calculating the realistic value of liabilities for a with-profits fund. In contrast to the mathematical reserves requirements in INSPRU 1.2.10R (4) and INSPRU 1.2.13 R, there is no requirement to include margins for adverse deviation of relevant factors in calculating the realistic value of liabilities. Assumptions need be no more prudent than is necessary to achieve a best estimate, taking into account the firm'sPPFM and its regulatory duty to treat its customers fairly. Where there is no requirement for a PPFM, for example non-UK business, a firm should use assumptions that are consistent with the firm's documented approach to treating its customers fairly. A firm may judge that a margin should be included in its calculations to avoid an understatement of the realistic value of liabilities as a result of uncertainty, for example, either in its method or in its data.

INSPRU 1.3.107

See Notes

handbook-guidance
The amount and timing of tax charges affect the amount of assets available to meet policyholder liabilities. INSPRU 1.3.105R (4) requires firms to provide fully for all tax payable out of the with-profits fund on a basis consistent with the other assumptions and methods used in deriving the realistic balance sheet. So, for example, all projections which underlie the realistic valuation of assets or liabilities must allow for taxation. The approach adopted should not give any credit for any reduction in tax deriving from future expenses or deficits which is attributable to future new business. For assets backing capital requirements it is not necessary to take into consideration future tax charges on investment income generated by those assets. However, firms should consider this aspect in their capital planning.

INSPRU 1.3.108

See Notes

handbook-guidance
[intentionally blank]

Valuation of contracts: General

INSPRU 1.3.109

See Notes

handbook-rule
(1) A firm must determine the amount of the with-profits benefits reserve or the future policy related liabilities for a with-profits fund by carrying out a separate calculation in relation to each with-profits insurance contract or for each group of similar contracts.
(2) Appropriate approximations or generalisations may be made where they are likely to provide the same, or a higher, result than a separate calculation for each contract.
(3) A firm must set up additional reserves on an aggregated basis for general risks which are not specific to individual contracts or a group of similar contacts where the firm considers the realistic value of liabilities may otherwise be understated.

INSPRU 1.3.110

See Notes

handbook-rule
For the purpose of INSPRU 1.3.109R (1), a group of similar contracts is such that the conditions in INSPRU 1.3.109R (2) are satisfied.

INSPRU 1.3.111

See Notes

handbook-guidance
Where a firm has grouped individual contracts for the purpose of calculating the mathematical reserves for a with-profits fund (in accordance with INSPRU 1.2.22 R), the firm is not required to use the same grouping of contracts in calculating the with-profits benefits reserve or future policy related liabilities for that fund.

INSPRU 1.3.112

See Notes

handbook-guidance
In contrast to INSPRU 1.2.24 R for the mathematical reserves, treating individual contracts as an asset is not prohibited if, and to the extent that, this treatment does not conflict with a firm's regulatory duty to treat its customers fairly.

INSPRU 1.3.113

See Notes

handbook-guidance
In calculating the with-profits benefits reserve, an overall (grouped or pooled) approach may be appropriate under either of the two methods set out in INSPRU 1.3.116 R. In particular, the calculation of aggregate retrospective reserves (see INSPRU 1.3.118 R) and the projection of future cash flows (see INSPRU 1.3.128 R) based on suitable specimen policies is permitted.

INSPRU 1.3.114

See Notes

handbook-guidance
In calculating the future policy related liabilities, the grouping of policies for valuing the costs of guarantees, options or smoothing, and their representation by representative policies, is acceptable provided the firm can demonstrate that the grouping of policies does not materially misrepresent the underlying exposure and does not significantly misstate the costs. A firm should exercise care in grouping policies in order to ensure that the risk exposure is not inappropriately distorted by, for example, forming groups containing policies with guarantees that are "in the money" and policies with guarantees well "out of the money". A firm should also have regard to the effects of policyholder behaviour over time on the spread of the outstanding guarantees or options.

INSPRU 1.3.115

See Notes

handbook-guidance
Where a firm groups similar policies for the purpose of calculating the with-profits benefits reserve or the future policy related liabilities, the firm should carry out sufficient validation to be reasonably sure that the grouping of policies has not resulted in the loss of any significant attributes of the portfolio being valued.

With-profits benefits reserve

INSPRU 1.3.116

See Notes

handbook-rule
A firm must calculate a with-profits benefits reserve for a with-profits fund using either:
(1) a retrospective calculation under INSPRU 1.3.118 R (the retrospective method); or
(2) a prospective calculation under INSPRU 1.3.128 R of all future cash flows expected to arise under, or in respect of, each of the with-profits insurance contracts written in that fund (the prospective method).

INSPRU 1.3.117

See Notes

handbook-rule
Subject to INSPRU 1.3.105R (2), a firm may use different methods under INSPRU 1.3.116 R for different types or generations of with-profits insurance contracts.

Retrospective method

INSPRU 1.3.118

See Notes

handbook-rule
In the retrospective method of calculating a with-profits benefits reserve, a firm must calculate either the aggregate of the retrospective reserves in respect of each with-profits insurance contract or, to the extent permitted by INSPRU 1.3.109 R and INSPRU 1.3.110 R, the total retrospective reserve in respect of each group of with-profits insurance contracts.

INSPRU 1.3.119

See Notes

handbook-rule
In calculating the retrospective reserve for a with-profits insurance contract, or the total retrospective reserve in respect of a group of with-profits insurance contracts, a firm must take account of at least the following:
(1) premiums received from the policyholder;
(2) any expenses incurred or charges made (including commissions);
(3) any partial benefits paid or due;
(4) any investment income on, and any increases (or decreases) in, asset values;
(5) any tax paid or payable;
(6) any amounts received (or paid) under contracts of reinsurance or analogous non-reinsurance financing agreements, where relevant to retrospective reserves;
(7) any shareholder transfers and any associated tax paid or payable; and
(8) any permanent enhancements to (or deductions from) the retrospective reserves made by the firm.

INSPRU 1.3.120

See Notes

handbook-guidance
In taking account of amounts in INSPRU 1.3.119R (6), due regard should be had to the specific details of each relevant contract of reinsurance or analogous non-reinsurance financing agreement and the relationship between the amounts received (or paid) and the value of the benefit granted (or received) under the arrangement. This should take into consideration, for example, the risk of default and differences in the firm's realistic assessment of the risks transferred and the contractual terms for such transfer of risk. Analogous non-reinsurance financing agreements include contingent loans, securitisations and any other arrangements in respect of contracts of insurance that are analogous to contracts of reinsurance in terms of the risks transferred and the finance provided.

INSPRU 1.3.121

See Notes

handbook-guidance
Where allowance is made for shareholder transfers, this should be in respect of the accrued bonus entitlement reflected in the retrospective reserve. This would include both annual bonuses already declared and accrued final bonus. However, shareholder transfers in respect of surplus yet to be credited to retrospective reserves should not be charged to those reserves until the corresponding surplus is credited.

INSPRU 1.3.122

See Notes

handbook-rule
In calculating retrospective reserves, a firm must have regard to its regulatory duty to treat its customers fairly and must ensure that its approach is consistent with its Principles and Practices of Financial Management.

INSPRU 1.3.123

See Notes

handbook-rule
In calculating retrospective reserves, a firm must ensure its treatment of past cash flows, and of any future cash flows, is consistent with those cash flows valued in its prospective calculation of the future policy related liabilities for that fund in accordance with the rules in INSPRU 1.3.136 G to INSPRU 1.3.189 G.

INSPRU 1.3.124

See Notes

handbook-guidance
An example of INSPRU 1.3.123 R concerns future shareholder transfers. A firm must make adequate provision for future shareholder transfers within the future policy related liabilities (see INSPRU 1.3.165 R). The basis of provisioning needs to be consistent with the amounts accrued within retrospective reserves and the amounts already transferred out of the with-profits fund.

INSPRU 1.3.125

See Notes

handbook-guidance
Another example of the application of INSPRU 1.3.123 R relates to the reference in INSPRU 1.3.119R (8) to past permanent enhancements to (or deductions from) retrospective reserves made by firms. This item may include past miscellaneous surplus (or losses) which have been credited to (or debited from) retrospective reserves. Any other enhancements (or deductions) made on a temporary basis and any future surplus (or losses) that firms intend to credit to (or debit from) retrospective reserves should be included under the future policy related liabilities (see INSPRU 1.3.137 R).

INSPRU 1.3.126

See Notes

handbook-guidance
Firms characteristically use a range of calculation methods to determine retrospective reserves. A firm's definition and calculation of retrospective reserves will depend on a number of factors. These include: the firm's practice; its administration and accounting systems; the extent of its historical records; and the composition of its with-profits portfolio. The rules and guidance for the retrospective method are drawn up to be sufficiently flexible to accommodate the diversity of calculation methods used by firms, rather than to enforce any particular method of calculation of retrospective reserves. INSPRU 1.3.119 R simply sets minimum standards that all retrospective methods must meet.

INSPRU 1.3.127

See Notes

handbook-guidance
For the purposes of INSPRU 1.3.119R (2) and INSPRU 1.3.128R (2), the phrases 'charges made' or 'charges to be made' refer to circumstances where types of risk (such as mortality risk, longevity risk and investment risk) are met by the firm or with-profits fund in return for a charge deducted by the firm from the with-profits benefits reserve.

Prospective method

INSPRU 1.3.128

See Notes

handbook-rule
In the prospective method of calculating a with-profits benefits reserve, a firm must take account of at least the following cash flows:
(1) future premiums;
(2) expenses to be incurred or charges to be made, including commissions;
(3) benefits payable (INSPRU 1.3.129 R);
(4) tax payable;
(5) any amounts to be received (or paid) under contracts of reinsurance or analogous non-reinsurance financing agreements, where relevant to with-profits insurance contracts being valued; and
(6) shareholder transfers.

INSPRU 1.3.129

See Notes

handbook-rule
For the purposes of INSPRU 1.3.128R (3), benefits payable include:
(1) all guaranteed benefits, including guaranteed amounts payable on death and maturity, guaranteed surrender values and paid-up values;
(2) vested, declared and allotted bonuses to which policyholders are entitled; and
(3) future annual and final bonuses at least equal to the levels required for the firm to fulfil its regulatory duty to treat its customers fairly.

INSPRU 1.3.130

See Notes

handbook-rule
A firm must value the cash flows listed in INSPRU 1.3.128 R using best estimate assumptions of future experience, having regard to generally accepted actuarial practice and taking into account the firm'sPPFM and its regulatory duty to treat its customers fairly.

INSPRU 1.3.131

See Notes

handbook-guidance
The prospective method sets the with-profits benefits reserve at the net present value of future cash flows listed in INSPRU 1.3.128 R.

INSPRU 1.3.132

See Notes

handbook-guidance
In contrast to INSPRU 1.2.10R (4) and INSPRU 1.2.13 R relating to the methods and assumptions used to value the mathematical reserves, there is no requirement to value future cash flows using assumptions that include margins for adverse deviation. Also there are no detailed rules as to the future yields on assets, discount rates, premium levels, expenses, tax, mortality, morbidity, persistency and reinsurance. A firm should make its own assessment as to the amount of these future cash flows including bonuses and discretionary surrender or transfer values. A firm should make a realistic assessment of longevity risk and asset default risk (including default risk arising under contracts of reinsurance or analogous non-reinsurance financing agreements) within the best estimate assumptions of future experience required by INSPRU 1.3.130 R.

INSPRU 1.3.133

See Notes

handbook-guidance
In valuing the future cash flows listed in INSPRU 1.3.128 R, the firm should use a projection term which is long enough to capture all material cash flows arising from the contract or groups of contracts being valued. If the projection term does not extend to the term of the last policy, the firm should check that the shorter projection term does not significantly affect the results.

INSPRU 1.3.134

See Notes

handbook-rule
Where a firm expects to pay additional benefits that are not included in the cash flows listed in INSPRU 1.3.128 R, it must make adequate provision for these benefits in calculating the future policy related liabilities in accordance with the rules in INSPRU 1.3.136 G to INSPRU 1.3.189 G.

INSPRU 1.3.135

See Notes

handbook-guidance
The prospective assessment of the with-profits benefits reserve will usually be on a deterministic basis. A firm will have to make further provision in the future policy-related liabilities for, for example, the costs of potential asset fluctuations or policy options.

Future policy related liabilities

INSPRU 1.3.136

See Notes

handbook-guidance
Overview of liabilities
INSPRU 1.3.137 R lists the future policy related liabilities for a with-profits fund that form part of a firm'srealistic value of liabilities in INSPRU 1.3.40 R. Detailed rules and guidance relating to particular types of liability and asset are set out in INSPRU 1.3.139 R to INSPRU 1.3.168 G. These are followed by rules and guidance that deal with certain aspects of several liabilities (that is, liabilities relating to guarantees, options and smoothing):
(1) INSPRU 1.3.169 R to INSPRU 1.3.186 G refer to valuing the costs of guarantees, options and smoothing; and
(2) INSPRU 1.3.187 R to INSPRU 1.3.189 G refer to the treatment of surplus on guarantees, options and smoothing.

INSPRU 1.3.137

See Notes

handbook-rule
The future policy related liabilities for a with-profits fund are equal to the sum of amounts, as they relate to that fund, in respect of (1) to (11) to the extent each is valued as a liability less the sum of amounts, as they relate to that fund, in respect of (1) to (11) to the extent each is valued as an asset:
(1) past miscellaneous surplus (or deficit) planned to be attributed to the with-profits benefits reserve (see INSPRU 1.3.139 R);
(2) planned enhancements to the with-profits benefits reserve (see INSPRU 1.3.141 R);
(3) planned deductions for the costs of guarantees, options and smoothing from the with-profits benefits reserve (see INSPRU 1.3.144 R);
(4) planned deductions for other costs deemed chargeable to the with-profits benefits reserve (see INSPRU 1.3.146 R);
(5) future costs of contractual guarantees (other than financial options) (see INSPRU 1.3.148 R);
(6) future costs of non-contractual commitments (see INSPRU 1.3.154 R);
(7) future costs of financial options (see INSPRU 1.3.156 G);
(8) future costs of smoothing (see INSPRU 1.3.158 R);
(9) financing costs (see INSPRU 1.3.162 R);
(10) any other further liabilities required for the firm to fulfil its regulatory duty to treat its customers fairly; and

INSPRU 1.3.138

See Notes

handbook-guidance
Some of the elements of the calculation set out in INSPRU 1.3.137 R may have already been taken into consideration in the calculation of the with-profits benefits reserve, either under the retrospective method (see INSPRU 1.3.118 R onwards) or the prospective method (see INSPRU 1.3.128 R onwards). Where this is the case, the adjustments made under INSPRU 1.3.137 R should be such that no double-counting arises.

Past miscellaneous surplus (or deficit) planned to be attributed to the with-profits benefits reserve

INSPRU 1.3.139

See Notes

handbook-rule
In calculating the future policy related liabilities for a with-profits fund, a firm must allow for past miscellaneous surplus (or deficit) which it intends to attribute to the with-profits benefits reserve for that fund but which has not yet been permanently credited to (or debited from) the with-profits benefits reserve for that fund.

INSPRU 1.3.140

See Notes

handbook-guidance
Past miscellaneous surplus (or deficit) already permanently credited to (or debited from) the with-profits benefits reserve will have been included in the calculation of the with-profits benefits reserve in accordance with INSPRU 1.3.119R (8).

Planned enhancements to the with-profits benefits reserve

INSPRU 1.3.141

See Notes

handbook-rule
In calculating the future policy related liabilities for a with-profits fund, a firm must make provision for any future planned enhancements to the with-profits benefits reserve for that fund that cannot be financed out of the resources of the with-profits benefits reserve and future premiums.

INSPRU 1.3.142

See Notes

handbook-guidance
For the purposes of INSPRU 1.3.141 R, planned enhancements to the with-profits benefits reserve will arise when a firm has a contractual obligation, or a non-contractual commitment (arising from its regulatory duty to treat customers fairly), to enhance claims on some classes of policy (perhaps in the form of specially enhanced future bonus rates). In such circumstances, the present value of the costs of paying out a target asset share that is more than the projected with-profits benefits reserve for those classes of policy for which this practice is applicable should be included in the amount of the future policy related liabilities. For example, a firm may have a non-contractual commitment (arising from its regulatory duty to treat customers fairly) to pay enhanced benefits but have discretion not to make such payments in adverse circumstances. Such planned enhancements should be provided for in the realistic balance sheet, but allowance should be made for management action in the calculation of the risk capital margin.

INSPRU 1.3.143

See Notes

handbook-guidance
The valuation of claims in excess of targeted asset shares in respect of guarantees, options and smoothing, including those arising under guaranteed annuity rates, should be carried out in accordance with INSPRU 1.3.169 R to INSPRU 1.3.186 G.

Planned deductions for the costs of guarantees, options and smoothing from the with-profits benefits reserve

INSPRU 1.3.144

See Notes

handbook-rule
Where a firm expects to deduct future charges from the with-profits benefits reserve for a with-profits fund to cover the costs of guarantees, options or smoothing for that fund, the firm must take credit for these future charges in calculating the future policy related liabilities for that fund.

INSPRU 1.3.145

See Notes

handbook-guidance
In calculating future policy related liabilities for a with-profits fund, a firm should take credit under INSPRU 1.3.137R (3) for the present value of the future "margins" available in respect of charges deducted to cover the costs of guarantees, options and smoothing. INSPRU 1.3.188 R requires firms that accumulate the charges made less costs incurred to provide for any surplus on the experience account as a realistic liability. Any such provision should be made under INSPRU 1.3.137R (5), INSPRU 1.3.137R (7) or INSPRU 1.3.137R (8) depending on the nature of the charges made, and has no effect on the amount calculated under INSPRU 1.3.144 R.

Planned deductions for other costs deemed chargeable to the with-profits benefits reserve

INSPRU 1.3.146

See Notes

handbook-rule
Where a firm expects to deduct future charges (other than those valued in INSPRU 1.3.144 R) from the with-profits benefits reserve for a with-profits fund, the firm must take credit for these future charges in calculating the future policy-related liabilities for that fund.

INSPRU 1.3.147

See Notes

handbook-guidance
A firm should take credit for the present value of the other future "margins" available. The circumstances where such margins may arise include:
(1) where a firm is targeting claims at less than 100% of the with-profits benefits reserve, the amount of such shortfall; and
(2) where a firm expects to deduct any future charges (other than those for guarantees, options and smoothing) from the with-profits benefits reserve.

Future costs of contractual guarantees (other than financial options)

INSPRU 1.3.148

See Notes

handbook-rule
A firm must make provision for the costs of paying excess claim amounts for a with-profits fund where the firm expects that the amount in (1) may be greater than the amount in (2), calculated as at the date of claim:
(1) the value of guarantees arising under a policy or group of policies in the fund; and
(2) the fund's with-profits benefits reserve allocated in respect of that policy or group of policies.

INSPRU 1.3.149

See Notes

handbook-rule
For the purposes of INSPRU 1.3.148 R, the future costs of guarantees cannot be negative.

INSPRU 1.3.150

See Notes

handbook-guidance
In carrying out projections to calculate the cost of guarantees under INSPRU 1.3.137 R the opening liability should be set equal to the with-profits benefit reserve (see INSPRU 1.3.118 R), adjusted for miscellaneous surplus or deficits (see INSPRU 1.3.137R (1)) and planned enhancements (see INSPRU 1.3.141 R).

INSPRU 1.3.151

See Notes

handbook-guidance
In projecting forward the with-profits benefits reserve, adjusted as in INSPRU 1.3.150 G, to the date of claim for the purposes of INSPRU 1.3.148 R, the firm should use market consistent assumptions for the expected future premium and investment income (including realised and unrealised gains or losses), expenses and claims, any charges to be deducted, tax and any other item of income or outgo. This projection should be carried out on the same basis as is described in INSPRU 1.3.130 R.

INSPRU 1.3.152

See Notes

handbook-guidance
INSPRU 1.3.169 R to INSPRU 1.3.186 G contain further rules and guidance on the valuation of guarantees, options and smoothing.

INSPRU 1.3.153

See Notes

handbook-guidance
Some examples of contractual guarantees are:
(1) for conventional with-profits insurance contracts, guaranteed sums assured and bonuses on death, maturity or retirement; and
(2) for accumulating with-profits policies, guarantees at a point in time or guaranteed minimum bonus rates.

Future costs of non-contractual commitments

INSPRU 1.3.154

See Notes

handbook-rule
A firm must make provision for future costs in addition to those in INSPRU 1.3.148 R where the firm expects to pay further amounts to meet non-contractual commitments to customers or pay other benefits that need to be provided to fulfil a firm's regulatory duty to treat its customers fairly.

INSPRU 1.3.155

See Notes

handbook-guidance
Some examples of these non-contractual commitments are:
(1) statements by the firm regarding the ability of policies to cover defined amounts, such as the repayment of a mortgage;
(2) statements by the firm regarding regular withdrawals from a policy being without penalty;
(3) guaranteed annuity and cash option rates being provided beyond the strict interpretation of the policy; and
(4) the costs of any promises to customers or other benefits that need to be provided to fulfil a firm's regulatory duty to treat its customers fairly.

Future costs of financial options

INSPRU 1.3.156

See Notes

handbook-guidance
Financial options include guaranteed annuity and cash option rates.

INSPRU 1.3.157

See Notes

handbook-guidance
INSPRU 1.3.169 R to INSPRU 1.3.186 G contain further rules and guidance on the valuation of options.

Future costs of smoothing

INSPRU 1.3.158

See Notes

handbook-rule
A firm must make provision for future smoothing costs of a with-profits fund where the firm expects that the claims paid on a policy or group of policies in the fund will vary from the greater of:
(1) the value of guarantees determined in INSPRU 1.3.148 R in respect of that policy or group of policies; and
(2) the fund's with-profits benefits reserve allocated in respect of that policy or group of policies which must be enhanced as described in INSPRU 1.3.141 R;
calculated as at the date of claim.

INSPRU 1.3.159

See Notes

handbook-rule
For the purposes of INSPRU 1.3.158 R, smoothing costs are defined as the present value of the difference between projected claims and the projected with-profits benefit reserve after enhancements (INSPRU 1.3.141 R), other than payouts on guarantees (INSPRU 1.3.148 R).

INSPRU 1.3.160

See Notes

handbook-rule
Subject to INSPRU 1.3.188 R, the future costs of smoothing can be negative.

INSPRU 1.3.161

See Notes

handbook-guidance
INSPRU 1.3.169 R to INSPRU 1.3.186 G contain further rules and guidance on the valuation of the future costs of smoothing.

Financing costs

INSPRU 1.3.162

See Notes

handbook-rule
A firm must provide for future liabilities to repay financing costs of a with-profits fund where the firm expects to have to meet such liabilities and to the extent that these liabilities are not already provided for by amounts included in the fund's realistic current liabilities (INSPRU 1.3.190 R and INSPRU 1.3.191 R). The amount of the liabilities to repay financing costs must be assessed on a market-consistent basis.

INSPRU 1.3.163

See Notes

handbook-guidance
In INSPRU 1.3.162 R, financing costs refer to the future costs incurred by way of capital, interest and fees payable to the provider. A firm should make a realistic assessment of the requirement to repay such financing in its expected future circumstances (which may be worse than currently). Having taken account of its particular circumstances:
(1) where a firm has no liability to repay such financing, it should not include such repayment as a liability;
(2) where a firm has a reduced liability to repay such financing, it should include a reduced repayment as a liability.

INSPRU 1.3.164

See Notes

handbook-guidance
In INSPRU 1.3.162 R, financing includes reinsurance financing arrangements and analogous non-reinsurance financing arrangements, such as contingent loans, securitisations and any other arrangements in respect of contracts of insurance that are analogous to contracts of reinsurance in terms of the risks transferred and the finance provided.

Other long-term insurance liabilities

INSPRU 1.3.165

See Notes

handbook-rule
A firm must provide for any other long-term insurance liabilities arising from or in connection with with-profits insurance contracts in a with-profits fund, to the extent that adequate provision has not been made in the with-profits benefits reserve or in any other part of the future policy related liabilities for that fund.

INSPRU 1.3.166

See Notes

handbook-guidance
Some examples of these other long-term insurance liabilities are:
(1) pension and other mis-selling reserves;
(2) provisions for tax; and
(3) provisions for future shareholder transfers.

INSPRU 1.3.167

See Notes

handbook-guidance
In determining the realistic liability for taxation firms should apply the general principles set out in INSPRU 1.3.105 R and the guidance given in INSPRU 1.3.107 G.

INSPRU 1.3.168

See Notes

handbook-guidance
INSPRU 1.3.105 R requires firms to provide for shareholder transfers out of the with-profits fund as a liability of the fund. The provision should be consistent with the methods and assumptions used in valuing the other realistic liabilities. So, for example, where the with-profits benefits reserve includes amounts that would be paid to policyholders through future bonuses, provision should also be made for future shareholder transfers associated with those bonuses.

Valuing the costs of guarantees, options and smoothing

INSPRU 1.3.169

See Notes

handbook-rule
For the purposes of INSPRU 1.3.137R (5), INSPRU 1.3.137R (7) and INSPRU 1.3.137R (8), a firm must calculate the costs of any guarantees, options and smoothing using one or more of the following three methods:
(1) a stochastic approach using a market-consistent asset model (INSPRU 1.3.170 R);
(2) using the market costs of hedging the guarantee or option;
(3) a series of deterministic projections with attributed probabilities.

INSPRU 1.3.170

See Notes

handbook-rule
The market-consistent asset model in INSPRU 1.3.169R (1):
(1) means a model that delivers prices for assets and liabilities that can be directly verified from the market; and
(2) must be calibrated to deliver market-consistent prices for those assets that reflect the nature and term of the with-profits insurance liabilities of the with-profits fund.

INSPRU 1.3.171

See Notes

handbook-guidance
Deterministic approaches will not usually capture the time value of the option generated by a guarantee. In order to calculate this value properly, firms are expected either to use market option values where these are readily available or to undertake a stochastic approach using a market-consistent asset model.

INSPRU 1.3.172

See Notes

handbook-guidance
The FSA considers stochastic modelling to be preferable for material groups or classes of with-profits insurance contracts unless it can be shown that more simplistic or alternative methods are both appropriate and sufficiently robust.

INSPRU 1.3.173

See Notes

handbook-guidance
Where the guarantee or option is relatively simple in nature, is capable of being hedged, and has a value unlikely to be affected by management actions (INSPRU 1.3.185 R) (for example, a guaranteed annuity rate option) then the cost of the guarantee or option would be the market cost of hedging the guarantee. Where that is generally the case but, in respect of a minor part of a portfolio, no market exists for hedging the option generated by the guarantee, a firm should take the value of the nearest equivalent benefit or right for which a market exists and record how it has adjusted the valuation to reflect the original option. Where the market value of the hedge is used firms should also make provisions for the credit risk arising from the hedge, both that arising from exposure to a counterparty and that arising from credit risk in the underlying instrument. The extent to which the guarantee or option is capable of being hedged depends on a firm's assumptions regarding future investment mix, persistency, annuitant mortality and take-up rates. While the FSA recognises that the hedge may not be perfectly matched to the underlying guarantee or option, a firm should ensure that hedge is reasonably well matched having regard to the sensitivity of the guarantee or option to the firm's choice of key assumptions.

INSPRU 1.3.174

See Notes

handbook-guidance
Where a firm has large cohorts of guarantees and uses stochastic or deterministic approaches, a firm should have regard to whether the cost of the guarantees determined under those approaches bears a reasonable relationship to the market cost of hedging those guarantees (where it exists).

INSPRU 1.3.175

See Notes

handbook-guidance
In determining the costs of smoothing, a firm should consider:
(1) the consistency of its assumptions (including the exercise of management discretion over bonus rates); and
(2) where targeted payouts currently exceed retrospective reserves in respect of those claims, the assumptions used in reducing the excess, if applicable, having regard to the firm'sPPFM and its regulatory duty to treat its customers fairly.

Stochastic approach

INSPRU 1.3.176

See Notes

handbook-guidance
For the purposes of INSPRU 1.3.169R (1), a stochastic approach would consist of an appropriate market-consistent asset model for projections of asset prices and yields (such as equity prices, fixed interest yields and property yields), together with a dynamic model incorporating the corresponding value of liabilities and the impact of any foreseeable actions to be taken by management. Under the stochastic approach, the cost of the guarantee, option or smoothing would be equal to the average of these stochastic projections.

INSPRU 1.3.177

See Notes

handbook-guidance
In performing the projections of assets and liabilities under the stochastic approach in INSPRU 1.3.169R (1), a firm should have regard to the aspects in (1) and (2).
(1) The projection term should be long enough to capture all material cash flows arising from the contract or groups of contracts being valued. If the projection term does not extend to the term of the last policy, the firm should check that the shorter projection term does not significantly affect the results.
(2) The number of projections should be sufficient to ensure a reasonable degree of convergence in the results, including the determination of the result of the risk capital margin. The firm should test the sensitivity of the results to the number of projections.

INSPRU 1.3.178

See Notes

handbook-guidance
The FSA considers a holistic approach to stochastic modelling to be preferable so as to value all items of costs together rather than using separate methods for different items of the realistic value of liabilities. This approach requires the projection of all material cash flows arising under the contract or group of contracts for each stochastic projection, rather than only those arising from the guarantee or option within the contract. The advantages of this approach are that it ensures greater consistency in the valuation of different components of the contract and explicitly takes into account the underlying hedges or risk mitigation between components of the contract or group of contracts being valued. Where a firm can use a stochastic approach to value simultaneously all components of the contract or group of contracts, the firm should adopt this approach where practical and feasible.

INSPRU 1.3.179

See Notes

handbook-guidance
Where a stochastic approach is used, a firm should make and retain a record under INSPRU 1.3.17 R of the nature of the asset model and of the assumptions used (including the volatility of asset values and any assumed correlations between asset classes or between asset classes and economic indicators, such as inflation).

INSPRU 1.3.180

See Notes

handbook-guidance
In calibrating asset models for the purposes of INSPRU 1.3.170 R, a firm should have regard to the aspects in (1), (2) and (3).
(1) Few (if any) asset models can replicate all the observable market values for a wide range of asset classes. A firm should calibrate its asset models to reflect the nature and term of the fund's liabilities giving rise to significant guarantee and option costs.
(2) A firm will need to apply judgement to determine suitable estimates of those parameters which cannot be implied from observable market prices (for example, long-term volatility). A firm should make and retain a record under INSPRU 1.3.17 R of the choice of parameters and the reasons for their use.
(3) A firm should calibrate the model to the current risk-free yield curve. Risk-free yields should be determined after allowing for credit and all other risks arising. Firms may have regard to any guidance from the actuarial professionon the calculation of the risk-free yield but should not assume a higher yield than suggested by any such guidance.

Deterministic approach

INSPRU 1.3.181

See Notes

handbook-rule
For the purposes of the deterministic approach in INSPRU 1.3.169R (3), a firm must calculate a series of deterministic projections of the values of assets and corresponding liabilities, where each deterministic projection corresponds to a possible economic scenario or outcome.

INSPRU 1.3.182

See Notes

handbook-guidance
A firm should determine a range of scenarios or outcomes appropriate to both valuing the costs of the guarantee, option or smoothing and the underlying asset mix, together with the associated probability of occurrence. These probabilities of occurrence should be weighted towards adverse scenarios to reflect market pricing for risk. The costs of the guarantee, option or smoothing should be equal to the expected cost based on a series of deterministic projections of the values of assets and corresponding liabilities. In using a series of deterministic projections, a firm should consider whether its approach provides a suitably robust estimate of the costs of the guarantee, option or smoothing.

INSPRU 1.3.183

See Notes

handbook-guidance
In performing the projections of assets and liabilities under the deterministic approach in INSPRU 1.3.169R (3), a firm should have regard to the aspects in (1) and (2).
(1) The projection term should be long enough to capture all material cash flows arising from the contract or group of contracts being valued. If the projection term does not extend to the term of the last contract, the firm should check that the shorter projection term does not significantly affect the results.
(2) The series of deterministic projections should be numerous enough to capture a wide range of possible outcomes and take into account the probability of each outcome's likelihood. The costs will be understated if only relatively benign or limited economic scenarios are considered.

INSPRU 1.3.184

See Notes

handbook-guidance
Where a series of deterministic projections is used, a firm should make and retain a record under INSPRU 1.3.17 R of the range of projections and how the probabilities attributed to each projection or outcome were determined (including the period of reference for any relevant data on past experience).

Management and policyholder actions

INSPRU 1.3.185

See Notes

handbook-rule
In calculating the costs of any guarantees, options or smoothing, a firm:
(1) may reflect its prospective management actions (within the meaning of INSPRU 1.3.53 R); and
(2) must reflect a realistic assessment of the policyholder actions (within the meaning of INSPRU 1.3.59 R);
in its projections of the value of assets and liabilities.

INSPRU 1.3.186

See Notes

handbook-guidance
For the purposes of INSPRU 1.3.185 R, the related guidance in INSPRU 1.3.54 G to INSPRU 1.3.57 G (management actions) and in INSPRU 1.3.60 G (policyholder actions) applies.

Treatment of surplus on guarantees, options and smoothing

INSPRU 1.3.187

See Notes

handbook-rule
INSPRU 1.3.188 R applies to firms calculating the costs of guarantees, options and smoothing to be included in the future policy-related liabilities in accordance with INSPRU 1.3.137R (5), INSPRU 1.3.137R (7) and INSPRU 1.3.137R (8).

INSPRU 1.3.188

See Notes

handbook-rule
Where a firm accumulates past experience and deducts or is otherwise able to take credit for charges for guarantees or options or smoothing, the future costs of guarantees or options or smoothing (as appropriate) must not be less than the greater of:
(1) the prospective calculation of the future cost of guarantees (see INSPRU 1.3.148 R) or options (see INSPRU 1.3.156 G) or smoothing (see INSPRU 1.3.158 R) (as appropriate); and
(2) the sum of:
(a) the accumulated charges (after deduction of past costs) for guarantees or options or smoothing (as appropriate); and
(b) the prospective calculation of the future charges deducted for guarantees or options or smoothing (see INSPRU 1.3.144 R) (as appropriate).

INSPRU 1.3.189

See Notes

handbook-guidance
The extent to which the amount in INSPRU 1.3.188R (2) exceeds the amount in INSPRU 1.3.188R (1) will determine the surplus available to support actions that would be taken by the firm's management. The purpose of INSPRU 1.3.188 R is to ensure that any resulting surplus at the valuation date arising from the accumulation of charges less costs remains available to support foreseeable actions that would be taken by the firm's management. Any additional liability arising from INSPRU 1.3.188 R is added to the liabilities under INSPRU 1.3.137R (5), INSPRU 1.3.137R (7) and INSPRU 1.3.137R (8), but has no impact on the adjustment for planned deductions for the costs of guarantees, options and smoothing (INSPRU 1.3.137R (3) and INSPRU 1.3.144 R).

Realistic current liabilities

INSPRU 1.3.190

See Notes

handbook-rule
For the purposes of INSPRU 1.3.40R (3), the realistic current liabilities of a with-profits fund are equal to the sum of the following amounts:
(1) the firm's best estimate provision for those liabilities for which prudent provision is made in regulatory current liabilities (see INSPRU 1.3.30 R); and
(2) to the extent that amounts have not been provided in (1), any tax and any other costs arising either in respect of excess admissible assets (within the meaning of INSPRU 1.3.36 R) or on the recognition of future shareholder transfers.

INSPRU 1.3.191

See Notes

handbook-rule
For the purpose of assessing the best estimate provision to be made under INSPRU 1.3.190R (1) in respect of a defined benefit occupational pension scheme, a firm must use either its defined benefit liability or its deficit reduction amount, consistent with the firm's election under INSPRU 1.3.5BR(2).

INSPRU 1.4

Equalisation provisions

Application

INSPRU 1.4.1

See Notes

handbook-rule

INSPRU 1.4.2

See Notes

handbook-guidance
The scope of INSPRU 1.4.11 R to INSPRU 1.4.37 G (non-credit equalisation provisions) is not restricted to firms subject to the relevant EC directives.

INSPRU 1.4.3

See Notes

handbook-guidance
The requirements of this section apply to a firm on a solo basis.

Purpose

INSPRU 1.4.4

See Notes

handbook-guidance
This section sets out rules and guidance on the calculation of the amount of the equalisation provisions that are required to be maintained by firms that carry on non-credit insurance business or credit insurance business.

INSPRU 1.4.5

See Notes

handbook-guidance
Credit or non-credit equalisation provisions form part of the technical provisions that a firm is required to establish under INSPRU 1.1.12R (1). They help to smooth fluctuations in loss ratios in future years for business where claims in any future year may be subject to significant deviation from recent or average claims experience, or where trends in experience may be subject to change. Such volatile claims experience might arise in the case, for example, of insurance against losses caused by major catastrophes such as hurricanes or earthquakes.

INSPRU 1.4.6

See Notes

handbook-guidance
In general terms, INSPRU 1.4 sets out rules and guidance as to:
(1) the circumstances in which a firm is required to maintain equalisation provisions;
(2) the methods to be used in calculating the amount of each provision;
(3) the geographical location of the business relevant to certain calculations for different types of firm - this is summarised in the Table in INSPRU 1.4.7 G.

INSPRU 1.4.7

See Notes

handbook-guidance

INSPRU 1.4.8

See Notes

handbook-guidance
The First Non-Life Directive (as amended) and the Reinsurance Directive require the calculation of credit equalisation provisions. Non-credit equalisation provisions are a domestic United Kingdom requirement. For insurance regulatory purposes under EC Directives, credit equalisation provisions are classified as liabilities.

INSPRU 1.4.9

See Notes

handbook-guidance
However, firms are permitted to include equalisation provisions within their financial resources when demonstrating compliance with non-Directive capital requirements. Hence equalisation provisions are deducted from the available capital resources of a firm for the purpose of meeting its minimum capital requirement for general insurance business; but, in the calculation of a firm'senhanced capital requirement for general insurance business under INSPRU 1.1.72C R, its equalisation provisions (if any) are added back to its capital resources.

INSPRU 1.4.10

See Notes

handbook-guidance
Under International Accounting Standards (IAS), which will apply to the financial statements of some insurers from 2005, there will be no requirement to treat equalisation provisions as liabilities in insurers' published financial statements. However, they will continue to be treated as liabilities for the purposes of demonstrating compliance with Directive capital requirements.

Non-credit equalisation provision

INSPRU 1.4.11

See Notes

handbook-rule
Firms carrying on non-credit insurance business
(1) INSPRU 1.4.11 R to INSPRU 1.4.37 G apply to any firm, other than an assessable mutual, which carries on the business of effecting or carrying out general insurance contracts falling within any description in column 2 in Table INSPRU 1.4.12 R ("non-credit insurance business").
(2) A firm falling within (1) must classify all of its non-credit insurance business into separate insurance business groupings, as specified in Table INSPRU 1.4.12 R.

INSPRU 1.4.12

See Notes

handbook-rule
Table : Groupings of non-credit insurance business

INSPRU 1.4.13

See Notes

handbook-rule
For the purposes of INSPRU 1.4.11 R to INSPRU 1.4.37 G, a firm with its head office in the United Kingdom must take account of non-credit insurance business carried on by it world-wide.

INSPRU 1.4.14

See Notes

handbook-rule
For the purposes of INSPRU 1.4.11 R to INSPRU 1.4.37 G, a firm with its head office outside the United Kingdom need only take account of non-credit insurance business carried on by it from a branch in the United Kingdom.

INSPRU 1.4.15

See Notes

handbook-guidance
The insurers affected by INSPRU 1.4.11 R include pure reinsurers, UK-deposit insurers, EEA-deposit insurer, and Swiss general insurers.

INSPRU 1.4.16

See Notes

handbook-guidance
For insurers (including pure reinsurers) with a head office in the United Kingdom, the calculations must be made in respect of world-wide business.

Requirement to maintain non-credit equalisation provision

INSPRU 1.4.17

See Notes

handbook-rule
In respect of each financial year, a firm must, unless INSPRU 1.4.18 R applies:
(1) calculate the amount of its non-credit equalisation provision as at the end of that year in accordance with INSPRU 1.4.20 R; and
(2) maintain a non-credit equalisation provision calculated in accordance with INSPRU 1.4.20 R for the following financial year.

INSPRU 1.4.18

See Notes

handbook-rule
(1) INSPRU 1.4.17 R does not apply to any firm in respect of any financial year if, as at the end of that year:
(a) no non-credit equalisation provision has been brought forward from the preceding financial year; and
(b) the amount of the annualised net written premiums for all the non-credit insurance business carried on by it in the financial year is less than the threshold amount.
(2) The threshold amount in respect of any financial year is the higher of:
(a) 1,500,000 Euro; and
(b) 4% of net written premiums in that financial year in respect of all its general insurance business, if this amount is less than 2,500,000 Euro.

INSPRU 1.4.19

See Notes

handbook-guidance
For non-EEA insurers, the calculation of the threshold amount in INSPRU 1.4.18R (2) is limited by INSPRU 1.4.14 R to the business of the firm carried on in the United Kingdom. Such a firm may do little UK non-credit insurance business, and so would not be required to set up a non-credit equalisation provision under INSPRU 1.4, but may do significant business outside the United Kingdom characterised by high-impact, low-frequency claims. Such a firm is required by INSPRU 1.5.41 R to hold adequate world-wide financial resources to avoid internal-contagion strain on the branch in the United Kingdom. In determining the adequacy of its financial resources, the firm should undertake stress and scenario testing of its underwriting and other risks as set out in GENPRU 1.2.

Calculating the amount of the provision

INSPRU 1.4.20

See Notes

handbook-rule
(1) Unless INSPRU 1.4.22 R applies, the amount of a firm'snon-credit equalisation provision as at the end of a financial year is the higher of:
(a) zero; and
(b) whichever is the lower of:
(i) the aggregate of the amounts of the maximum provision for each insurance business grouping as at the end of that financial year; and
(ii) the sum of A and B.
(2) For the purposes of (1)(b)(ii):
(a) A is the amount of the non-credit equalisation provision, if any, brought forward from the financial year immediately preceding that in respect of which the calculation is being performed; and
(b) B is:
(i) the aggregate of the amounts of the provisional transfers-in for each insurance business grouping; minus
(ii) the aggregate of the amounts of the provisional transfers-out for each insurance business grouping.
(3) For any insurance business grouping:
(a) the amount of the maximum provision in (1)(b)(i) is to be determined in accordance with INSPRU 1.4.24 R;
(b) the amount of the provisional transfers-in in (2)(b)(i) is to be determined in accordance with INSPRU 1.4.26 R; and
(c) the amount of the provisional transfers-out in (2)(b)(ii) is to be determined in accordance with INSPRU 1.4.29 R.

INSPRU 1.4.21

See Notes

handbook-guidance
If provisional transfers-out are in excess of provisional transfers-in, the non-credit equalisation provision as calculated in accordance with INSPRU 1.4.20 R in respect of a particular financial year may be less than that calculated for the preceding financial year although, by virtue of INSPRU 1.4.20R (1)(a), it cannot be negative.

INSPRU 1.4.22

See Notes

handbook-rule
(1) The amount of a firm'snon-credit equalisation provision as at the end of a financial year is zero if:
(a) as at the end of that year, the firm meets either of the conditions specified in (2) and (3); and
(b) the annualised net written premiums for all the non-credit insurance business carried on by the firm in that year are less than the threshold amount.
(2) The first condition is that the firm carried on non-credit insurance business in the first financial year of the relevant period and, for each of any two or more financial years of that period, the annualised net written premiums for business of that description were less than the threshold amount.
(3) The second condition is that the firm did not carry on non-credit insurance business in the first financial year of the relevant period and the average of the annualised net written premiums for business of that description carried on by the firm in each financial year of the relevant period was less than the threshold amount.
(4) For the purposes of this rule:
(a) the threshold amount is the amount determined in accordance with INSPRU 1.4.18R (2): and
(b) the relevant period is the period of four financial years ending immediately before the beginning of the financial year in (1).

INSPRU 1.4.23

See Notes

handbook-guidance
If INSPRU 1.4.22 R applies, a firm may need to make sufficient transfers from its non-credit equalisation provision to bring the non-credit equalisation provision for that financial year to zero.

The calculation: the maximum provision

INSPRU 1.4.24

See Notes

handbook-rule
(1) For the purposes of the calculation required by INSPRU 1.4.20 R, the amount of the maximum provision for any insurance business grouping is to be determined in accordance with (2) to (5).
(2) Unless (4) applies, the amount of the maximum provision for the grouping, as at the end of a financial year, is the amount determined by multiplying X and Y.
(3) For the purposes of (2):
(a) X is the percentage specified in Table INSPRU 1.4.25 R in relation to the grouping; and
(b) Y is the average of the amount of the annualised net written premiums for non-credit insurance business in the grouping carried on by the firm in each financial year of the relevant period.
(4) Where Y is a negative amount, the maximum provision for that insurance business grouping is zero.
(5) For the purposes of (3)(b), the relevant period is the five-year period comprising:
(a) the financial year in (2); and
(b) the previous four financial years.

INSPRU 1.4.25

See Notes

handbook-rule
Table : Calculation of maximum provision for any insurance business grouping

The calculation: provisional transfers-in

INSPRU 1.4.26

See Notes

handbook-rule
(1) For the purposes of the calculation required by INSPRU 1.4.20 R, the amount of the provisional transfers-in for any insurance business grouping is to be determined in accordance with (2).
(2) The amount of the provisional transfers-in for the grouping, as at the end of a financial year, is the amount determined by multiplying X and Y.
(3) For the purposes of (2):
(a) X is the percentage specified in Table INSPRU 1.4.27 R in relation to the grouping; and
(b) Y is the amount of the net written premiums for non-credit insurance business in the grouping that was carried on by the firm in the financial year in (2), including adjustments in respect of previous financial years.

INSPRU 1.4.27

See Notes

handbook-rule
Table : Provisional transfers-in for any insurance business grouping

INSPRU 1.4.28

See Notes

handbook-guidance
Since each insurance business grouping should be assessed individually, negative net written premiums in relation to any insurance business grouping should be transferred in to the non-credit equalisation provision.

The calculation: provisional transfers-out

INSPRU 1.4.29

See Notes

handbook-rule
(1) For the purposes of the calculation required by INSPRU 1.4.20 R, the amount of the provisional transfers-out for any insurance business grouping is to be determined in accordance with (2).
(2) The amount of the provisional transfers-out for the grouping, as at the end of a financial year, is the lower of:
(a) the amount of the maximum provision for the grouping under INSPRU 1.4.24 R for that financial year; and
(b) the abnormal loss for the grouping under INSPRU 1.4.30 R for that financial year.

INSPRU 1.4.30

See Notes

handbook-rule
R For each insurance business grouping, the abnormal loss as at the end of a financial year in relation to which an equalisation provision is calculated is:
(1) (for business within the insurance business grouping accounted for on an accident year basis) the amount, if any, by which the amount of net claims incurred exceeds the greater of:
(a) zero; and
(b) the percentage of net earned premiums in that financial year specified in the Table in INSPRU 1.4.31 R; or
(2) (for business within the insurance business grouping accounted for on an underwriting year basis) the amount, if any, by which the amount of net claims paid (plus adjustment for change in net technical provisions, other than any change in provisions for claims handling expenses or equalisation) exceeds the greater of:
(a) zero; and
(b) the percentage of net written premiums in that financial year specified in the Table in INSPRU 1.4.31 R.

INSPRU 1.4.31

See Notes

handbook-rule
Table : Abnormal loss for any insurance business grouping

Adjustments to calculations

INSPRU 1.4.32

See Notes

handbook-rule
Transfers of business from the firm
(1) This rule applies to modify the application of INSPRU 1.4.24 R and INSPRU 1.4.26 R in any case where a firm has transferred to another undertaking any rights and obligations under general insurance contracts falling within any insurance business grouping.
(2) As at the end of the financial year in which the transfer takes place, net written premiums in respect of the transferred contracts in any grouping must be deducted from total net written premiums for that grouping before calculating the maximum provision under INSPRU 1.4.24 R or provisional transfers-in under INSPRU 1.4.26 R.

INSPRU 1.4.33

See Notes

handbook-rule
If all the rights and obligations of a firm in relation to non-credit insurance business in any insurance business grouping have been transferred, the maximum provision for the grouping under INSPRU 1.4.24 R is zero.

Transfers of business to the firm

INSPRU 1.4.34

See Notes

handbook-rule
(1) This rule applies to modify the application of INSPRU 1.4.24 R, INSPRU 1.4.26 R and INSPRU 1.4.29 R in any case where another undertaking has transferred to a firm any rights and obligations under general insurance contracts falling within any insurance business grouping.
(2) As at the end of the financial year in which the transfer takes place a sum equal to that part of the consideration for the transfer that relates to business in an insurance business grouping must be:
(a) excluded from net premiums (written or earned) before performing the calculations required by INSPRU 1.4.24 R (maximum provision) and INSPRU 1.4.26 R (provisional transfers in);
(b) included in net premiums (written or earned) before performing the calculation required by INSPRU 1.4.30 R (abnormal loss); and
(c) excluded from net claims (paid or incurred) before performing the calculation required by INSPRU 1.4.30 R (abnormal loss).

INSPRU 1.4.35

See Notes

handbook-guidance
For the purposes of INSPRU 1.4.34 R, the consideration payable should be apportioned between insurance business groupings according to the groupings within which the general insurance contracts which are the subject of the acquisition fall. In appropriate cases, apportionment may reflect the split of liabilities acquired, including unearned premium.

INSPRU 1.4.36

See Notes

handbook-guidance
Where business is accounted for on an accounting year basis, in any year following the transfer, net earned premiums must include an appropriate amount in respect of the transfer.

INSPRU 1.4.37

See Notes

handbook-guidance
INSPRU 1.4.32 R to INSPRU 1.4.34 R apply to transfers by way of transfer under Part VII of the Act and by novation.

Credit equalisation provisions

INSPRU 1.4.38

See Notes

handbook-rule
Firms carrying on credit insurance business
INSPRU 1.4.39 R to INSPRU 1.4.47 G apply to any firm which carries on the business of effecting or carrying out general insurance contracts falling within general insurance businessclass 14 (which business is referred to in INSPRU 1.4 as "credit insurance business"), unless it is:
(2) a pure reinsurer which became a firm in run-off before 31 December 2006 and whose Part IV permission has not subsequently been varied to add back the regulated activity of effecting contracts of insurance.

INSPRU 1.4.39

See Notes

handbook-rule
For the purposes of INSPRU 1.4.43 R and INSPRU 1.4.44 R, a firm whose head office is in the United Kingdom must take account of the credit insurance business carried on by it world-wide.

INSPRU 1.4.40

See Notes

handbook-rule
(1) For the purposes of INSPRU 1.4.43 R:
(a) a Swiss general insurer or an EEA-deposit insurer must take account of the credit insurance business carried on by it in the United Kingdom; and
(b) any other firm whose head office is outside the United Kingdom (including a UK-deposit insurer) must take account of the credit insurance business carried on by it world-wide.
(2) For the purposes of INSPRU 1.4.44 R:
(a) a UK-deposit insurer need only take account of the credit insurance business carried on by it in all EEA States, taken together; and
(b) any other firm whose head office is outside the United Kingdom (including an EEA-deposit insurer and a Swiss general insurer) need only take account of the credit insurance business carried on by it in the United Kingdom.

INSPRU 1.4.41

See Notes

handbook-guidance
For firms whose head office is in the United Kingdom both calculations must be made in respect of world-wide business.

INSPRU 1.4.42

See Notes

handbook-guidance
The requirements of INSPRU 1.4.39 R and INSPRU 1.4.40 R are summarised in the table in INSPRU 1.4.7 G.

Requirement to maintain credit equalisation provision

INSPRU 1.4.43

See Notes

handbook-rule
In respect of each financial year, a firm must, unless INSPRU 1.4.44 R applies:
(1) calculate the amount of its credit equalisation provision as at the end of that year in accordance with INSPRU 1.4.45 R; and
(2) maintain a credit equalisation provision calculated in accordance with INSPRU 1.4.45 R for the following financial year.

INSPRU 1.4.44

See Notes

handbook-rule
INSPRU 1.4.43 R does not apply to a firm in respect of any financial year if, as at the end of that year, the annualised net written premiums for its credit insurance business are less than 4% of annualised net written premiums in that financial year in respect of all its general insurance business, if this amount is less than 2,500,000 Euro.

Calculating the amount of the provision

INSPRU 1.4.45

See Notes

handbook-rule
(1) The amount of a firm'scredit equalisation provision as at the end of a financial year ("financial year A") is the higher of:
(a) zero; and
(b) whichever is the lower of:
(i) 150% of the highest amount of net written premiums for credit insurance business carried on by the firm in financial year A or in any of the previous four financial years; and
(ii) the amount of the credit equalisation provision brought forward from the preceding financial year, after making either of the adjustments in (2).
(2) The adjustments are:
(a) the deduction of the amount of any technical deficit arising in financial year A; or
(b) the addition of the lower of:
(i) 75% of the amount of any technical surplus arising in financial year A; and
(ii) 12% of the amount of the net written premiums for credit insurance business carried on by the firm in financial year A.
(3) For the purposes of (2) the amount of technical deficit or technical surplus is to be determined in accordance with INSPRU 1.4.46 R.

INSPRU 1.4.46

See Notes

handbook-rule
For the purposes of the adjustments in INSPRU 1.4.45R (2), technical surplus (or technical deficit) in respect of credit insurance business is the amount by which the aggregate of net earned premiums and other technical income exceeds (or falls short of) the sum of net claims incurred, claims management costs and any technical charges.

INSPRU 1.4.47

See Notes

handbook-guidance
The calculation of technical surplus or technical deficit should be made before tax and before any transfer to or from the credit equalisation provision. Investment income should not be included in these calculations.

Euro conversion

INSPRU 1.4.48

See Notes

handbook-rule
For the purposes of INSPRU 1.4, the exchange rate from the Euro to the pound sterling for each year beginning on 31 December is the rate applicable on the last day of the preceding October for which the exchange rates for the currencies of all the European Union member states were published in the Official Journal of the European Union.

Application of INSPRU 1.4 to Lloyd's

INSPRU 1.4.49

See Notes

handbook-rule
INSPRU 1.4 applies to the Society in accordance with INSPRU 8.1.2 R:
(1) with the modification set out in INSPRU 1.4.50 R; and

INSPRU 1.4.50

See Notes

handbook-rule
The Society must calculate a credit equalisation provision for the aggregate insurance business of all members; it is not required to calculate a credit equalisation provision separately for the business of each member.

INSPRU 1.4.51

See Notes

handbook-rule
The Society must allocate the result of INSPRU 1.4.50 R between itself and each of the members on a fair and reasonable basis.

INSPRU 1.5

Internal-contagion risk

Application

INSPRU 1.5.1

See Notes

handbook-rule
INSPRU 1.5 applies to an insurer.

INSPRU 1.5.2

See Notes

handbook-rule
INSPRU 1.5 does not apply, to the extent stated, to any insurer in (1) to (4):
(1) none of the provisions apply to non-directive friendly societies;
(2) none of the provisions, apart from INSPRU 1.5.33 R (payment of financial penalties) apply to firms which qualify for authorisation under Schedule 3 or 4 of the Act;
(3) INSPRU 1.5.33 R (payment of financial penalties) does not apply to mutuals;

INSPRU 1.5.3

See Notes

handbook-guidance
The scope of application of INSPRU 1.5 is not restricted to firms that are subject to the relevant EC directives.

INSPRU 1.5.4

See Notes

handbook-rule
In its application to a firm with its head office in the United Kingdom, this section applies to the whole of the firm's business carried on world-wide.

INSPRU 1.5.5

See Notes

handbook-rule
In the application of this section to activities carried on by a non-EEA insurer:
(1) INSPRU 1.5.13 R to INSPRU 1.5.15 G and INSPRU 1.5.41 R apply in relation to the whole of its business carried on world-wide;
(2) all other provisions of this section apply only in relation to:
(a) in the case of any UK-deposit insurer, activities carried on from branches in any EEA State; and
(b) in any other case, activities carried on from a branch in the United Kingdom.

INSPRU 1.5.6

See Notes

handbook-guidance
The adequacy of a firm's financial resources needs to be assessed in relation to all the activities of the firm and the risks to which they give rise.

INSPRU 1.5.7

See Notes

handbook-guidance
The requirements of this section apply to a firm on a solo basis.

Purpose

INSPRU 1.5.8

See Notes

handbook-guidance
This section sets out requirements for a firm relating to 'internal-contagion risk'. This is the risk that losses or liabilities from one activity might deplete or divert financial resources held to meet liabilities from another activity. It arises where the two activities are carried on within the same firm. It may also arise from the combination of activities within the same group, but this aspect of internal-contagion risk falls outside the scope of this section. Requirements relevant to group contagion risk are set out in INSPRU 6.

INSPRU 1.5.9

See Notes

handbook-guidance
Internal-contagion risk includes in particular the risk that arises where a firm carries on:
(1) both insurance and non-insurance activities; or
(2) two or more different types of insurance activity; or
(3) insurance activities from offices or branches located in both the United Kingdom and overseas.

INSPRU 1.5.10

See Notes

handbook-guidance
This section requires firms other than pure reinsurers to limit non-insurance activities to those that directly arise from their insurance business, e.g. investing assets, employing insurance staff etc. It also requires that an adequate provision be established for non-insurance liabilities. pure reinsurers must limit their activities to the business of reinsurance and related operations.

INSPRU 1.5.11

See Notes

handbook-guidance
This section also sets out requirements for the separation of different types of insurance activity. However, in most circumstances the combination of different types of insurance activity within the same firm is a source of strength. Adequate pooling and diversification of insurance risk is fundamental to sound business practice. The requirements, therefore, only apply in two specific cases where without adequate protection the combination might operate to the detriment of policyholders. They apply where a firm carries on both:
(2) linked and non-linked insurance business.

INSPRU 1.5.12

See Notes

handbook-guidance
Finally, the section sets out requirements to protect policyholders of branches of non-EEA firms where these are supervised by the FSA . These apply only to a non-EEAfirm that has established a branch in the United Kingdom.

Requirements: Non-insurance activities


Restriction of business

INSPRU 1.5.13

See Notes

handbook-rule
(1) A firm other than a pure reinsurer must not carry on any commercial business other than insurance business and activities directly arising from that business.
(2) (1) does not prevent a friendly society which was on 15 March 1979 carrying on long-term insurance business from continuing to carry on savings business.

INSPRU 1.5.13A

See Notes

handbook-rule
A pure reinsurer must not carry on any business other than the business of reinsurance and related operations.

INSPRU 1.5.13B

See Notes

handbook-guidance
In INSPRU 1.5.13A R related operations include, for example, activities such as provision of statistical or actuarial advice, risk analysis or research for its clients. It may also include a holding company function and activities with respect to financial sector activities within the meaning of Article 2, point 8, of the Financial Groups Directive. But it does not allow the carrying on of, for example, unrelated banking and financial activities.

Financial limitation of non-insurance activities

INSPRU 1.5.14

See Notes

handbook-rule
A firm must limit, manage and control its non-insurance activities so that there is no significant risk arising from those activities that it may be unable to meet its liabilities as they fall due.

INSPRU 1.5.15

See Notes

handbook-guidance
For the purpose of INSPRU 1.5.14 R a firm should consider how the financial impact of non-insurance activities might diverge from expectations. However, it need only take into account unexpected variations in amount and timing in so far as they are reasonably possible and may take into account effective mitigating factors.

Requirements: long-term insurance business

INSPRU 1.5.16

See Notes

handbook-guidance
INSPRU 1.5.18 R, INSPRU 1.5.21 R, INSPRU 1.5.30 R and INSPRU 1.5.31 R require a firm to identify the assets attributable to the receipts of the long-term insurance business, called long-term insurance assets, and only to apply those assets for the purpose of that business. This has the effect of prohibiting a composite firm from using long-term insurance assets to meet general insurance liabilities. It also keeps long-term insurance assets separate from shareholder funds.

Permissions not to include both types of insurance

INSPRU 1.5.17

See Notes

handbook-guidance
Under section 31 of the Act, a firm may not carry on a regulated activity unless it has permission to do so (or is exempt in relation to the particular activity). Both general insurance business and long-term insurance business are regulated activities and permission will extend to the effecting or carrying out of one or more particular classes of contracts of insurance. A firm'spermission can be varied so as to add other classes. It is FSA policy, in compliance with EC directives on insurance, not to grant or vary permission if that would allow a firm to engage in both general insurance business and long-term insurance business. This does not apply where a firm'spermission is restricted to reinsurance. It also does not apply where a firm'spermission extends to effecting or carrying out life and annuitycontracts of insurance. This will automatically include permission to effect or carry out accident contracts of insurance or sicknesscontracts of insurance on an ancillary or supplementary basis (see article 2(1) of the Consolidated Life Directive).

Separately identify and maintain long term insurance assets

INSPRU 1.5.18

See Notes

handbook-rule
A firm carrying on long-term insurance business must identify the assets relating to its long-term insurance business which it is required to hold by virtue of INSPRU 1.1.20 R or INSPRU 1.1.21 R.

INSPRU 1.5.19

See Notes

handbook-guidance
INSPRU 1.1.16 R requires a firm to establish adequate technical provisions for its long-term insurance contracts. INSPRU 1.1.20 R requires a firmto hold admissible assets of a value at least equal to the amount of the technical provisions and its other long-term insurance liabilities. INSPRU 1.1.21 R ensures that a composite firm identifies separate admissible assets with a value at least equal to the technical provisions for long-term insurance business and its other long-term insurance liabilities as well as holding other admissible assets of a value at least equal to the amount of its technical provisions for general insurance business and its other general insurance liabilities. The overall impact of these provisions in INSPRU 1.1, and of INSPRU 1.5.18 R, is that any firm writing long-term insurance business must identify separately admissible assets of a value at least equal to the amount of its long-term insurance businesstechnical provisions and its other long-term insurance liabilities.

INSPRU 1.5.20

See Notes

handbook-guidance
INSPRU 1.5.18 R does not prohibit a firm from identifying other assets as being available to meet the liabilities of its long-term insurance business. It may transfer such other assets to a long-term insurance fund (see INSPRU 1.5.21 R and INSPRU 1.5.22 R ) and the transfer will take effect when it is recorded in the firm's accounting records (see INSPRU 1.5.23 R). After the transfer takes effect, a firm may not transfer the assets out of a long-term insurance fund except where they represent an established surplus (see INSPRU 1.5.27 R).

INSPRU 1.5.21

See Notes

handbook-rule
(1) A firm's long-term insurance assets are the items in (2), adjusted to take account of:
(a) outgo in respect of the firm'slong-term insurance business; and
(b) any transfers made in accordance with INSPRU 1.5.27 R.
(2) The items are:
(a) the assets identified under INSPRU 1.5.18 R (including assets into which those assets have been converted);
(b) any other assets identified by the firm as being available to cover its long-term insurance liabilities;
(c) premiums and other receivables in respect of long-term insurance contracts;
(d) other receipts of the long-term insurance business; and
(e) all income and capital receipts in respect of the items in (2).

INSPRU 1.5.22

See Notes

handbook-rule
(1) Unless (2) applies, all the long-term insurance assets of the firm constitute its long-term insurance fund.
(2) Where a firm identifies particular long-term insurance assets in connection with different parts of its long-term insurance business, the assets identified in relation to each such part constitute separate long-term insurance funds of the firm.

INSPRU 1.5.23

See Notes

handbook-rule
A firm must maintain a separate accounting record in respect of each of its long-term insurance funds (including any with-profits fund).

INSPRU 1.5.24

See Notes

handbook-guidance
Firms must ensure that long-term insurance assets are separately identified and allocated to a long-term insurance fund at all times. Assets in external accounts, for example at banks, custodians, or brokers should be segregated in the firm's books and records into separate accounts for long-term insurance business and general insurance business. Where a firm has more than one long-term insurance fund, a separate accounting record must be maintained for each fund. Accounting records should clearly document the allocation.

INSPRU 1.5.25

See Notes

handbook-guidance
Where the surplus arising from business is shared between policyholders and shareholders in different ways for different blocks of business, it may be necessary to maintain a separate fund to ensure that policyholders are, and will be, treated fairly. For example, if a proprietary company writes some business on a with-profits basis, this should be written in a with-profits fund separate from any business where the surplus arising from that business is wholly owned by shareholders.

INSPRU 1.5.26

See Notes

handbook-guidance
Where a firm merges separate funds for different types of business, it will need to ensure that the merger will not result in policyholders being treated unfairly. When considering merging the funds, the firm should consider the impact on its PPFM (see COB 6.10 ) and on its obligations to notify the FSA (see SUP 15.3). In particular, a firm would need to consider how any inherited estate would be managed and how the fund would be run in future, such that policyholders are treated fairly.

INSPRU 1.5.27

See Notes

handbook-rule
A firm may not transfer assets out of a long-term insurance fund unless:
(1) the assets represent an established surplus; and
(2) no more than three months have passed since the determination of that surplus.

INSPRU 1.5.28

See Notes

handbook-guidance
As a result of INSPRU 1.5.27R (2), an actuarial investigation undertaken to determine an established surplus remains in-date for three months from the date as at which the determination of the surplus was made. However, even where the investigation is still in-date, the firm should not make the transfer unless there is sufficient surplus at the time of the transfer to allow it to be made without breach of INSPRU 1.1.20 R or INSPRU 1.1.21 R.

INSPRU 1.5.29

See Notes

handbook-guidance
INSPRU 1.1.27 R and INSPRU 1.1.28 R provide further constraints on the transfer of assets out of a with-profits fund. INSPRU 1.1.27 R requires a firm to have admissible assets in each of its with-profits funds to cover the technical provisions and other long-term insurance liabilities relating to all the business in that fund. INSPRU 1.1.28 R requires a realistic basis life firm to ensure that the realistic value of assets for each of its with-profits funds is at least equal to the realistic value of liabilities of that fund.

Exclusive use of long-term insurance assets

INSPRU 1.5.30

See Notes

handbook-rule
(1) A firm must apply a long-term insurance asset only for the purposes of its long-term insurance business.
(2) For the purpose of (1), applying an asset includes coming under any obligation (even if only contingently) to apply that asset.

INSPRU 1.5.31

See Notes

handbook-rule
A firm must not agree to, or allow, any mortgage or charge on its long-term insurance assets other than in respect of a long-term insurance liability.

INSPRU 1.5.32

See Notes

handbook-guidance
The purposes of the long-term insurance business include the payment of claims, expenses and liabilities arising from that business, the acquisition of lawful access to fixed assets to be used in that business and the investment of assets. The payment of liabilities may include repaying a loan but only where that loan was incurred for the purpose of the long-term insurance business. The purchase or investment of assets may include an exchange at fair market value of assets (including money) between the long-term insurance fund and other assets of the firm. A firm may also lend securities held in a long-term insurance fund under a stock lending transaction or transfer assets as collateral for a stock lending transaction where the firm is the borrower, where such lending or transfer is for the benefit of the long-term insurance business.

Payment of financial penalties

INSPRU 1.5.33

See Notes

handbook-rule
If the FSA imposes a financial penalty on a long-term insurer, the firm must not pay that financial penalty from a long-term insurance fund.

INSPRU 1.5.34

See Notes

handbook-guidance
INSPRU 1.5.2 R states that this provision applies to all firms, except mutuals, and includes firms qualifying for authorisation under Schedule 3 or 4 to the Act.

Requirements: property-linked funds

INSPRU 1.5.35

See Notes

handbook-guidance
INSPRU 3.1.57 R requires a firm to cover, as closely as possible, its property-linked liabilities by the property to which those liabilities are linked. In order to comply with this rule, a firm should identify the assets it holds to cover property-linked liabilities and should not apply those assets (as long as they are needed to cover the property-linked liabilities) for any purpose other than to meet those liabilities.

INSPRU 1.5.36

See Notes

handbook-rule
A firm must select, allocate and manage the assets to which its property-linked liabilities are linked taking into account:
(1) the firm's contractual obligations to holders of property-linked policies; and
(2) its regulatory duty to treat customers fairly, including in the way it makes discretionary decisions as to how it selects, allocates and manages assets.

INSPRU 1.5.37

See Notes

handbook-guidance
Property-linked liabilities may be linked either to specified assets (with no contractual discretion given to the firm as to the choice of assets) or to assets of a specified kind where the selection of the actual assets is left to the firm.

Requirements: UK branches of certain non-EEA firms

INSPRU 1.5.38

See Notes

handbook-guidance
The purpose of the rules and guidance set out in INSPRU 1.5.38 G to INSPRU 1.5.57 R is to protect against the risk that the financial resources required in respect of the activities of the United Kingdom (or EEA) branch(es) might be depleted by the other activities of the non-EEA direct insurer.

INSPRU 1.5.39

See Notes

handbook-guidance
By virtue of INSPRU 1.5.2R (4), the rules in INSPRU 1.5.41 R to INSPRU 1.5.57 R apply to non-EEA direct insurers except for Swiss general insurers and EEA-deposit insurers. Responsibility for determining the adequacy of the world-wide financial resources of Swiss general insurers or EEA-deposit insurers rests exclusively with the Swiss authorities or the authorities in the EEA State (other than the United Kingdom) in which the deposit was made.

INSPRU 1.5.40

See Notes

handbook-guidance
(1) INSPRU 1.5.41 R requires a non-EEA direct insurer to hold adequate world-wide resources to meet the needs of the world-wide business without the need to rely on UK or EEAbranch assets other than to meet branch liabilities.
(2) INSPRU 1.5.42 R to INSPRU 1.5.47 R require non-EEA direct insurers to calculate a local MCR and to hold assets representing that requirement in the EEA or the United Kingdom.
(3) INSPRU 1.5.48 R to INSPRU 1.5.52 R require non-EEA direct insurers to hold a minimum level of assets in the United Kingdom or EEA.
(4) INSPRU 1.5.54 R requires the deposit of a minimum level of assets in the United Kingdom.
(5) INSPRU 1.5.56 R and INSPRU 1.5.57 R require non-EEA direct insurers to keep adequate accounting records in the United Kingdom.

Worldwide financial resources

INSPRU 1.5.41

See Notes

handbook-rule
(1) A non-EEA direct insurer must maintain adequate worldwide financial resources, to ensure that there is no significant risk that its liabilities cannot be met as they fall due.
(2) For the purpose of (1):
(a) a UK-deposit insurer must not rely upon the assets held under INSPRU 1.1.20 R as available to meet liabilities other than those arising from the activities of its branches in EEA States;
(b) other non-EEA direct insurers to whom (1) applies must not rely upon the assets held under INSPRU 1.1.20 R as available to meet liabilities other than those arising from the activities of any UKbranch.

UK or EEA MCR to be covered by admissible assets

INSPRU 1.5.42

See Notes

handbook-rule
A non-EEA direct insurer must:
(1) calculate a UK or EEA MCR in accordance with INSPRU 1.5.44 R to INSPRU 1.5.47 R; and
(2) hold admissible assets (in addition to those required under INSPRU 1.1.20 R) to represent its UK or EEA MCR calculated under (1).

INSPRU 1.5.43

See Notes

handbook-rule
The assets held under INSPRU 1.5.42R (2) must be identified and valued as if the non-EEA direct insurer was a firm with its head office in the United Kingdom.

INSPRU 1.5.44

See Notes

handbook-rule
For the purposes of INSPRU 1.5.42 R, a non-EEA direct insurer (except a UK-deposit insurer) must calculate a UK MCR:
(1) for long-term insurance business, in accordance with GENPRU 2.1.36 R but only in relation to business carried on by the firm in the United Kingdom;
(2) for general insurance business, in accordance with GENPRU 2.1.34 R but only in relation to business carried on by the firm in the United Kingdom.

INSPRU 1.5.45

See Notes

handbook-rule
For a composite firm, the UK MCR is the sum of the amounts arrived at under INSPRU 1.5.44R (1) and INSPRU 1.5.44R (2).

INSPRU 1.5.46

See Notes

handbook-rule
For the purposes of INSPRU 1.5.42 R, a UK-deposit insurer must calculate an EEA MCR:
(1) for long-term insurance business, in accordance with GENPRU 2.1.36 R but only in relation to business carried on by the firm in all EEA States, taken together;
(2) for general insurance business, in accordance with GENPRU 2.1.34 R but only in relation to business carried on by the firm in all EEA States, taken together.

INSPRU 1.5.47

See Notes

handbook-rule
For a composite firm, the EEA MCR is the sum of the amounts arrived at under INSPRU 1.5.46R (1) and INSPRU 1.5.46R (2).

Localisation of assets

INSPRU 1.5.48

See Notes

handbook-rule
A non-EEA direct insurer (except a UK-deposit insurer) must hold:
(1) admissible assets which are required to cover its technical provisions in accordance with INSPRU 1.1.20R (1) or INSPRU 1.1.21R (1)(a) and (2)(a); and
(2) other admissible assets not required to cover property-linked liabilities or index-linked liabilities in accordance with INSPRU 3.1.57 R or INSPRU 3.1.58 R which represent its UK MCR as calculated in accordance with INSPRU 1.5.44 R;
as follows:
(a) (where the assets cover the technical provisions and the guarantee fund) in the United Kingdom;
(b) (where the assets represent the amount of the UK MCR in excess of the guarantee fund) in any EEA State.

INSPRU 1.5.49

See Notes

handbook-rule
A UK-deposit insurer must hold:
(1) admissible assets which are required to cover its technical provisions in accordance with INSPRU 1.1.20R (1) or INSPRU 1.1.21R (1)(a) and INSPRU 1.1.21R (2)(a); and
(2) other admissible assets not required to cover property-linked liabilities or index-linked liabilities in accordance with INSPRU 3.1.57 R or INSPRU 3.1.58 R which represent its EEA MCR as calculated in accordance with INSPRU 1.5.46 R;
as follows:
(a) (where the assets cover the technical provisions and the guarantee fund) within the EEA states where the firm carries on insurance business;
(b) (where the assets represent the amount of the EEA MCR in excess of the guarantee fund) in any EEA State.

INSPRU 1.5.50

See Notes

handbook-rule
INSPRU 1.5.48 R and INSPRU 1.5.49 R do not apply to assets covering technical provisions which are debts owed by reinsurers.

INSPRU 1.5.51

See Notes

handbook-guidance
The admissible assets in excess of the technical provisions and UK or EEA MCR may be held outside the EEA.

INSPRU 1.5.52

See Notes

handbook-rule
For the purpose of INSPRU 1.5.48 R and INSPRU 1.5.49 R:
(1) a tangible asset is to be treated as held in the country or territory where it is situated;
(2) an admissible asset consisting of a claim against a debtor is to be regarded as held in any country or territory where it can be enforced by legal action;
(3) a listed security is to be treated as held in any country or territory where there is a regulated market in which the security is dealt; and
(4) a security which is not a listed security is to be treated as held in the country or territory in which the issuer has its head office.

INSPRU 1.5.53

See Notes

handbook-guidance
INSPRU 3.1.53 R to INSPRU 3.1.55R (currency matching of assets and liabilities) apply to the assets held to match insurance liabilities calculated under INSPRU 1.1.12 R or INSPRU 1.1.16 R.

Deposit of assets as security

INSPRU 1.5.54

See Notes

handbook-rule
A non-EEA direct insurer must keep assets of a value at least equal to one quarter of the base capital resources requirement on deposit in the United Kingdom with a BCD credit institution.

INSPRU 1.5.55

See Notes

handbook-guidance
The assets deposited as security may count towards the assets required under INSPRU 1.5.48 R and INSPRU 1.5.49 R. If, after the deposit is made, the value of the deposited assets falls below one quarter of the base capital resources requirement, the firm should deposit further admissible assets in order to comply with INSPRU 1.5.48 R and INSPRU 1.5.49 R. Deposited assets may be exchanged for other admissible assets and excess assets may be withdrawn, provided that the exchange or deposit does not cause a breach of INSPRU 1.5.48 R or INSPRU 1.5.49 R.

Branch accounting records in the United Kingdom

INSPRU 1.5.56

See Notes

handbook-rule
A non-EEA direct insurer must maintain at a place of business in the United Kingdom adequate records relating to:
(1) the activities carried on from its United Kingdombranch; and
(2) if it is an EEA-deposit insurer, the activities carried on from the branches in other EEA States.

INSPRU 1.5.57

See Notes

handbook-rule
The records maintained as required by INSPRU 1.5.56 R must include a record of:
(1) the income, expenditure and liabilities arising from activities of the branch or branches; and
(2) the assets identified under INSPRU 1.1.20 R as available to meet those liabilities.

Application of INSPRU 1.5 to Lloyd's

INSPRU 1.5.58

See Notes

handbook-rule
INSPRU 1.5 applies to managing agents and to the Society in accordance with:
(2) for the Society, INSPRU 8.1.2 R.

INSPRU 1.5.59

See Notes

handbook-rule
The Society and managing agents must take all reasonable steps to ensure that:
(1) a corporate member does not carry on any commercial business other than insurance business and activities arising directly from that business; and
(2) individual members do not, in their capacity as underwriting members, carry on any commercial business other than insurance business and activities arising directly from that business.

INSPRU 1.5.60

See Notes

handbook-rule
A managing agent must not permit both general insurance business and long-term insurance business to be carried on together through any syndicate managed by it.

INSPRU 1.6

Insurance Special Purpose Vehicles

Application and Purpose

INSPRU 1.6.1

See Notes

handbook-rule
(2) INSPRU 1.6.13 G to INSPRU 1.6.18 G apply to an insurer which has a contract of reinsurance with an ISPV.

INSPRU 1.6.2

See Notes

handbook-guidance
An ISPV is a special purpose vehicle which assumes risks from insurance undertakings or reinsurance undertakings and which fully funds its exposure to such risks through the proceeds of a debt issuance or some other financing mechanism where the repayment rights of the providers of such debt or other financing mechanism are subordinated to the reinsurance obligations of that vehicle. The special feature of an ISPV, when compared to other reinsurers, is that it is fully funded to meet its reinsurance liabilities. It is, therefore, not subject to insurance risk to the same extent as other reinsurers. The Reinsurance Directive permits ISPVs to be subject to different rules to those applying to other reinsurers.

INSPRU 1.6.3

See Notes

handbook-guidance
To satisfy the definition of an ISPV under the Reinsurance Directive the ISPV must be fully funded. The FSA considers that to be fully funded an ISPV must have actually received the proceeds of the debt issuance or other mechanism by which it is financed. The FSA would not, therefore, grant a Part IV permission to an ISPV where part of the financing for its reinsurance liabilities was on a contingent basis, for example, a standby facility or letter of credit.

INSPRU 1.6.4

See Notes

handbook-guidance
The purpose of INSPRU 1.6 is:
(1) to set out the rules applying to UK ISPVs in respect of:
(a) their assets and liabilities; and
(b) their contractual arrangements; and
(2) to set out the conditions that must be met in order for an insurer to claim credit for reinsurance with an ISPV.

Assets and liabilities

INSPRU 1.6.5

See Notes

handbook-rule
A UK ISPV must ensure that at all times its assets are equal to or greater than its liabilities.

INSPRU 1.6.6

See Notes

handbook-guidance
In addition to liability under its contracts of reinsurance, an ISPV will incur liability for other expenses, for example, staff and accommodation costs, claims handling arrangements and professional advisers' fees. INSPRU 1.6.5 R requires a UK ISPV to ensure that it always has sufficient assets to meet its liabilities.

INSPRU 1.6.7

See Notes

handbook-rule
A UK ISPV must invest its assets in accordance with the requirements set out in INSPRU 3.1.61AR.

INSPRU 1.6.8

See Notes

handbook-rule
A UK ISPV's assets must be held by, or on behalf of:
(1) the UK ISPV; or
(2) the insurance undertaking or reinsurance undertaking which cedes to the UK ISPV the risks in respect of which the relevant assets are held.

Contractual arrangements

INSPRU 1.6.9

See Notes

handbook-rule
A UK ISPV must include in each of its contracts of reinsurance terms which secure that its aggregate maximum liability at any time under those contracts of reinsurance does not exceed the amount of its assets at that time.

INSPRU 1.6.10

See Notes

handbook-guidance
INSPRU 1.6.9 R requires that a UK ISPV's contracts of reinsurance should include terms that secure that its maximum reinsurance liability is capped at a level that is no greater than the ISPV's assets. In the FSA's view, this is a necessary condition of the ISPV being fully funded, as it means that the ISPV should not find that its assets are insufficient to meet its reinsurance liabilities.

INSPRU 1.6.11

See Notes

handbook-rule
A UK ISPV must ensure that under the terms of any debt issuance or other financing arrangement used to fund its reinsurance liabilities the rights of the providers of that debt or other financing are fully subordinated to the claims of creditors under its contracts of reinsurance.

INSPRU 1.6.12

See Notes

handbook-rule
A UK ISPV must only enter into contracts or otherwise assume obligations which are necessary for it to give effect to the reinsurance arrangements which represent the special purpose for which it has been established.

Reinsurance with an ISPV

INSPRU 1.6.13

See Notes

handbook-guidance
As a result of GENPRU 1.3.55 R, GENPRU 2 Annex 7, INSPRU 1.1.92A R and INSPRU 1.2.28 R an insurer may not:
(1) treat amounts recoverable from an ISPV as:
(a) an admissible asset, or
(b) reinsurance for the purposes of calculating its mathematical reserves, or
(c) reinsurance reducing its MCR, or
(2) otherwise ascribe a value to such amounts,

unless it first obtains a waiver from the FSA . INSPRU 1.6.14 G to INSPRU 1.6.18 G set out the information which the FSA will expect to receive as part of the application for the waiver. Those paragraphs also set out the factors, in addition to the statutory tests under section 148 of the Act, to which the FSA will have regard in deciding:
(i) whether to grant such a waiver (assuming the section 148 conditions are met); and
(ii) the amount recoverable from the ISPV which it will allow the insurer to bring into account for these purposes.

INSPRU 1.6.14

See Notes

handbook-guidance
Where the ISPV is a UK ISPV, the FSA will wish to be satisfied that the UK ISPV complies with INSPRU 1.6.5 R to INSPRU 1.6.12 R. The FSA may rely on information supplied in connection with its application for authorisation. However, if the application for a waiver is made some time after authorisation was granted, the FSA may request confirmation that there has been no material change to the information originally supplied.

INSPRU 1.6.15

See Notes

handbook-guidance
Where the ISPV is not a UK ISPV, the FSA will expect to receive confirmation that the ISPV has received an official authorisation in accordance with article 46 of the Reinsurance Directive in the EEA State in which it has been established. In addition, it will need details of the debt issuance or other financing mechanism by which the ISPV'sreinsurance liabilities are funded. The FSA will also expect to receive information about the ISPV's key management and control functions, including details of the ISPV's auditors and arrangements for claims handling, and any material outsourcing agreements. The FSA will also need information about the structure of any group of which the ISPV is a member.

INSPRU 1.6.16

See Notes

handbook-guidance
No credit may be taken for a contract of reinsurance with an ISPV unless the contract meets the risk transfer principle set out in INSPRU 1.1.19A R. The FSA will require evidence that the contract of reinsurance and the extent of the credit that the firm proposes to take for it satisfy the risk transfer principle.

INSPRU 1.6.17

See Notes

handbook-guidance
The FSA will require information about the impact of the ISPV arrangement on the ceding firm's individual capital assessment carried out in accordance with INSPRU 7.1. This should include evidence that all residual risks associated with the arrangement (including credit, market, liquidity and operational risks) are reflected in that assessment.

INSPRU 1.6.18

See Notes

handbook-guidance
The FSA will also expect to receive an analysis of the potential for risk to revert to the firm or any of its associates under realistic adverse scenarios or for liabilities to arise in respect of the risks transferred for which no provision has been made.

INSPRU 1 Annex 1

INSPRU 1.2 (Mathematical reserves) and INSPRU 1.3 (With-profits insurance capital component)

See Notes

handbook-guidance