Prudential Regulation Authority Rulebook

7.1

In respect of assets backing TPs, the PPP requires that these must be invested ‘in a manner appropriate to the nature and duration of the firm’s insurance and reinsurance liabilities and in the best interests of all policyholders, taking into account any disclosed policy objectives’.^[39]

7.2

The requirement for assets backing TPs to be invested in policyholders’ best interests has particular implications for certain intragroup transactions such as intragroup loans and participations or arrangements to that effect (‘intragroup transactions’). Investments in or loans to other group companies may be in the interests of shareholders but they may not necessarily be in the best interests of policyholders. For example, the issuers of loans may be less willing or able to enforce repayment, particularly where loans are upstream. The PRA expects that it would be a high hurdle for firms to demonstrate that intragroup loans and participations are in the best interests of policyholders and, as such, a high hurdle to demonstrate that they are appropriate for covering TPs.

7.3

The PPP requires that in the case of a conflict of interest, ‘the investment of assets is made in the best interest of all policyholders’.^[40] This provision applies to all asset classes but is highlighted here as the PRA considers that investment in intragroup assets is very likely to lead to a conflict of interest (for example, between shareholders and policyholders, between subsidiaries and parent companies, and between policyholders in different subsidiaries). The PRA therefore expects that a firm’s board should be satisfied that any conflicts of interest have been resolved in the best interest of policyholders before investing in an intragroup asset. Further to this, the PRA expects that any conflicts of interest that arise following investment in an intragroup transaction should also be resolved in the best interest of policyholders, which may mean ceasing to invest in that asset.

7.4

Intragroup reinsurance is used to back TPs, but the PRA generally expects that intragroup reinsurance arrangements with no element of investment are less likely to present conflicts of interest in the way it observes, for example, that intragroup loans can. Intragroup reinsurance transfers can be, and usually are, different in substance economically from intragroup investments. They usually transfer risk away from the ceding firm in a way designed to ensure that the insurance obligations are closely matched by the reinsurance. As such, in many situations, the PRA would expect the interests of policyholders and the interests of the ceding firm to be better aligned.

7.5

Nevertheless, the PRA remains very interested in intragroup reinsurance arrangements recognising that they carry risks of their own that firms need to be able to measure, monitor, manage, control and mitigate. The PRA will look to the economic substance of arrangements, and where an intragroup reinsurance arrangement is structured to effectively function as a loan the PRA would treat it as such for the purposes of this section.

7.6

As with any investment, intragroup assets are subject to all the other requirements placed on firms under the PPP. As an example of this, the PRA expects that intragroup assets are subject to at least the same level of ‘arm’s length’ scrutiny and risk management as other assets, as well as proper governance and documentation with regard to:

• conflicts of interest;
• concentration risk;
• credit risk;
• liquidity risk;
• legal and operational risk;
• wrong-way risk where counterparty default risk is positively correlated with other risks borne by the firm (when the crystallisation of a risk could affect the financial condition both of the firm and of other group entities); and
• increased complexity of the group structure leading to dependencies that increase the fragility of the group or entity in stress scenarios.