Prudential Regulation Authority Rulebook

11.1

The rates of interest to be used in calculating the present value of future payments by or to a firm must be no greater than the rates of interest determined from a prudent assessment of the yields on existing assets attributed to the long-term insurance business and, to the extent appropriate, the yields which it is expected will be obtained on sums to be invested in the future.

11.2

For the purposes of 11.1, the assumed yield on an asset attributed to the long-term insurance business, before any adjustment to take account of the effect of taxation, must not exceed the yield on that asset calculated in accordance with 11.3 to 11.13, reduced by 2.5% of that yield.

11.3

For the purpose of calculating the yield on an asset:

1. (1) the asset must be valued in accordance with the Friendly Society – Asset Valuation Part of the PRA Rulebook, excluding any provision under which assets may be taken at lower book values for the purposes of an investigation to which Friendly Society – Reporting 2 applies; and
2. (2) the future income from the asset required to be taken into account (whether interest, dividends or repayment of capital) must be reduced by a proportion corresponding to such part of any excess exposure to assets of that description, calculated in accordance with Friendly Society – Asset Valuation 22.2, as may reasonably be attributed to such assets.

11.4

For fixed interest securities the yield on an asset, subject to 11.13, must be that annual rate of interest which, if used to calculate the present value of future payments of interest before the deduction of tax and the present value of repayments of capital, would result in the sum of those amounts being equal to the value of the asset.

11.5

1. (1) For variable interest investments that are equity shares (other than those within 11.6) or land, the yield on an asset must, subject to 11.13, be the ratio to the value of the asset of the income before deduction of tax which would be received in the period of twelve months following the valuation date on the assumption that the asset will be held throughout that period and that the factors which affect income will remain unchanged.
2. (2) Account must be taken of any changes in the factors referred to in (1) known to have occurred by the valuation date and in particular:
1. (a) any known changes in the rental income from property or in dividends on equity shares;
2. (b) any forecast changes in dividends which have been publicly announced by the valuation date;
3. (c) the effect of any alterations in capital structure; and
4. (d) the value (at the most recent date for which it is known at the valuation date) of any determinant of the amount of any future interest payment, such value being deemed to remain unaltered for all subsequent dates.

11.6

For variable interest investments that are equity shares in bodies corporate drawing up accounts in accordance with legislation implementing the Accounts Directives or in accordance with the International Accounting Standards Committee accounting standards or US generally accepted accounting practice, the yield on an asset must, subject to 11.14, be the ratio to the value of the asset of:

1. (1) A + B; or
2. (2) 2 times A,

whichever is lower, where A = the income which would be received if it were calculated in accordance with 11.5, and B = half the excess (if any) of the relevant amount over A, but B must not be less than zero.

11.7

For the purposes of 11.6, the ‘relevant amount’ in relation to equity shares is the issuer’s profits after taxation from its ordinary activities for the most recent financial year ending on or before the valuation date which is reported in accounts in accordance with 11.8 which are publicly available, in so far as attributable to those equity shares, taking account of the effect of any alterations in capital structure.

11.8

For the purposes of 11.7, the issuer’s profits after taxation from its ordinary activities for the relevant financial year must be derived from accounts drawn up in accordance with legislation implementing the Accounts Directives or, if accounts are not drawn up in accordance with the Accounts Directives, from accounts drawn up in accordance with International Accounting Standards Committee accounting standards or US generally accepted accounting practice.

11.9

Where 11.6 applies, and a undertaking’s accounting period is longer or shorter than a year, the amount of profits or losses for that period must be annualised, and the annualised figure must be used to calculate the yield.

11.10

If the requirements in 11.7 and 11.8 are not, or cannot be, met, then the relevant amount is zero.

11.11

Subject to 11.12, for variable interest investments other than equity shares or land, the yield on an asset must, subject to 11.13, be that annual rate of interest which, if used to calculate the present value of future payments of interest (before deduction of tax), and the present value of repayments of capital, where applicable, would result in the sum of these amounts being equal to the value of the asset, on the assumption that:

1. (1) the value of any determinant of the amount of the next interest rate payment and capital repayment made during the following 12 months will be the value of that determinant at the most recent date for which it is known at the valuation date;
2. (2) the amount of future interest payments and capital repayments will take account, where appropriate, of:
1. (a) the right of either party to have the investment repaid, and
2. (b) an assumed yield on other comparable investments made in the future not exceeding an amount determined in accordance with 11.15 to 11.17; and
3. (3) indices and all other factors which affect future income payments or capital repayment will remain unchanged after the valuation date.

11.12

For investments in collective investment schemes given a value as an asset in accordance with Friendly Society – Asset Valuation 13, the yield may be determined as the weighted average of the yields (as determined by this Chapter) on each of the investments held by the collective investment scheme.

11.13

In calculating the yield on an asset under this Chapter:

1. (1) for an asset other than equity shares or land:
1. (a) a prudent adjustment must be made to exclude that part of the yield estimated to represent compensation for the risk that the income from the asset might not be maintained or that capital repayments might not be received as they fall due; and
2. (b) in making that adjustment, regard must be had wherever possible to the yields on risk-free investments of a similar term in the same currency;
2. (2) for equity shares or land, adjustments to yields must be made as appropriate to exclude that part, if any, of the yield from each category of assets of a similar nature, type and degree of risk that is needed to compensate for the risk that the aggregate income from such category of assets, taking one year with another, might not be maintained.

11.14

Notwithstanding 11.13(2), for equity shares within 11.6, adjustments to yields must be made as appropriate to exclude that part, if any, of the yield from each category of assets of a similar nature, type and degree of risk that is needed to compensate for the risk that the aggregate profits earned by a undertaking might not be maintained.

11.15

To the extent that it is necessary to make an assumption about the yields which will be obtained on sums to be invested in future, the yield must be determined in accordance with 11.16 and 11.17.

11.16

Where the liabilities are denominated in UK sterling, the yield assumed, before any adjustments to take account of the effect of taxation;

1. (1) on any investment to be made more than three years after the valuation date, must not exceed the lowest of:
1. (a) the long-term gilt yield current on the valuation date,
2. (b) 3% per annum, increased by two-thirds of the excess, if any, of the long-term gilt yield current on the valuation date over 3% per annum, or
3. (c) 6.5% per annum, where "the long-term gilt yield" means the annualised equivalent of the 15 year yield for United Kingdom Government fixed interest securities jointly compiled by the Financial Times, the Institute of Actuaries and the Faculty of Actuaries; and
2. (2) on any investment to be made at any time not more than three years after the valuation date must not exceed the assumed yield determined under 11.2 adjusted linearly over the said three years to the yield determined in accordance with (1).

11.17

Where the liabilities are denominated in currencies other than UK sterling, the yield must be determined on assumptions that are as prudent as those made under 11.16.

11.18

1. (1) In no case must a rate of interest determined for the purposes of 11.1 exceed the adjusted overall yield on assets calculated as the weighted average of the reduced yields on the individual assets arrived at under 11.2.
2. (2) In calculating the weighted averaged referred to in (1):
1. (a) the weight given to each investment must be its value as an asset determined in accordance with the Friendly Society – Asset Valuation, except where assets may be taken at lower book values for the purposes of any investigation to which Friendly Society – Reporting 2 applies; and
2. (b) except in relation to the rate of interest used in valuing payments of property linked benefits, both the yield and the value of any linked assets must be omitted from the calculation.