Insurance Company – Overall Resources and Valuation

1.1

Unless otherwise stated, this Part applies to:

1. (1) a non-directive insurer other than a non-directive friendly society; and
2. (2) a Swiss general insurer.

1.2

In this Part, the following definitions shall apply:

business risk

means any risk to a firm arising from changes in its business, including:

1. (1) the risk that the firm may not be able to carry out its business plan and its desired strategy; and
2. (2) risks arising from a firm's remuneration policy.

exposure

means the maximum loss which a firm might suffer if:

1. (1) a counterparty or a group of connected counterparties fail to meet their obligations; or
2. (2) the firm realises assets or off-balance sheet positions.

liquidity risk

means the risk that a firm, although solvent, either does not have available sufficient financial resources to enable it to meet its obligations as they fall due, or can secure such resources only at excessive cost.

mark to market

means valuation at readily available close out prices from independent sources.

mark to model

means any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input.

pension obligation risk

means the risk:

1. (1) to a firm caused by its contractual or other liabilities to or with respect to a pension scheme (whether established for its employees or otherwise); and
2. (2) that the firm will make payments or other contribution to or with respect to a pension scheme because of a moral obligation or because the firm considers that it needs to do so for some other reason.

regulatory surplus value

means the sum of:

1. (1) the total capital after deductions of the undertaking; less
2. (2) the individual capital resources requirement of the undertaking,

where:

1. (a) only the proportion of the total number of shares issued by the undertaking held, directly or indirectly, by the firm is to be taken into account, or
2. (b) if the individual capital resources requirement of an undertaking that:
1. (i) has a Part 4A permission; and
2. (ii) is a subsidiary

exceeds total capital after deductions, then the full amount of the items referred to in (1) and (2) must be taken into account.

residual risk

means the risk that credit risk mitigation techniques used by the firm prove less effective than expected.

restricted assets

means assets of the undertaking which are subject to a legal restriction or other requirement having the effect that those assets cannot be transferred or otherwise made available to the firm for the purposes of the firm meeting its CR Requirement without causing a breach of that legal restriction or requirement.

securitisation risk

includes the risk that the capital resources held by a firm in respect of assets which it has securitised are inadequate having regard to the economic substance of the transaction, including the degree of risk transfer achieved.

specific valuation rule

means any rule in the Non-Solvency II Firms Sector of the PRA Rulebook that provides in particular circumstances for a particular method of recognition or valuation.

2.1

This Chapter does not apply to a Swiss general insurer.

2.2

If a firm carries on long-term insurance business and general insurance business the rules in this Chapter apply separately to each type of business.

2.3

A firm must at all times maintain overall financial resources, including capital resources and liquidity resources, which are adequate, both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due.

2.4

A firm must have in place sound, effective and complete processes, strategies and systems to assess and maintain on an ongoing basis the amounts, types and distribution of financial resources and capital resources that it considers adequate to cover:

1. (1) the nature and level of the risks to which it is or might be exposed;
2. (2) the risk that its liabilities cannot be met as they fall due; and
3. (3) the risk that the firm might not be able to meet its CR Requirement in the future.

2.5

The processes, strategies and systems required by 2.4 must enable a firm to identify and manage the major sources of risks referred to in 2.4, including the major sources of risk in each of the following categories where they are relevant to the firm given the nature and scale of its business:

1. (1) credit risk;
2. (2) market risk;
3. (3) liquidity risk;
4. (4) operational risk;
5. (5) insurance risk;
6. (6) concentration risk;
7. (7) residual risk;
8. (8) securitisation risk;
9. (9) business risk;
10. (10) interest rate risk;
11. (11) pension obligation risk; and
12. (12) group risk.

2.6

A firm must identify separately the amount of tier one capital, tier two capital, other capital eligible to form part of its capital resources and each category of capital (if any) that is not eligible to form part of its capital resources which it considers adequate for the purposes described in 2.4.

2.7

The processes and systems required by 2.4 must:

1. (1) include an assessment of how the firm intends to deal with each of the major sources of risk identified in accordance with 2.5;
2. (2) take into account the impact of diversification effects and how such effects are factored into the firm's systems for measuring and managing risks; and
3. (3) include an assessment of the firm-wide impact of the risks identified in accordance with 2.4, to which end a firm must aggregate the risks across its various business lines and units, making appropriate allowance for the correlation between risks.

2.8

A firm must carry out assessments of the processes, strategies and systems required by 2.4 to ensure that they remain compliant with this Chapter.

2.9

A firm must carry out the assessments required by 2.4 and 2.8:

1. (1) annually; and
2. (2) whenever changes in the business, strategy, nature or scale of its activities or operational environment suggest that the current level of financial resources is no longer adequate.

2.10

A firm must make and retain for at least three years a written record of the assessments required under this Chapter, including a written record of:

1. (1) the major sources of risk identified in accordance with 2.5; and
2. (2) how it intends to deal with those risks.

3.1

Subject to 3.2 to 3.5, 8.1 and any specific valuation rule, whenever a rule refers to an asset, liability, exposure, equity or income statement item, a firm must, for the purpose of that rule, recognise the asset, liability, exposure, equity or income statement item and measure its value in accordance with the accounting principles.

3.2

Except where a specific valuation rule provides otherwise:

1. (1) when a firm, upon initial recognition, designates its liabilities as at fair value through profit or loss, it must always adjust any value calculated in accordance with 3.1 by subtracting any unrealised gains or adding back in any unrealised losses which are not attributable to changes in a benchmark interest rate; and
2. (2) in respect of a defined benefit occupational pension scheme:
1. (a) a firm must derecognise any defined benefit asset; and
2. (b) a firm may elect to substitute for a defined benefit liability the firm's deficit reduction amount.

An election made under (2)(b) must be applied consistently for the purposes of all applicable rules in respect of any one financial year.

3.3

Except where a specific valuation rule provides otherwise a firm must comply with 4 to 7:

(1) subject to 3.4, to account for

(a) investments that are, or amounts owed arising from the disposal of:

(i) debt securities, bonds and other money- and capital-market instruments;

(ii) loans;

(iii) shares and other variable yield participations;

(iv) units in any collective investment scheme falling within Insurance Company – Capital Resources 13.1(1)(d)(iv); and

(b) derivatives and quasi-derivatives; and

(2) to any balance sheet position not falling within (1) that is measured at market value or fair value.

3.4

3.3 does not apply to shares in an affiliated company that is:

1. (1) an undertaking with a Part 4A permission;
2. (2) an ancillary services undertaking; or
3. (3) any other subsidiary, the shares of which a firm elects to value in accordance with 8.1.

3.5

A firm must not place any value on amounts recoverable from an ISPV for the purposes of any rule.

4.1

Wherever possible, a firm must use mark to market in order to measure the value of investments and positions.

4.2

Subject to 4.3, when marking to market, a firm must use the more prudent side of bid/offer unless the firm is a significant market maker in a particular position type and it can close out at the mid-market price, in which case the firm can use the mid-market price.

4.3

When calculating the current exposure value of a credit risk exposure to a counterparty:

1. (1) a firm must select as a basis of valuation either:
1. (a) the more prudent side of bid/offer; or
2. (b) the mid-market price;
2. (2) the firm must be consistent in the basis of valuation it applies under (1) both between counterparties and year-on-year; and
3. (3) where the difference between the more prudent side of bid/offer and the mid-market price is material, the firm must consider making adjustments or establishing reserves.

5.1

Where marking to market is not possible, a firm must use mark to model in order to measure the value of the investments and positions.

5.2

When the model used is developed by the firm, that model must be:

1. (1) based on appropriate assumptions which have been assessed and challenged by suitably qualified parties independent of the development process; and
2. (2) independently tested, including validation of the mathematics, assumptions, and software implementation.

5.3

A firm must ensure that its senior management are aware of the positions which are subject to mark to model and understand the materiality of the uncertainty this creates in the reporting of the performance of the business of the firm and the risks to which it is subject.

5.4

A firm must source market inputs in line with market prices so far as possible and assess the appropriateness of the market inputs for the position being valued and the parameters of the model on a frequent basis.

5.5

A firm must use generally accepted valuation methodologies for particular products where these are available.

5.6

A firm must establish formal change control procedures, hold a secure copy of the model, and periodically use that model to check valuations.

5.7

A firm must ensure that its risk management functions are aware of the weaknesses of the models used and how best to reflect those in the valuation output.

5.8

A firm must periodically review the model to determine the accuracy of its performance.

6.1

In addition to marking to market or marking to model, a firm must regularly verify market prices and model inputs for accuracy and independence.

7.1

The recognition of any gains or losses arising from valuations subject to 3.3 must be recognised for the purpose of calculating capital resources in accordance with 4 to 7, unless a rule provides for another treatment of such gains or losses, in which case that other treatment must be applied.

7.2

A firm using third-party valuations, or marking to model, must consider whether valuation adjustments are necessary.

7.3

A firm must consider the need for making adjustments or establishing reserves for less liquid positions (including those arising from both market events and institution-related situations, including concentration positions and/or stale positions) and, on an ongoing basis, review their continued appropriateness in accordance with 7.5.

7.4

A firm must consider adjustments or reserves in respect of unearned credit spreads, close-out costs, operational risks, early termination, investing and funding costs, future administrative costs and, where appropriate, model risk.

7.5

A firm must consider at least the following factors when determining whether a valuation adjustment or reserve is necessary for less liquid positions:

1. (1) the amount of time it would take to hedge out the position/risks within the position;
2. (2) the average and volatility of bid/offer spreads;
3. (3) the availability of market quotes (number and identity of market makers);
4. (4) the average and volatility of trading volumes;
5. (5) market concentrations;
6. (6) the ageing of positions;
7. (7) the extent to which valuation relies on marking to model; and
8. (8) the impact of other model risks.

7.6

If the result of making adjustments or establishing reserves under 7.1 to 7.5 is a valuation which differs from the fair value determined in accordance with 3.1, a firm must reconcile the two valuations.

8.1

Except where the contrary is expressly stated in this Part, whenever a rule refers to shares held in an affiliated company referred to in 3.4(1) or (3), a firm must value the shares held as the sum of:

1. (1) the regulatory surplus value of that undertaking; less
2. (2) the sum of:
1. (a) the book value of the investments by the firm and its affiliated companies in the tier two capital resources of the undertaking; and
2. (b) if the undertaking is an insurance undertaking, any restricted assets of the undertaking.

8.2

A firm must value shares held in an ancillary services undertaking in accordance with 3.1.