Prudential Regulation Authority Rulebook

1.

A firm must calculate the capital requirement for lapse risk as equal to the highest of the following capital requirements:

1. (1) the capital requirement for the risk of a permanent increase in lapse rates;
2. (2) the capital requirement for the risk of a permanent decrease in lapse rates; and
3. (3) the capital requirement for mass lapse risk.

2.

A firm must calculate the capital requirement for the risk of a permanent increase in lapse rates as equal to the loss in its basic own funds that would result from an instantaneous permanent increase of 50% in the option exercise rates of the relevant options (as set out in 3B6.4 and 3B6.5), provided that the increased option exercise rates must not exceed 100% and the increase in option exercise rates must only apply to relevant options for which the exercise of the option would result in an increase in technical provisions without the risk margin.

3.

A firm must calculate the capital requirement for the risk of a permanent decrease in lapse rates as equal to the loss in its basic own funds that would result from an instantaneous permanent decrease of 50% in the option exercise rates of the relevant options (as set out in 3B6.4 and 3B6.5), provided that the decrease in option exercise rates must not exceed 20 percentage points and the decrease in option exercise rates must only apply to relevant options for which the exercise of the option would result in a decrease in technical provisions without the risk margin.

4.

The relevant options for the purposes of 3B6.2 and 3B6.3 are the following:

1. (1) all legal or contractual policyholder rights to fully or partly terminate, surrender, decrease, restrict or suspend insurance cover or permit the insurance policy to lapse; and
2. (2) all legal or contractual policyholder rights to fully or partially establish, renew, increase, extend or resume the insurance or reinsurance cover.

For the purposes of 3B6.4(2) the change in the option exercise rate referred to in 3B6.2 and 3B6.3 must be applied to the rate reflecting that the relevant option is not exercised.

5.

In relation to reinsurance contracts the relevant options for the purposes of 3B6.2 and 3B6.3 are the following:

1. (1) the rights referred to in 3B6.4 of the policyholders of the reinsurance contracts;
2. (2) the rights referred to in 3B6.4 of the policyholders of the contracts of insurance underlying the reinsurance contracts; and
3. (3) where the reinsurance contract covers contracts of insurance or reinsurance contracts that will be written in the future, the right of the potential policyholders not to conclude those contracts of insurance or reinsurance contracts.

6.

A firm must calculate the capital requirement for mass lapse risk as equal to the loss in its basic own funds that would result from a combination of the following instantaneous events:

1. (1) the discontinuance of 70% of the insurance policies falling within the scope of operations referred to with Regulated Activities Order Schedule 1, Part II, class VII for which discontinuance would result in an increase in technical provisions without the risk margin and where one of the following requirements are met:
   1. (a) the policyholder is not a natural person and discontinuance of the policy is not subject to approval by the beneficiaries of the pension fund; or
   2. (b) the policyholder is a natural person acting for the benefit of the beneficiaries of the policy, except where there is a family relationship between that natural person and the beneficiaries, or where the policy is effected for private estate planning or inheritance purposes and the number of beneficiaries under the policy does not exceed 20;
2. (2) the discontinuance of 40% of the insurance policies other than those falling within 3B6.6(1) for which discontinuance would result in an increase in technical provisions without the risk margin; and
3. (3) where reinsurance contracts cover contracts of insurance or reinsurance contracts that will be written in the future, the decrease of 40% of the number of those future contracts of insurance or reinsurance contracts used in the calculation of technical provisions.

7.

A firm must apply the events referred to in 3B6.6 uniformly to all relevant contracts of insurance and reinsurance contracts and, in respect of any such reinsurance contracts, the firm must apply the event referred to in 3B6.6(1) to the underlying contracts of insurance.

8.

For the purposes of determining the loss in its basic own funds under the events referred to in 3B6.6(1) and (2) the firm must base the calculation on the type of discontinuance that most negatively affects its basic own funds on a per policy basis.

9.

Where the highest of the capital requirements referred to in 3B6.1(1), (2) and (3) and the highest of the corresponding capital requirements calculated in accordance with 6.3(2) are not based on the same scenario, the capital requirement for lapse risk must be the capital requirement referred to in 3B6.1(1), (2) and (3) for which the underlying scenario results in the highest corresponding capital requirement calculated in accordance with 6.3(2).