Technical Provisions

1.1

Unless otherwise stated, this Part applies to:

1. (1) a UK Solvency II firm;
2. (2) in accordance with Insurance General Application 3, the Society, as modified by 16; and
3. (3) in accordance with Insurance General Application 3, managing agents, as modified by 16.

1.2

In this Part, the following definitions shall apply:

cost-of-capital rate

means the rate (above the relevant risk-free interest rate) that must be used in the determination of the cost that a UK Solvency II firm would incur in order to hold an amount of eligible own funds equal to the SCR necessary to support the insurance and reinsurance obligations over their lifetime, which, as specified in regulation 7B(b) of the IRPR Regulations, equals 4%. 

[Note: regulation 7B of the IRPR Regulations provides that where the PRA’s rules require the best estimate and the risk margin to be calculated separately, the risk margin must be calculated in accordance with that regulation. This definition therefore requires a firm that values the best estimate and the risk margin separately to calculate the risk margin using the cost-of-capital rate specified in regulation 7B(b) of the IRPR Regulations]

reference undertaking

means the hypothetical firm which is assumed, for the purpose of calculating the risk margin, to take over the whole portfolio of insurance and reinsurance obligations of the firm (or in the case of a composite firm either the general insurance business or long-term insurance business of the firm) on the basis of the assumptions in 4B.

reference undertaking notional SCR

means the hypothetical SCR of the reference undertaking, calculated in accordance with 4B.1.

volatility adjustment permission

means the permission granted to a firm by the PRA pursuant to section 138BA of FSMA to  permit it to apply a volatility adjustment for the purposes of calculating the best estimate.

2.1

Firms must establish adequate technical provisions with respect to all of their insurance and reinsurance obligations towards policyholders.

[Note: Art. 76(1) of the Solvency II Directive]

2.2

The value of technical provisions must correspond to the current amount that the firm would have to pay if it were to transfer its insurance and reinsurance obligations immediately to another UK Solvency II firm.

[Note: Art. 76(2) of the Solvency II Directive]

2.3

Firms must calculate their technical provisions:

1. (1) such that the calculation makes use of and is consistent with information provided by the financial markets and generally available data on underwriting risks (market consistency);
2. (2) in a prudent, reliable and objective manner;
3. (3) taking into account the principles set out in Valuation 2; and
4. (4) in accordance with 2.4 to 12.2.

[Note: Art. 76(3)–(5) of the Solvency II Directive]

2.4

The value of technical provisions must be equal to the sum of a best estimate and a risk margin which must be calculated in accordance with 2.5, 3 and 4.

[Note: Art. 77(1) of the Solvency II Directive]

2.5

1. (1) Firms must value the best estimate and the risk margin separately, except where (2) applies.
2. (2) Where:
1. (a) future cash-flows associated with insurance or reinsurance obligations can be replicated reliably; and
2. (b) that replication is provided using financial instruments; and
3. (c) those financial instruments have a reliable market value which is observable;

then the value of technical provisions associated with those future cash-flows must be determined on the basis of the market value of those financial instruments.

[Note: Art. 77(4) of the Solvency II Directive]

3.1

The best estimate must:

1. (1) correspond to the probability-weighted average of future cash-flows, taking into account the time value of money (expected present value of future cash-flows) using the relevant risk-free interest rate term structure; and
2. (2) be calculated:
1. (a) based upon up-to-date and credible information and realistic assumptions;
2. (b) using adequate, applicable and relevant actuarial and statistical methods; and
3. (c) gross, without deduction of the amounts recoverable from reinsurance contracts and UK ISPVs, which firms must calculate separately in accordance with 11.

[Note: Art. 77(2) of the Solvency II Directive]

3.2

The cash-flow projection used in the calculation of the best estimate (whether valued separately or determined on the basis of financial instruments in accordance with 2.5) must take into account all the cash in- and out-flows required to settle the insurance and reinsurance obligations over their lifetime.

[Note: Art. 77(2) of the Solvency II Directive]

4.1

Where firms value the best estimate and risk margin separately, the risk margin must be an amount equal to the cost that a UK Solvency II firm would incur in order to hold eligible own funds to cover the SCR necessary to support the insurance and reinsurance obligations over their lifetime, determined using the cost-of-capital rate.

[Note: Art. 77(5) of the Solvency II Directive]

4.2

The risk margin must be such as to ensure that the value of the technical provisions is equivalent to the amount that a UK Solvency II firm would be expected to require in order to take over and meet the insurance and reinsurance obligations over their lifetime.

[Note: Art. 77(3) of the Solvency II Directive]

4A.1

In accordance with regulation 7B of the IRPR Regulations, where a firm values the best estimate and the risk margin separately, the firm must calculate the risk margin for the whole portfolio of insurance and reinsurance obligations in accordance with the following formula:

$$\text{RM}=\text{CoC}\cdot {\sum }_{t\ge 0}\frac{\text{SCR}\left(\text{t}\right)\cdot max({\lambda }^t,{\lambda }_{floor})}{{(1+r(t+1))}^{t+1}}$$

where:

1. (1) RM denotes risk margin;
2. (2) CoC denotes the cost-of-capital rate;
3. (3) the sum covers all integers including zero;
4. (4) SCR(t) denotes the reference undertaking notional SCR after t years;
5. (5) λ denotes the risk tapering factor, and equals: 
   (a) 0.9 for long-term insurance and reinsurance obligations; and 
   (b) 1.0 for general insurance and reinsurance obligations;
6. (6)  λ^t denotes the relevant risk tapering factor to the power of t years; 
7. (7) λ_floor denotes the floor of the risk tapering factor, and equals 0.25; 
8. (8)  r(t+1) denotes the basic relevant risk-free interest rate for the maturity of t+1 years, derived from the basic relevant risk-free interest rate term structure and selected in accordance with the currency used for the firm’s financial statements.

[Note: regulation 7B of the IRPR Regulations provides that where the PRA’s rules require the best estimate and the risk margin to be calculated separately, the risk margin must be calculated in accordance with that regulation. Rules 2.2 and 2.4 require the value of technical provisions to correspond to a current transfer value and to consist of a best estimate and a risk margin. Rule 2.5 (1) requires the best estimate and the risk margin to be valued separately, unless 2.5(2) applies. Rule 4A.1 therefore requires a firm that values the best estimate and the risk margin separately to calculate the risk margin as required by regulation 7B of the IRPR Regulations]

4A.2

Where a firm calculates its SCR using an internal model for which it has received internal model permission, it must, unless it is inappropriate to do so, use that internal model to calculate the reference undertaking notional SCR.

4A.3

A firm must allocate the risk margin for the whole portfolio of insurance and reinsurance obligations to each relevant line of business and such allocation must adequately reflect the contributions of the lines of business to the reference undertaking notional SCR over the lifetime of the whole portfolio of insurance and reinsurance obligations.

4B.1

The risk margin must be based on all the following assumptions:

1. (1) the whole portfolio of insurance and reinsurance obligations of the firm is taken over by a reference undertaking;
2. (2) notwithstanding (1), a composite firm must assume that its general insurance business and long-term insurance business are each taken over separately by two different reference undertakings;
3. (3) the transfer of insurance and reinsurance obligations includes any reinsurance contracts and arrangements with special purpose vehicles relating to those obligations;
4. (4) the reference undertaking does not have any insurance or reinsurance obligations or own funds before the transfer takes place;
5. (5) after the transfer, the reference undertaking does not assume any new insurance or reinsurance obligations;
6. (6) after the transfer, the reference undertaking raises eligible own funds equal to the reference undertaking notional SCR necessary to support the insurance and reinsurance obligations over the lifetime of those obligations;
7. (7) after the transfer, the reference undertaking holds assets which amount to the sum of the reference undertaking notional SCR and of the reference undertaking’s technical provisions net of the amounts recoverable from reinsurance contracts and special purpose vehicles;
8. (8) the assets referred to in (7) are selected in such a way that they minimise the reference undertaking notional SCR for market risk that the reference undertaking is exposed to;
9. (9) the reference undertaking notional SCR captures all the following risks:
   1. (a) underwriting risk with respect to the transferred business;
   2. (b) where it is material, the market risk referred to in (8), other than interest rate risk;
   3. (c) credit risk with respect to reinsurance contracts, arrangements with special purpose vehicles, intermediaries, policyholders and any other material exposures which are closely related to the insurance and reinsurance obligations; and
   4. (d) operational risk;
10. (10) the loss-absorbing capacity of technical provisions for the reference undertaking corresponds, in respect of each risk, to the loss-absorbing capacity of technical provisions for the firm;
11. (11) there is no loss-absorbing capacity of deferred taxes for the reference undertaking;
12. (12) the reference undertaking will, subject to (5) and (6), adopt future management actions that are consistent with assumed future management actions, as referred to in Technical Provisions – Further Requirements 8, of the firm; and
13. (13) the reference undertaking does not apply to its technical provisions any of the following:
    1. (a) matching adjustment; 
    2. (b) volatility adjustment; 
    3. (c) risk-free interest rate transitional measure; or 
    4. (d) TMTP.
       

4B.2

Over the lifetime of the insurance and reinsurance obligations, the SCR necessary to support the insurance and reinsurance obligations referred to in 4.1 must be assumed to be equal to the reference undertaking notional SCR.

4B.3

For the purposes of 4B.1(9), a risk must be considered material where its impact on the calculation of the risk margin could influence the decision-making or the judgment of the users of that information, including the PRA and FCA.

5.1

Firms must ensure that the relevant risk-free interest rate term structure:

1. (1) is determined using, and consistent with, information derived from relevant financial instruments;
2. (2) takes account of relevant financial instruments of those maturities where the markets for those financial instruments as well as for bonds, are deep, liquid and transparent; and
3. (3) is only extrapolated for maturities where the markets for the relevant financial instruments or for bonds are not deep, liquid and transparent.

5.2

For the purpose of 5.1, the extrapolated part of the relevant risk-free interest rate term structure shall be based on forward rates converging smoothly from one set of forward rates in relation to the longest maturities for which the relevant financial instrument and the bonds can be observed in a deep, liquid and transparent market to an ultimate forward rate.

[Note: Art. 77a of the Solvency II Directive]

6.1

[Deleted]

6.2

[Deleted]

6.3

[Deleted]

6.4

[Deleted]

7.1

[Deleted]

7.2

[Deleted]

7.3

[Deleted]

7.4

[Deleted]

7.5

[Deleted]

8.1

A firm may only apply a volatility adjustment to the relevant risk-free interest rate term structure to calculate the best estimate of its insurance or reinsurance obligations:

1. (1) if it has been granted a volatility adjustment permission; 
2. (2) the volatility adjustment has been published by the PRA under regulation 3 of the IRPR regulations; and
3. (3) to the extent of its volatility adjustment permission.

8.2

The volatility adjustment must not be applied to the risk-free interest rates of the relevant risk-free interest rate term structure that are derived by means of extrapolation in accordance with 5.

8.3

Where a firm applies a volatility adjustment in accordance with 8, the extrapolation of the relevant risk-free interest rate term structure referred to in 5 shall be based on the risk-free interest rates adjusted with the volatility adjustment.

8.4

[Deleted]

8.5

A firm with a volatility adjustment permission must not apply the volatility adjustment with respect to insurance or reinsurance obligations where the relevant risk-free interest rate term structure used to calculate the best estimate for those obligations includes a matching adjustment.

[Note: Art. 77d of the Solvency II Directive]

9.1

When calculating technical provisions, firms must take into account:

1. (1) all expenses that will be incurred in servicing insurance and reinsurance obligations;
2. (2) inflation, including expenses and claims inflation; and
3. (3) all payments to policyholders, including future discretionary bonuses, which firms expect to make, whether or not those payments are contractually guaranteed, unless those payments fall within Surplus Funds 2.1.

[Note: Art. 78 of the Solvency II Directive]

9.2

1. (1) When calculating technical provisions, firms must take account of the value of financial guarantees and any contractual options included in contracts of insurance and reinsurance contracts.
2. (2) Any assumptions used by a firm to determine the likelihood that policyholders will exercise contractual options, including lapses and surrenders, must:
1. (a) be realistic and based on current and credible information; and
2. (b) take into account, either explicitly or implicitly, the impact that future changes in financial and non-financial conditions may have on the exercise of those options.

[Note: Art. 79 of the Solvency II Directive]

10.1

When calculating technical provisions, firms must segment their insurance and reinsurance obligations into homogenous risk groups and, as a minimum, by lines of business.

[Note: Art. 80 of the Solvency II Directive]

11.1

1. (1) Firms must calculate amounts recoverable from reinsurance contracts and UK ISPVs in accordance with 2 to 10.
2. (2) For the purposes of (1), firms must take into account the time difference between amounts becoming recoverable and the actual receipt of those amounts.
3. (3) Firms must adjust the calculation referred to in (1) to take into account expected losses due to the default of the counterparty. That adjustment must be based on an assessment of the probability of default of the counterparty and the average loss that would result from that default (loss-given- default).

[Note: Art. 81 of the Solvency II Directive]

12.1

Firms must ensure that the data used in the calculation of their technical provisions is appropriate, complete and accurate.

12.2

Where firms have insufficient data of appropriate quality to apply a reliable actuarial method to a set or subset of their insurance and reinsurance obligations, or amounts recoverable from their reinsurance contracts and UK ISPVs, firms may use appropriate approximations, including case-by-case approaches, in the calculation of the best estimate.

[Note: Art. 82 of the Solvency II Directive]

13.1

1. (1) Firms must ensure that the best estimate, and the assumptions underlying the calculation of the best estimate, are regularly compared against experience.
2. (2) Where the comparison in (1) identifies that a systematic deviation exists between the firm’s best estimate calculations and experience, the firm must make appropriate adjustments to the actuarial methods being used and/or the assumptions being made to ensure that the best estimate is calculated in accordance with 2 to 12.

[Note: Art. 83 of the Solvency II Directive]

14.1

Upon request by the PRA, the firm must demonstrate to the PRA:

1. (1) the appropriateness of the level of the firm’s technical provisions;
2. (2) the applicability and relevance of the methods applied; and
3. (3) the adequacy of the underlying statistical data used.

[Note: Art. 84 of the Solvency II Directive]

15.1

[Deleted.]

15.2

[Deleted.]

16.1

This Chapter applies to the Society and managing agents.

16.2

For the purposes of complying with 4.1, managing agents must construe the reference to “SCR” in 4.1 as a reference to the notional syndicate SCR required to be calculated pursuant to Solvency Capital Requirement – General Provisions 8.2.

16.3

For the purpose of complying with 1.1(2) the Society must calculate technical provisions in respect of the insurance business of each member.

16.4

For the purpose of complying with 1.1(3), a managing agent must calculate technical provisions in respect of each syndicate it manages

16.5

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

16.6

For the purposes of 10.1 in relation to managing agents, a managing agent must carry out the segmentation referred to in that rule in respect of each syndicate managed by the managing agent.