Credit risk in insurance

Part

INSPRU Prudential Sourcebook for Insurers

Chapter

Credit risk in insurance

Printed on: 15/11/2024

Rulebook at: 06/01/2010

INSPRU 2

Credit risk in insurance

INSPRU 2.1

Application

31/12/2006

INSPRU 2.1.1

INSPRU 2.1 applies to an insurer unless it is:

(1) a non-directive friendly society; or

(2) an incoming EEA firm; or

(3) an incoming Treaty firm.

31/12/2006

INSPRU 2.1.2

All of INSPRU 2.1, except INSPRU 2.1.20 R and INSPRU 2.1.23 R to INSPRU 2.1.32 G, applies to:

(1) an EEA-deposit insurer; and

(2) a Swiss general insurer;

but only in respect of the activities of the firm carried on from a branch in the United Kingdom.

31/12/2006

INSPRU 2.1.3

The scope of application of INSPRU 2.1 is not restricted to firms that are subject to relevant EU directives.

01/12/2009

INSPRU 2.1.4

(1) This section applies to a firm in relation to the whole of its business, except where a particular provision provides for a narrower scope.

(2) Where a firm carries on both long-term insurance business and general insurance business, this section applies separately to each type of business.

31/12/2006

Purpose

INSPRU 2.1.5

The purpose of this section is to protect policyholders and potential policyholders by setting out the requirements applicable to a firm in respect of credit risk. Credit risk is incurred whenever a firm is exposed to loss if a counterparty fails to perform its contractual obligations including failure to perform them in a timely manner. Credit risk may therefore have an impact upon a firm's ability to meet its valid claims as they fall due. Credit risk can also arise from underlying causes that have an impact upon the creditworthiness of all counterparties of a particular description or geographical location. A detailed explanation of credit risk is given at SYSC 15.1.4 G.

31/12/2006

INSPRU 2.1.6

The requirements in this section address both current and contingent exposure to credit risk. PRIN and SYSC require a firm to establish adequate internal systems and controls for exposure to credit risk. This section requires a firm to restrict its exposure to different counterparties and assets to prudent levels and to ensure that those exposures are adequately diversified. It also requires a firm to make deductions from the value of assets in respect of exposures to one asset, counterparty or group of closely related counterparties in excess of prescribed limits.

31/12/2006

INSPRU 2.1.7

This section also sets limits on the market risk arising from holding assets including securities issued or guaranteed by counterparties. This market risk is incurred whenever a firm is exposed to loss if an asset were to reduce in value or even become worthless. These market risk limits are set out in this section rather than the market risk sections in INSPRU because they are closely linked to the counterparty limits set out in this section.

31/12/2006

Overall limitation of credit risk

INSPRU 2.1.8

Taking into account relevant risks, a firm must restrict its counterparty exposures and asset exposures to prudent levels and ensure that those exposures are adequately diversified.

31/12/2006

INSPRU 2.1.9

(1) For the purposes of INSPRU 2.1, counterparty exposure is the amount a firm would lose if a counterparty were to fail to meet its obligations (either to the firm or to any other person) and if simultaneously securities issued or guaranteed by the counterparty were to become worthless.

(2) For the purposes of INSPRU 2.1, asset exposure is the amount a firm would lose if an asset or class of identical assets (whether or not held directly by the firm) were to become worthless.

(3) For the purposes of (1) and (2), the amount of loss is the amount, if any, by which the firm's capital resources (as calculated in accordance with the capital resources table but without making any deduction for assets in excess of market risk and counterparty limits) would decrease as a result of the counterparty failing to meet its obligations and the securities or assets becoming worthless.

(4) In determining the amount of loss in accordance with (3), the firm must take into account decreases in its capital resources that would result not only from its own direct exposures but also from:

(a) exposures held by any of its subsidiary undertakings; and

(b) synthetic exposures arising from derivatives or quasi-derivatives held or entered into by the firm or any of its subsidiary undertakings.

(5) If a firm elects under INSPRU 2.1.35 R to make a deduction in respect of collateral, the firm must deduct from the amount of loss determined in accordance with (3) so much of the value of that collateral as:

(a) would be realised by the firm were it to exercise its rights in relation to the collateral; and

(b) does not exceed any of the relevant limits in INSPRU 2.1.22R (3).

31/12/2006

INSPRU 2.1.10

Exposure is defined in terms of loss (which is decrease in capital). It does not include exposures arising from assets that are not represented in capital or exposures which if crystallised in a loss would be offset by a consequent gain, reduction in liabilities or release of provisions, but only in so far as that gain, reduction or release would itself lead to an offsetting increase in capital resources. Examples include:

(1) exposure from the holding of assets to which the firm has attributed no value;

(2) exposure from the holding of assets that the firm has deducted from capital resources; and

(3) exposure in respect of which (and to the extent that) the firm has established a provision.

31/12/2006

INSPRU 2.1.11

In assessing the adequacy of diversification required by INSPRU 2.1.8 R, a firm should take into account concentrations of exposure including those arising from:

(1) different types of exposure to the same counterparty, such as deposits, loans, securities, reinsurance and derivatives;

(2) links between counterparties such that default by one might have an impact upon the creditworthiness of another; and

(3) possible changes in circumstance that would have an impact upon the creditworthiness of all counterparties of particular description or geographical location.

31/12/2006

INSPRU 2.1.12

A firm should consider how the spreading of credit risk will impact on overall counterparty quality.

31/12/2006

INSPRU 2.1.13

In assessing its exposure to a counterparty for the purpose of INSPRU 2.1.8 R, a firm should take into account:

(1) the period for which the exposure to that counterparty might continue;

(2) the likelihood of default during that period by the counterparty; and

(3) the loss that might result in the event of default.

31/12/2006

INSPRU 2.1.14

In assessing the loss that might result from the default of a counterparty for the purposes of INSPRU 2.1.8 R, a firm should take into account the circumstances that might lead to default and, in particular, how these might have an impact upon:

(1) the amount of exposure to the counterparty; and

(2) the effectiveness of any loss mitigation techniques employed by the firm.

31/12/2006

INSPRU 2.1.15

Often the same circumstances which lead to the crystallisation of contingent credit exposure, e.g. a significant claims event or a significant movement in interest, currency or asset values, also lead to an increase in the risk of default by the counterparty. In particular, if a reinsurer or derivative counterparty is being relied upon to provide protection against the consequences of an event or circumstance, a firm should take into account how that event or circumstance might have an impact upon the creditworthiness of the reinsurer or derivative counterparty.

31/12/2006

INSPRU 2.1.16

For the purposes of INSPRU 2.1.8 R and of determining counterparty exposure and asset exposure in accordance with INSPRU 2.1.9 R and reinsurance exposure in accordance with INSPRU 2.1.25 R, a firm must only rely upon a loss mitigation technique where it has good reason to believe that, taking into account the possible circumstances of default, it is likely to be effective.

31/12/2006

INSPRU 2.1.17

Loss mitigation techniques include:

(1) the right, upon default, to preferential access to some or all of the counterparty's assets, for example by exercising rights of set off, holding collateral or assets deposited back, or exercising rights under fixed or floating charges;

(2) rights against third parties upon default by the counterparty, such as guarantees, credit insurance and credit derivatives; and

(3) where the counterparty is a reinsurer, having back-up or flexible reinsurance which covers the gap in coverage left by the reinsurer's default, for example 'top and drop' reinsurance.

31/12/2006

INSPRU 2.1.18

For the purposes of INSPRU 2.1.8 R and of determining counterparty exposure and asset exposure in accordance with INSPRU 2.1.9 R and reinsurance exposure in accordance with INSPRU 2.1.25 R, a firm must not rely upon preferential access to assets unless it has taken into account appropriate professional advice as to its effectiveness.

31/12/2006

INSPRU 2.1.19

In particular, a firm should consider whether any preferential access to a counterparty's assets would be effective even if the counterparty were wound up by a court or other legal process or it were to be subject to any other insolvency process. A firm should also consider, where it is relying upon a right against a third party, whether, in the circumstances of the counterparty's default, the creditworthiness of that third party might be impaired.

31/12/2006

Large exposure limits

INSPRU 2.1.20

(1) A firm must take reasonable steps to limit its counterparty exposure or asset exposure to:

(a) a single counterparty;

(b) each of the counterparties within a group of closely related counterparties; and

to a level where, if a total default were to occur, the firm would not become unable to meet its liabilities as they fall due.

(2) In (1), a total default occurs where:

(a) the single counterparty or all of the counterparties within the group of closely related counterparties fail to meet its or their obligations and simultaneously any securities issued or guaranteed by it or any of them become worthless; or

(b) the asset becomes worthless or all of the assets within the identical class become worthless at the same time.

(3) (1) does not apply to:

(a) a reinsurance exposure; or

(b) a counterparty exposure or asset exposure to an approved credit institution.

31/12/2006

INSPRU 2.1.21

In assessing its exposure to a counterparty or group of closely related counterparties, a firm should consider exposures from different sources including deposits, loans, securities and derivatives.

31/12/2006

Market risk and counterparty limits

INSPRU 2.1.22

(1) A firm must calculate the amount of the deduction from total capital required by stage L in the capital resources table in respect of assets in excess of market risk and counterparty limits as the aggregate amount by which its counterparty exposures and asset exposures exceed the relevant limits set out in (3).

(2) Except where the contrary is expressly stated in INSPRU, whenever:

(a) a rule in INSPRU refers to assets of a firm, or of any part of a firm, or of any fund or part of a fund within a firm, which are assets of a kind referred to in any of the limits in (3); and

(b) the firm's counterparty exposure (or aggregate exposure arising from the counterparty exposures to each member of a group of closely related persons) or asset exposure in respect of those assets exceeds any of the limits in (3);

the firm must deduct from the measure of the value of those assets (as determined in accordance with GENPRU 1.3) the amount by which that exposure exceeds the relevant limit in (3), or that portion of the deduction that relates to the part of the firm or fund or part of a fund in question.

(3) The limits referred to in (1) and (2) are the following, expressed as a percentage of the firm's business amount:

(a) for a counterparty exposure to an individual, unincorporated body of individuals or the aggregate exposure arising from the counterparty exposures to each member of a group of closely related individuals or unincorporated bodies of individuals:

(i) ¼% for that part of the exposure that arises from unsecured debt;

(ii) 1% for the whole exposure (after deduction of the excess arising from the limit in (a)(i));

(b) for a counterparty exposure to an approved counterparty or the aggregate exposure arising from the counterparty exposures to each member of a group of closely related approved counterparties :

(i) 40% for that part of the exposure arising from covered bonds;

(ii) 5% for that part of the exposure not arising from covered bonds or, if the counterparty is an approved credit institution, from short term deposits; this limit is increased to 10% if the total of such exposures which are greater than 5% arising from applying a 10% limit, when taken together with any exposures arising from covered bonds which are within the 40% limit in (i), does not exceed 40%;

(iii) 20% or 2 million, if larger, for the whole exposure (but excluding any exposure arising from covered bonds and after deduction of the excess arising from the limit in (b) (ii));

(c) for a counterparty exposure to a person, or the aggregate exposure arising from the counterparty exposures to each member of a group of closely related persons, who do not fall into the categories of counterparty to whom (a) and (b) apply:

(i) 1% for that part of the exposure arising from unsecured debt; this limit is increased to 2.5% in the case of an exposure to a regulated institution;

(ii) 1% for that part of the exposure arising from shares and other variable yield participations, bonds, debt securities and other money market instruments and capital market instruments from the same counterparty that are not dealt in on a regulated market, or a beneficial interest in a collective investment scheme to which INSPRU 2.1.39 R applies; the limit for that part of the exposure arising from debt securities (other than hybrid securities) issued by the same regulated institution is increased to 5%;

(iii) 5% for the whole exposure (after deduction of the excesses arising from the limits in (c)(i) and (ii));

(d) 5% for the aggregate of all counterparty exposures that fall within (c)(i) whether or not they arise from persons who are closely related, but excluding amounts that are in excess of the limit in (c)(i);

(e) 10% for the aggregate of all counterparty exposures and asset exposures that fall within (c)(ii) above or (j) below, whether or not they arise from persons who are closely related, but excluding amounts that are in excess of the limit in (c)(ii) above or, in the case of an asset exposure, (j) below;

(f) 5% for the aggregate of all counterparty exposures arising from unsecured loans, other than those falling within (3)(b);

(g) 3% for the asset exposure arising from all cash in hand;

(h) 10% for the asset exposure (including an exposure arising from a reversionary interest) arising from any one piece of land or building, or a number of pieces of land or buildings close enough to each other to be considered effectively as one investment;

(i) 5% for the asset exposure arising from a beneficial interest in any single non-UCITS retail scheme or recognised scheme which does not fall within the UCITS Directive; and

(j) 1% for the asset exposure arising from a beneficial interest in any single collective investment scheme which does not fall within the UCITS Directive and is not a non-UCITS retail scheme or a recognised scheme.

(4) In (3) a firm's business amount means the sum of:

(a) the firm's total gross technical provisions (that is, calculated gross of reinsurance);

(b) the amount of its other liabilities (except those included in the calculation of capital resources in accordance with the capital resources table); and

(c) such amount as the firm may select not exceeding, in the case of a firm which is not a participating insurance undertaking, the amount of the firm's total capital after deductions as calculated at stage M of the capital resources table or, in the case of a firm which is a participating insurance undertaking, the amount calculated in accordance with (5A) or, in either case, if higher:

(i) in the case of a firm carrying on general insurance business, the amount of its general insurance capital requirement; and

(ii) in the case of a firm carrying on long-term insurance business, the amount of its long-term insurance capital requirement and, where it is a regulatory basis only life firm, the amount of its resilience capital requirement.

(5) For the purpose of (4)(a), a firm's total gross technical provisions exclude technical provisions in respect of index-linked liabilities or property-linked liabilities, except that where the linked long-term contract of insurance in question includes a guarantee of investment performance or some other guaranteed benefit, the total gross technical provisions include the technical provisions in respect of that guaranteed element.

(5A) For the purpose of (4)(c), a firm which is a participating insurance undertaking must calculate the amount of the firm's group capital resources less the difference between:

(a) the firm's group capital resources requirement; and

(b) the firm's capital resources requirement.

(5B) In (3)(b)(ii) short term deposit means a deposit which may be withdrawn at the discretion of the lender without penalty or loss of accrued interest by giving notice of withdrawal of one month or less.

(6) In (3)(c)(ii) hybrid security means a debt security, other than an approved security, the terms of which provide, or have the effect that, the holder does not, or would not, have an unconditional entitlement to payment of interest and repayment of capital in full within 75 years of the date on which the security is being valued.

(7) In (3)(a)(i) and (3)(c)(i) an unsecured debt is any debt in respect of which the conditions in INSPRU 2.1.35 R or INSPRU 2.1.36 R and INSPRU 2.1.37 R are not satisfied or, if satisfied only in relation to part of the debt, that part of the debt which is not covered by collateral or a guarantee, letter of credit or credit derivative in accordance with those rules.

31/12/2009

INSPRU 2.1.22A

INSPRU 2.1.22 R does not apply to a pure reinsurer.

31/12/2006

Large exposure calculation for reinsurance exposures

INSPRU 2.1.23

A firm must notify the FSA in accordance with SUP 15.7 as soon as it first becomes aware that:

(1) a reinsurance exposure to a reinsurer or group of closely related reinsurers is reasonably likely to exceed 100% of its capital resources; or

(2) if (1) does not apply, that it has exceeded this limit.

31/12/2006

INSPRU 2.1.24

Upon notification under INSPRU 2.1.23 R, a firm must:

(1) demonstrate that prudent provision has been made for the reinsurance exposure in excess of the 100% limit, or explain why in the opinion of the firm no provision is required; and

(2) explain how the reinsurance exposure is being safely managed.

31/12/2006

INSPRU 2.1.25

(1) For the purposes of INSPRU 2.1, a reinsurance exposure is the amount of loss which a firm would suffer if a reinsurer or group of closely related reinsurers were to fail to meet its or their obligations under contracts of reinsurance reinsuring any of the firm's contracts of insurance.

(2) For the purposes of (1), the amount of loss is the amount, if any, by which the firm's capital resources (as calculated in accordance with the capital resources table but without making any deduction for assets in excess of market risk and counterparty limits) would decrease as a result of the reinsurer or group of closely related reinsurers failing to meet its or their obligations under the contracts of reinsurance.

(3) If a firm elects under INSPRU 2.1.35 R to make a deduction in respect of collateral, the firm must deduct from the amount of loss determined in accordance with (2) so much of the value of that collateral as:

(a) would be realised by the firm were it to exercise its rights in relation to the collateral; and

(b) does not exceed any of the relevant limits in INSPRU 2.1.22R (3).

31/12/2006

INSPRU 2.1.26

A firm must, in determining its reinsurance exposures for the purposes of INSPRU 2.1, aggregate any reinsurance exposure where the identity of the reinsurer is not known by the firm with the highest reinsurance exposure where it does know the identity of the reinsurer.

31/12/2006

INSPRU 2.1.27

INSPRU 2.1.8 R provides that, taking into account relevant risks, a firm must restrict to prudent levels, and adequately diversify, its exposure to counterparties.

31/12/2006

INSPRU 2.1.28

(1) In each financial year, a firm should restrict the gross earned premiums which it pays to a reinsurer or group of closely related reinsurers to the higher of:

(a) 20% of the firm's projected gross earned premiums for that financial year; or

(b) 4 million.

(2) Compliance with this provision may be relied upon as tending to establish compliance with INSPRU 2.1.8 R.

31/12/2006

INSPRU 2.1.29

A firm must notify the FSA immediately in accordance with SUP 15.7 if it has exceeded, or anticipates exceeding, the limit expressed in INSPRU 2.1.28 E.

31/12/2006

INSPRU 2.1.30

Upon notification under INSPRU 2.1.29 R, a firm must explain to the FSA how, despite the excess reinsurance concentration, the credit risk is being safely managed.

31/12/2006

INSPRU 2.1.31

For the purposes of INSPRU 2.1.24 R and INSPRU 2.1.30 R, a firm's explanation of how a reinsurance exposure is being safely managed should also describe the reinsurance market in which the exposure has occurred, and the nature of the reinsurance contract. If appropriate, the firm should also provide a detailed plan and timetable explaining how the excess exposure will be reduced to an acceptable level. The explanation should be approved by a person at the firm of appropriate seniority.

31/12/2006

INSPRU 2.1.32

Where a firm can demonstrate that the arrangement does not give rise to unacceptable levels of credit risk it is unlikely that further action will be required.

31/12/2006

Exposures excluded from limits

INSPRU 2.1.33

In INSPRU 2.1.20 R and INSPRU 2.1.22 R, references to a counterparty exposure or an asset exposure do not include such an exposure arising from:

(1) [deleted]

(2) premium debts;

(3) advances secured on, and not exceeding the surrender value of, long-term insurance contracts of the firm;

(4) rights of salvage or subrogation;

(5) deferred acquisition costs;

(6) assets held to cover index-linked liabilities or property-linked liabilities, except that where the linked long-term contract of insurance in question includes a guarantee of investment performance or some other guaranteed benefit, INSPRU 2.1.20 R and INSPRU 2.1.22 R will nevertheless apply to assets held to cover that guaranteed element;

(7) moneys due from, or guaranteed by, a Zone A country;

(8) an approved security;

(9) a holding in a collective investment scheme falling within the UCITS Directive.

31/12/2006

INSPRU 2.1.34

In INSPRU 2.1.22 R references to a counterparty exposure or an asset exposure do not include such an exposure resulting from debts arising from reinsurance ceded and the reinsurer's share of technical provisions.

31/12/2008

INSPRU 2.1.35

If:

(1) a firm has a counterparty exposure, an asset exposure or a reinsurance exposure in respect of which it has rights over collateral (except where that collateral is a letter of credit see INSPRU 2.1.36 R and INSPRU 2.1.37 R); and

(2) the assets constituting that collateral would, if owned by the firm, be admissible assets;

the firm may, in determining the amount of that exposure, deduct the value of that collateral in accordance with INSPRU 2.1.9R (5) or, in the case of a reinsurance exposure, INSPRU 2.1.25R (3).

31/12/2006

INSPRU 2.1.36

If a firm has a counterparty exposure, asset exposure or reinsurance exposure the whole or any part of which is:

(1) guaranteed by a credit institution or an investment firm subject in either case to the Capital Adequacy Directive or supervision by a third country (non-EEA) supervisory authority with a Capital Adequacy Directive-equivalent regime; or

(2) adequately mitigated by a credit derivative;

the firm may, for the purposes of INSPRU 2.1.20 R, INSPRU 2.1.22 R and INSPRU 2.1.23 R, treat that exposure, or that part of the exposure which is so guaranteed or mitigated, as an exposure to the guarantor or derivative counterparty, rather than to the original counterparty, asset or reinsurer.

31/12/2006

INSPRU 2.1.37

For the purposes of INSPRU 2.1.36 R, references to an exposure being guaranteed include an exposure secured by a letter of credit, but to fall within INSPRU 2.1.36 R the guarantee or letter of credit must be direct, explicit, unconditional and irrevocable.

31/12/2006

INSPRU 2.1.38

The portion of exposure which is guaranteed or mitigated by a credit derivative is itself, as an exposure to the guarantor or derivative counterparty, subject to the limits in INSPRU 2.1.20 R and INSPRU 2.1.22 R.

31/12/2006

INSPRU 2.1.39

For the purposes of INSPRU 2.1.20 R and INSPRU 2.1.22 R, units in a collective investment scheme that does not fall within the UCITS Directive must be treated as a counterparty exposure to the issuer of the units in that scheme if the issuer and those units are to be regarded as constituting a single risk because they are so interconnected that, if the issuer were to experience financial problems, this would be likely to affect the value of the units.

31/12/2006

INSPRU 2.1.39A

Where the value of units in a collective investment scheme other than one falling within the UCITS Directive would be likely to be adversely affected by financial problems experienced by the issuer of those units, for the purposes of INSPRU 2.1.20 R and INSPRU 2.1.22 R, the units must be treated as a counterparty exposure to the issuer, with the result that the exposure is subject to the limit in INSPRU 2.1.22R (3)(c)(ii). In all other cases, the units would fall to be treated as an asset exposure, with the result that they are subject to the relevant limit under INSPRU 2.1.22R (3)(i) or (j).

31/12/2006

Meaning of closely related

INSPRU 2.1.40

For the purposes of INSPRU 2.1, a group of persons is closely related if it consists solely of two or more persons who, unless it is shown otherwise, constitute a single risk because as between any two of them one or other of the following relationships apply:

(1) one of them, directly or indirectly, has control, as defined in INSPRU 2.1.41 R, over the other or they are both controlled by the same third party; or

(2) there is no relationship of control as defined in INSPRU 2.1.41 R but they are to be regarded as constituting a single risk because they are so interconnected that, if one of them were to experience financial problems, the other would be likely to encounter repayment difficulties.

31/12/2006

INSPRU 2.1.41

For the purposes of INSPRU 2.1.40 R, control means the relationship between a parent undertaking and a subsidiary undertaking, as defined in Article 1 of the Consolidated Accounts Directive (83/349/EEC), or a similar relationship between any natural or legal person and an undertaking.

31/12/2006

Meaning of reinsurance

INSPRU 2.1.41A

For the purposes of INSPRU 2.1, references to reinsurance include analogous non-reinsurance financing agreements, including contingent loans, securitisations and any other arrangements in respect of contracts of insurance that are analogous to contracts of reinsurance in terms of the risks transferred and the finance provided and references to reinsurer shall be construed accordingly.

31/12/2007

Application of INSPRU 2.1 to Lloyd's

INSPRU 2.1.42

Subject to INSPRU 2.1.43 R, INSPRU 2.1 applies to managing agents and to the Society in accordance with:

(1) for managing agents, INSPRU 8.1.4 R; and

(2) for the Society, INSPRU 8.1.2 R.

31/12/2006

INSPRU 2.1.43

INSPRU 2.1.23 R to INSPRU 2.1.32 G (Large exposure calculation for reinsurance exposures) do not apply to the Society.

31/12/2006

Overall limitation of credit risk

INSPRU 2.1.44

For Lloyd's, counterparty exposure is:

(1) for managing agents, the amount by which the net assets managed by or under the direction of a managing agent in respect of a syndicate together with any relevant balancing amount would decrease if the counterparty were to default;

(2) for the Society, the amount by which its net assets (which include those of its subsidiary undertakings) would decrease if the counterparty were to default; and

(3) for the Society's management of each member's funds at Lloyd's, the amount by which the member's net assets would decrease if the counterparty were to default.

31/12/2006

Large exposures

INSPRU 2.1.45

For the purposes of INSPRU 2.1.20 R (Large exposure limits: counterparty exposure and asset exposure), the Society may determine the exposure to any letters of credit, guarantees or members' life assurance policies as an exposure of the members in aggregate.

31/12/2006

INSPRU 2.1.46

For the purposes of INSPRU 2.1.22 R (Large exposure limits: market risk and counterparty limits), the Society must calculate the amount of and deduct from capital resources:

(1) an exposure (expressed as a percentage of the relevant member's capital resources held as funds at Lloyd's), other than to the assets identified in INSPRU 2.1.46R (2)(a) to INSPRU 2.1.46R (2)(c), of a member's capital resources held as funds at Lloyd's to a counterparty, in excess of the limits in INSPRU 2.1.22 R;

(2) an exposure in excess of 20% (expressed as a percentage of the aggregate of capital resources held as funds at Lloyd's) of the aggregate of capital resources held as funds at Lloyd's to a single issuer of:

(a) letters of credit;

(b) guarantees; or

(3) an exposure of its own to a counterparty, in excess of the limits in INSPRU 2.1.22 R, expressed as a percentage of the Society's own assets.

31/12/2006

INSPRU 2.1.47

For the purposes of INSPRU 2.1.22 R (Large exposure limits: market risk and counterparty limits), managing agents must calculate the amount of and deduct from capital resources an exposure (expressed as a percentage of the admissible assets held in respect of the relevant syndicate) of admissible assets held in respect of a syndicate to a counterparty in excess of the limits in INSPRU 2.1.22 R.

31/12/2006

INSPRU 2.1.48

If the exposures of capital resources held as funds at Lloyd's for members in the aggregate do not exceed the limits in INSPRU 2.1.22R (3)(c), then, for each individual member, that limit may be replaced by 10%.

31/12/2006

Exposures excluded from the large exposure limits

INSPRU 2.1.49

For managing agents, in INSPRU 2.1.33 R and INSPRU 2.1.35 R, references to an exposure do not include exposure arising from balancing amounts.

31/12/2006

INSPRU 2.2

Asset-related Capital Requirement

31/12/2006

Application

INSPRU 2.2.1

INSPRU 2.2 applies to an insurer unless it is:

(1) a non-directive friendly society; or

(2) a Swiss general insurer; or

(3) an EEA-deposit insurer; or

(4) an incoming EEA firm; or

(5) an incoming Treaty firm.

31/12/2006

INSPRU 2.2.2

The scope of application of INSPRU 2.2 is not restricted to firms that are subject to the relevant EU directives.

01/12/2009

INSPRU 2.2.3

INSPRU 2.2 applies to a firm only in relation to its general insurance business.

31/12/2006

INSPRU 2.2.4

The adequacy of a firm's financial resources needs to be assessed in relation to all the activities of the firm and the risks to which they give rise.

31/12/2006

INSPRU 2.2.5

The requirements in INSPRU 2.2 apply to a firm on a solo basis.

31/12/2006

Purpose

INSPRU 2.2.6

GENPRU 2.1.13 R requires that a firm must maintain at all times capital resources equal to or in excess of its capital resources requirement. GENPRU 2.1.17 R provides that for a firm carrying on general insurance business the firm's capital resources requirement is the minimum capital requirement.

31/12/2006

INSPRU 2.2.7

The FSA will use the enhanced capital requirement as the benchmark for individual capital guidance for a firm carrying on general insurance business, other than a non-directive insurer. The enhanced capital requirement is the sum of the asset-related capital requirement and the insurance-related capital requirement less the firm's equalisation provisions. This section sets out rules and guidance relating to the asset-related capital requirement. Rules and guidance relating to the insurance-related capital requirement are set out in INSPRU 1.1.

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INSPRU 2.2.8

The asset-related capital requirement is a measure of the capital that a firm should hold against the risk of loss if another party fails to perform its financial obligations to the firm or from adverse movements in the value of assets.

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INSPRU 2.2.9

The asset-related capital requirement is calculated by applying capital charge factors, expressed as a percentage, to different categories of a firm's assets. A firm should refer to GENPRU 1.3 which sets out how a firm must recognise and value assets and liabilities.

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Calculation of asset-related capital requirement

INSPRU 2.2.10

A firm must calculate its asset-related capital requirement in accordance with INSPRU 2.2.11 R.

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INSPRU 2.2.11

(1) The value of each of the firm's assets of a kind listed in the table in INSPRU 2.2.16 R must be multiplied by the corresponding capital charge factor.

(2) If any amount which is to be multiplied by a capital charge factor is a negative amount, that amount shall be treated as zero.

(3) No account shall be taken of:

(a) the value of any asset which is not an admissible asset;

(b) the amount (if any) by which the value of any assets exceeds the limits on exposures to a type of asset or counterparty as set out in INSPRU 2.1.22 R.

(4) Where a firm has entered into a derivative, then for the purposes of applying the appropriate capital charge factor as set out in INSPRU 2.2.16 R, it must treat the value of the derivative and the value of the asset associated with the derivative as a single asset of a type and value which most closely reflects the economic risk to the firm of the combined rights and obligations associated with the derivative and the asset associated with the derivative.

(5) The amounts resulting from multiplying each of the asset items referred to in (1) by the corresponding capital charge factor must be aggregated.

(6) The asset-related capital requirement is the amount resulting from the aggregation in (5).

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INSPRU 2.2.12

Options: some derivatives may allow a firm an option whether to buy or sell a particular asset. If an option has a positive market value (that is, in-the-money) it is likely that the firm will exercise the option in the future and the current value of the derivative and associated asset will generally acquire new characteristics and volatility (a 'synthetic asset'). For instance, an option to acquire shares at a price below their current market value is likely to be exercised and the appropriate asset-related capital requirement calculation would be to combine the cash cost of acquiring the number of shares covered by the option with the value of the derivative and apply a factor of 16% to that combined value. If an option has no market value (that is, out-of-the-money) then it is unlikely that a firm would exercise the option in which case the appropriate asset-related capital requirement charge would be zero in respect of the derivative, and the corresponding capital charge contained in Table INSPRU 2.2.16 R in relation to the asset associated with the derivative.

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INSPRU 2.2.13

Futures and swaps: futures or swaps may not allow the firm such an option in which case the appropriate asset-related capital charge factor to apply is the one corresponding to the asset that would be held on fulfilment of the contract and the value to which this should be applied would be the value of the asset held after the contract is fulfilled.

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INSPRU 2.2.14

(1) The asset-related capital charge factor for money market funds set out in the Table INSPRU 2.2.16 R must be applied to exposures to funds that meet the definition in (2).

(2) In INSPRU 2.2 an investment in a money market fund means a participation in a collective investment scheme which satisfies the following conditions:

(a) the primary investment objective of the collective investment scheme is:

(i) to maintain the net asset value of the collective investment scheme constant at par (net of earnings); or

(ii) to maintain the net asset value of the collective investment scheme at the value of investors' initial capital plus earnings;

(b) in order to pursue its primary investment objective the collective investment scheme invests exclusively in cash or in short term instruments with characteristics similar to cash or both; and

(i) not to allow the assets held in the collective investment scheme to exceed a weighted average maturity of 60 days;

(ii) not to invest in equity or securities with characteristics similar to equity; and

(iii) on a basis of marking-to-market at least weekly, not to permit the value of each collective investment scheme unit at any point in time to move by more than 50 basis points (0.5% of total collective investment scheme value).

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INSPRU 2.2.15

In INSPRU 2.2.16 R an insurance dependant means a regulated related undertaking which is an insurance undertaking or an insurance holding company.

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INSPRU 2.2.16

Table: Asset-related capital charge factors

Asset item

ECR asset-related capital charge factor

Investments

Land and Buildings

7.5%

Investments in group undertakings and participating interests

Shares in group undertakings excluding participating interests

Insurance dependants

Other

7.5%

Debt securities issued by, and loans to, group undertakings

3.5%

Participating interests

7.5%

Debt securities issued by, and loans to, undertakings in which the insurer has a participating interest

3.5%

Other financial investments

Shares and other variable-yield securities and units in unit trusts

16.0%

Money market funds

Debt securities and other fixed income securities

Approved securities

3.5%

Other

3.5%

Participation in investment pools

16.0%

Loans secured by mortgages

2.5%

Other loans

2.5%

Deposits with approved credit institutions and approved financial institutions

Other

7.5%

Deposits with ceding undertakings

3.5%

Reinsurers' share of technical provisions

Provision for unearned premium

2.5%

Claims outstanding

2.5%

Other

2.5%

Debtors

Debtors arising out of direct insurance operations

Policyholders

4.5%

Intermediaries

3.5%

Debtors arising out of reinsurance operations

2.5%

Other debtors

1.5%

Called up share capital not paid

Other Assets

Tangible assets

7.5%

Cash at bank and in hand

Other

Prepayments and accrued income

Accrued interest and rent

Deferred acquisition costs

Other prepayments and accrued income

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Application of INSPRU 2.2 to Lloyd's

INSPRU 2.2.17

INSPRU 2.2 applies to managing agents and to the Society in accordance with:

(1) for managing agents, INSPRU 8.1.4 R; and

(2) for the Society, INSPRU 8.1.2 R

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INSPRU 2.2.18

This chapter applies to the Society for each member, including the capital charge relating to central assets, to the extent that those assets are held to support a particular member.

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