COBS 21.3 Further rules for firms engaged in linked long-term insurance business4

Application

COBS 21.3.-1RRP

4The rules in this section apply to linked long-term contracts of insurance where the investment risk is borne by a policyholder who is a natural person.

Permitted links and conditional permitted links

COBS 21.3.1RRP

An insurer must not contract to provide benefits under linked long-term contracts of insurance4 that are determined:

4
  1. (1)

    wholly or partly, or directly or indirectly, by reference to fluctuations in any index other than an approved index;

  2. (2)

    wholly or partly by reference to the value of, or the income from, or fluctuations in the value of, property other than any of the following:

    1. (a)

      approved securities;

    2. (b)

      listed securities;

    3. (c)

      permitted unlisted securities;

    4. (d)

      permitted land and property;

    5. (e)

      permitted loans;

    6. (f)

      permitted deposits;

    7. (g)

      permitted scheme interests;

    8. (h)

      approved money market instruments meeting the requirements in COBS 21.3.6 R to COBS 21.3.8 G;4

      4
    9. (i)

      cash;

    10. (j)

      permitted units;

    11. (k)

      permitted stock lending; 7

    12. (l)

      permitted derivatives contracts; and7

    13. (m)

      conditional permitted links.7

COBS 21.3.1ARRP

4A firm must classify the types of property listed in COBS 21.3.1R (2)(a) to (2)(m)7 according to their economic behaviour ahead of their legal form.

COBS 21.3.2GRP
  1. (1)

    Nothing in these rules prevents a firm making allowance in the value of any permitted link or conditional permitted link7 for any notional tax loss associated with the relevant linked assets for the purposes of fair pricing.3

  2. (2)

    In the FCA's5 view the Consumer Prices Index, as well as the Retail Prices Index, is a national index of retail prices and so may be used as an approved index for the purposes of COBS 21.3.1R (1).3

Money-market instruments

COBS 21.3.6RRP

4A money-market instrument will be regarded as normally dealt in on the money market if it:

  1. (1)

    has a maturity at issuance of up to, and including, 397 days; or

  2. (2)

    has a residual maturity of up to, and including, 397 days; or

  3. (3)

    undergoes regular yield adjustments in line with money market conditions at least every 397 days; or

  4. (4)

    undergoes regular yield adjustments in line with money market conditions at least every 397 days.

COBS 21.3.7RRP
  1. (1)

    4A money-market instrument will be regarded as liquid if it can be sold at limited cost in an adequately short timeframe.

  2. (2)

    A money-market instrument will be regarded as having a value which can be accurately determined at any time if accurate and reliable valuations systems, which fulfil the following criteria, are available:

    1. (a)

      enabling the firm to calculate a net asset value in accordance with the value at which the instrument held in the portfolio could be exchanged between knowledgeable willing parties in an arm's length transaction; and

    2. (b)

      based either on market data or on valuation models, including systems based on amortised costs.

  3. (3)

    A money-market instrument that is normally dealt in on the money market and is admitted to, or dealt in, on an eligible market will be presumed to be liquid and have a value which can be accurately determined at any time, unless there is information available to the firm that would lead to a different determination.

COBS 21.3.8GRP

4A firm should assess the liquidity of a money-market instrument in accordance with CESR's UCITS eligible assets guidelines, with respect to article 4(1) of the UCITS eligible assets Directive.

Permitted stock lending transactions

COBS 21.3.9RRP

4A permitted stock lending transaction is one which, for a Solvency II firm, satisfies the requirements in COBS 21.3.11 R to COBS 21.3.12 R and, for an insurer which is not a Solvency II firm, satisfies INSPRU 3.2.36A R to INSPRU 3.2.42 G.

COBS 21.3.10RRP

4The specific method of stock lending permitted is an arrangement of the kind described in section 263B of the Taxation of Chargeable Gains Act 1992, under which the lender transfers securities to the borrower other than by way of sale and the borrower is to transfer those securities, or securities of the same type and amount, back to the lender at a later date. In accordance with good market practice, a separate transaction by way of transfer of assets is also involved for the purpose of providing collateral to the "lender" to cover him against the risk that the future transfer back of the securities may not be satisfactorily completed.

Stock lending: requirements

COBS 21.3.11RRP
  1. (1)

    4The stock lending arrangement is of the kind described in section 263B of the Taxation of Chargeable Gains Act 1992 (without extension by section 263C), and:

    1. (a)

      all the terms of the agreement under which securities are to be reacquired by the firm for the account of the unit-linked fund are in a form which is acceptable to the firm and in accordance with good market practice;

    2. (b)

      the counterparty is:

      1. (i)

        an authorised person; or

      2. (ii)

        a person authorised by a Home State regulator; or

      3. (iii)

        a person registered as a broker-dealer with the Securities and Exchange Commission of the United States of America; or

      4. (iv)

        a bank, or a branch of a bank, supervised and authorised to deal in investments as principal, with respect to OTC derivatives, by at least one of the following federal banking supervisory authorities of the United States of America:

        1. (A)

          [deleted]5;

        2. (B)

          the Federal Deposit Insurance Corporation;

        3. (C)

          the Board of Governors of the Federal Reserve System; and

        4. (D)

          the Office of Thrift Supervision; and

    3. (c)

      collateral is obtained to secure the obligation of the counterparty under the terms in (a) and the collateral is:

      1. (i)

        acceptable to the firm;

      2. (ii)

        adequate; and

      3. (iii)

        sufficiently immediate; and

    4. (d)

      for the purposes of property-linked assets only:

      1. (i)

        where the linked policyholder bears the whole of the risk associated with the stock lending transaction, the linked policyholder receives the whole of the recompense (net of fees and expenses);

      2. (ii)

        the extent of any risk that the linked policyholder bears in relation to the stock lending transaction is disclosed to them; and

      3. (iii)

        where the risk associated with the stock lending transaction is borne outside the linked fund, the linked fund receives a fair and reasonable recompense for the use of the linked policyholders' funds.

  2. (2)

    The counterparty for the purpose of (1) is the person who is obliged under the agreement in (1)(a) to transfer to the firm the securities transferred by the firm under the stock lending arrangement or securities of the same kind.

  3. (3)

    COBS 21.3.11R (1)(c) does not apply to a stock lending transaction made through Euroclear Bank SA/NV’s Securities Lending and Borrowing Programme.

Stock lending: treatment of collateral

COBS 21.3.12RRP
  1. (1)

    4Collateral is adequate for the purposes of this section only if it is:

    1. (a)

      transferred to the firm or the firm's agent;

    2. (b)

      at least equal in value, at the time of the transfer to the firm or its agent, to the value of the securities transferred by the firm; and

    3. (c)

      in the form of one or more of:

      1. (i)

        cash;

      2. (ii)

        a certificate of deposit;

      3. (iii)

        a letter of credit;

      4. (iv)

        a readily realisable security;

      5. (v)

        commercial paper with no embedded derivative content;

      6. (vi)

        a qualifying money market fund.

  2. (2)

    Collateral is sufficiently immediate for the purposes of this section if:

    1. (a)

      it is transferred before or at the time of the transfer of the securities by the firm; or

    2. (b)

      the firm takes reasonable care to determine at the time referred to in (a) that it will be transferred at the latest by the close of business on the day of the transfer.

  3. (3)

    The firm must ensure that the value of the collateral at all times is at least equal to the value of the securities transferred by the firm.

  4. (4)

    The duty in (3) may be regarded as satisfied in respect of collateral the validity of which is about to expire, or has expired, where the firm takes reasonable care to determine that sufficient collateral will be transferred, at the latest, by the close of business on the day of expiry.

Permitted derivatives contracts

COBS 21.3.13RRP

4A permitted derivatives contract is one which:

  1. (1)

    for a Solvency II firm, is effected or issued:

    1. (a)

      on or under the rules of a regulated market; or

    2. (b)

      off-market with an approved counterparty; and

    satisfies COBS 21.3.14 G; and

  2. (2)

    for an insurer which is not a Solvency II firm, satisfies INSPRU 3.2.5 R to INSPRU 3.2.35A G with the exception of INSPRU 3.2.18 R; and

  3. (3)

    in each of (1) and (2) the provisions are applied in relation to assets covering liabilities in respect of linked long-term contracts of insurance.

COBS 21.3.14GRP

4Solvency II firms5 are also required to comply with the PRA Rulebook Solvency II Firms Investment and ensure that the use of derivative contracts is adequately covered. Firms are also referred to the rules in COLL 5.3 (Derivative Exposure) in relation to the use of derivatives in investment funds and the further guidance from CESR and its successor body, ESMA, which represent good practice in this area.

Conditional permitted links

COBS 21.3.15R
COBS 21.3.16R

7The conditions for the property in COBS 21.3.15R to be a conditional permitted link are that an insurer must ensure, on a continuing basis, that:

  1. (1)

    a linked policyholder is not prevented by the nature of any conditional permitted link from exercising any right under the linked long-term contract of insurance within the timeframe specified in that contract and, in any event;

    1. (a)

      (in relation to rights to take benefits due under the contract) within a reasonable timeframe based on the needs of the linked policyholder; and

    2. (b)

      (in relation to other rights under the contract) within a timeframe that may be reasonably necessary to allow the firm to manage the linked fund prudently and in the best interests of all relevant policyholders linked to the fund.

  2. (2)

    the investment risks of any conditional permitted links, both individually and in combination with other investments within a linked fund, are suitable and appropriate for:

    1. (a)

      circumstances where investment risk is borne by a linked policyholder;

    2. (b)

      the expected period to maturity of the linked long-term contract of insurance; and

    3. (c)

      the purpose for which the linked policyholder holds the linked long-term contract of insurance.

COBS 21.3.17G
  1. (1)

    7Rights under a linked long-term contract of insurance which may be relevant for the purposes of COBS 21.3.16R(1) would include a linked policyholder’s right to:

    1. (a)

      change the property to which the benefits of the linked long-term contract of insurance are linked;

    2. (b)

      take benefits due under the linked long-term contract of insurance. Benefits due are those which the contract envisages will be paid at a particular date or on the occurrence of a particular event; or

    3. (c)

      withdraw early or transfer the proceeds of, or benefits under, the linked long-term contract of insurance. Early withdrawal refers to withdrawals prior to the time or event for paying benefits due that is specifically envisaged in the contract.

  2. (2)

    A firm will have to pay benefits due under a linked long-term contract of insurance (for example on death or maturity) as specified in the contract. A firm is not permitted to specify in the contract that it can defer the payment of any such benefits as, in any event, benefit payments have to be made within a reasonable period based on the needs of the policyholder.

  3. (3)

    A linked long-term contract of insurance may provide that the policyholder’s right to exercise rights under (1)(a) or (1)(c) is deferred for as long as may be reasonably necessary to allow the firm to ensure that a linked fund can be managed in a manner that is prudent and in the best interests of all relevant policyholders linked to the fund. The firm will need to ensure that it explains clearly to a policyholder the impact of any such provision on the policyholder’s rights to withdraw early, switch or transfer.

COBS 21.3.18G

7The assessment in COBS 21.3.16R(2), in relation to a linked fund which is included in a default or similar arrangement for a pension scheme, would include ongoing consideration of whether the investment risks of any conditional permitted links remain suitable and appropriate for a particular cohort of linked policyholders, including as that cohort moves toward retirement.

Conditional permitted links: requirements

COBS 21.3.19R

7Where a linked fund is invested in any conditional permitted link, no more than 35% of the gross assets of the linked fund, when aggregated together, can be invested in:

  1. (1)

    permitted scheme interests in (b)(v) of the Glossary definition of that term; and

  2. (2)

    conditional permitted links.

COBS 21.3.20R

7Where a linked fund is invested in any conditional permitted link, the information that a firm must give a linked policyholder under COBS 21.2.4R must also prominently include, clearly and in language capable of being understood by a linked policyholder:

  1. (1)

    an explanation of the risks associated with any conditional permitted links and/or gross assets in permitted scheme interests exceeding 20%, how these might crystallise and how they might impact on a linked policyholder;

  2. (2)

    a description of the tools and arrangements which the insurer would propose using, including those required by FCA rules, to mitigate the risks in (1);

  3. (3)

    an explanation of the circumstances in which these tools and arrangements would typically be deployed and the likely consequences for linked policyholders; and

  4. (4)

    an explanation of the possible impact on the policyholder of any provision in a linked long-term contract of insurance permitted under this section which allows for the deferral of the exercise of any rights under the contract.