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INSPRU 1.4 Equalisation provisions

Application

INSPRU 1.4.1R

INSPRU 1.4 applies to an insurer carrying on general insurance business unless it is:

  1. (1)

    a non-directive friendly society; or

  2. (2)

    an incoming EEA firm; or

  3. (3)

    an incoming Treaty firm.

INSPRU 1.4.2G

The scope of INSPRU 1.4.11 R to INSPRU 1.4.37 G (non-credit equalisation provisions) is not restricted to firms subject to the relevant EC directives.

INSPRU 1.4.3G

The requirements of this section apply to a firm on a solo basis.

Purpose

INSPRU 1.4.4G

This section sets out rules and guidance on the calculation of the amount of the equalisation provisions that are required to be maintained by firms that carry on non-credit insurance business or credit insurance business.

INSPRU 1.4.5G

Credit or non-credit equalisation provisions form part of the technical provisions that a firm is required to establish under INSPRU 1.1.12R (1). They help to smooth fluctuations in loss ratios in future years for business where claims in any future year may be subject to significant deviation from recent or average claims experience, or where trends in experience may be subject to change. Such volatile claims experience might arise in the case, for example, of insurance against losses caused by major catastrophes such as hurricanes or earthquakes.

INSPRU 1.4.6G

In general terms, INSPRU 1.4 sets out rules and guidance as to:

  1. (1)

    the circumstances in which a firm is required to maintain equalisation provisions;

  2. (2)

    the methods to be used in calculating the amount of each provision;

  3. (3)

    the geographical location of the business relevant to certain calculations for different types of firm - this is summarised in the Table in INSPRU 1.4.7 G.

INSPRU 1.4.7G

Table: Scope of insurance business to be included in calculations

Type Of Firm

Credit Equalisation Provision

Non Credit Equalisation Provision

Threshold in INSPRU 1.4.4 G

Provision in INSPRU 1.4.43 R

Threshold in INSPRU 1.4.18R (2) and provision in INSPRU 1.4.17 R

UK insurer

World-wide

World-wide

World-wide

Pure reinsurer with head office outside United Kingdom

UK

World-wide

UK

Pure reinsurer with head office in United Kingdom

World-wide

World-wide

World-wide

Non-EEA direct insurers

EEA-deposit insurer

UK

UK

UK

Swiss general insurer

UK

UK

UK

UK-deposit insurer

All EEA

World-wide

UK

All other non-EEA direct insurers

UK

World-wide

UK

INSPRU 1.4.8G

The First Non-Life Directive (as amended) and the Reinsurance Directive require the calculation of credit equalisation provisions. Non-credit equalisation provisions are a domestic United Kingdom requirement. For insurance regulatory purposes under EC Directives, credit equalisation provisions are classified as liabilities.

INSPRU 1.4.9G

However, firms are permitted to include equalisation provisions within their financial resources when demonstrating compliance with non-Directive capital requirements. Hence equalisation provisions are deducted from the available capital resources of a firm for the purpose of meeting its minimum capital requirement for general insurance business; but, in the calculation of a firm's enhanced capital requirement for general insurance business under INSPRU 1.1.72C R1, its equalisation provisions (if any) are added back to its capital resources.

INSPRU 1.4.10G

Under International Accounting Standards (IAS), which will apply to the financial statements of some insurers from 2005, there will be no requirement to treat equalisation provisions as liabilities in insurers' published financial statements. However, they will continue to be treated as liabilities for the purposes of demonstrating compliance with Directive capital requirements.

Non-credit equalisation provision

INSPRU 1.4.11R

Firms carrying on non-credit insurance business

  1. (1)

    INSPRU 1.4.11 R to INSPRU 1.4.37 G apply to any firm, other than an assessable mutual, which carries on the business of effecting or carrying out general insurance contracts falling within any description in column 2 in Table INSPRU 1.4.12 R ("non-credit insurance business").

  2. (2)

    A firm falling within (1) must classify all of its non-credit insurance business into separate insurance business groupings, as specified in Table INSPRU 1.4.12 R.

INSPRU 1.4.12R

Table : Groupings of non-credit insurance business

Insurance Business Grouping

General Insurance Contracts

A

Contracts of insurance which fall within general insurance business classes 4, 8 or 9, other than:

(a)

contracts of insurance under non-proportional reinsurance treaties; and

(b)

contracts of insurance against nuclear risks

B

Contracts of insurance which fall within general insurance business class 16(a), other than:

(a)

contracts of insurance under non-proportional reinsurance treaties; and

(b)

contracts of insurance against nuclear risks

C

Contracts of insurance which fall within general insurance business classes 5, 6, 11 or 12, other than:

(a)

contracts of insurance against nuclear risks; and

(b)

reinsurance contracts corresponding to contracts in (a).

D

Contracts of insurance against nuclear risks.

E

Contracts of insurance under non-proportional reinsurance treaties and which fall within general insurance business classes 4, 8, 9 or 16(a) other than contracts of insurance against nuclear risks.

INSPRU 1.4.13R

For the purposes of INSPRU 1.4.11 R to INSPRU 1.4.37 G, a firm with its head office in the United Kingdom must take account of non-credit insurance business carried on by it world-wide.

INSPRU 1.4.14R

For the purposes of INSPRU 1.4.11 R to INSPRU 1.4.37 G, a firm with its head office outside the United Kingdom need only take account of non-credit insurance business carried on by it from a branch in the United Kingdom.

INSPRU 1.4.15G

The insurers affected by INSPRU 1.4.11 R include pure reinsurers, UK-deposit insurers, EEA-deposit insurer, and Swiss general insurers.

INSPRU 1.4.16G

For insurers (including pure reinsurers) with a head office in the United Kingdom, the calculations must be made in respect of world-wide business.

Requirement to maintain non-credit equalisation provision

INSPRU 1.4.17R

In respect of each financial year, a firm must, unless INSPRU 1.4.18 R applies:

  1. (1)

    calculate the amount of its non-credit equalisation provision as at the end of that year in accordance with INSPRU 1.4.20 R; and

  2. (2)

    maintain a non-credit equalisation provision calculated in accordance with INSPRU 1.4.20 R for the following financial year.

INSPRU 1.4.18R

  1. (1)

    INSPRU 1.4.17 R does not apply to any firm in respect of any financial year if, as at the end of that year:

    1. (a)

      no non-credit equalisation provision has been brought forward from the preceding financial year; and

    2. (b)

      the amount of the annualised net written premiums for all the non-credit insurance business carried on by it in the financial year is less than the threshold amount.

  2. (2)

    The threshold amount in respect of any financial year is the higher of:

    1. (a)

      1,500,000 Euro; and

    2. (b)

      4% of net written premiums in that financial year in respect of all its general insurance business, if this amount is less than 2,500,000 Euro.

INSPRU 1.4.19G

For non-EEA insurers, the calculation of the threshold amount in INSPRU 1.4.18R (2) is limited by INSPRU 1.4.14 R to the business of the firm carried on in the United Kingdom. Such a firm may do little UK non-credit insurance business, and so would not be required to set up a non-credit equalisation provision under INSPRU 1.4, but may do significant business outside the United Kingdom characterised by high-impact, low-frequency claims. Such a firm is required by INSPRU 1.5.41 R to hold adequate world-wide financial resources to avoid internal-contagion strain on the branch in the United Kingdom. In determining the adequacy of its financial resources, the firm should undertake stress and scenario testing of its underwriting and other risks as set out in GENPRU 1.2.

Calculating the amount of the provision

INSPRU 1.4.20R

  1. (1)

    Unless INSPRU 1.4.22 R applies, the amount of a firm's non-credit equalisation provision as at the end of a financial year is the higher of:

    1. (a)

      zero; and

    2. (b)

      whichever is the lower of:

      1. (i)

        the aggregate of the amounts of the maximum provision for each insurance business grouping as at the end of that financial year; and

      2. (ii)

        the sum of A and B.

  2. (2)

    For the purposes of (1)(b)(ii):

    1. (a)

      A is the amount of the non-credit equalisation provision, if any, brought forward from the financial year immediately preceding that in respect of which the calculation is being performed; and

    2. (b)

      B is:

      1. (i)

        the aggregate of the amounts of the provisional transfers-in for each insurance business grouping; minus

      2. (ii)

        the aggregate of the amounts of the provisional transfers-out for each insurance business grouping.

  3. (3)

    For any insurance business grouping:

    1. (a)

      the amount of the maximum provision in (1)(b)(i) is to be determined in accordance with INSPRU 1.4.24 R;

    2. (b)

      the amount of the provisional transfers-in in (2)(b)(i) is to be determined in accordance with INSPRU 1.4.26 R; and

    3. (c)

      the amount of the provisional transfers-out in (2)(b)(ii) is to be determined in accordance with INSPRU 1.4.29 R.

INSPRU 1.4.21G

If provisional transfers-out are in excess of provisional transfers-in, the non-credit equalisation provision as calculated in accordance with INSPRU 1.4.20 R in respect of a particular financial year may be less than that calculated for the preceding financial year although, by virtue of INSPRU 1.4.20R (1)(a), it cannot be negative.

INSPRU 1.4.22R

  1. (1)

    The amount of a firm's non-credit equalisation provision as at the end of a financial year is zero if:

    1. (a)

      as at the end of that year, the firm meets either of the conditions specified in (2) and (3); and

    2. (b)

      the annualised net written premiums for all the non-credit insurance business carried on by the firm in that year are less than the threshold amount.

  2. (2)

    The first condition is that the firm carried on non-credit insurance business in the first financial year of the relevant period and, for each of any two or more financial years of that period, the annualised net written premiums for business of that description were less than the threshold amount.

  3. (3)

    The second condition is that the firm did not carry on non-credit insurance business in the first financial year of the relevant period and the average of the annualised net written premiums for business of that description carried on by the firm in each financial year of the relevant period was less than the threshold amount.

  4. (4)

    For the purposes of this rule:

    1. (a)

      the threshold amount is the amount determined in accordance with INSPRU 1.4.18R (2): and

    2. (b)

      the relevant period is the period of four financial years ending immediately before the beginning of the financial year in (1).

INSPRU 1.4.23G

If INSPRU 1.4.22 R applies, a firm may need to make sufficient transfers from its non-credit equalisation provision to bring the non-credit equalisation provision for that financial year to zero.

The calculation: the maximum provision

INSPRU 1.4.24R

  1. (1)

    For the purposes of the calculation required by INSPRU 1.4.20 R, the amount of the maximum provision for any insurance business grouping is to be determined in accordance with (2) to (5).

  2. (2)

    Unless (4) applies, the amount of the maximum provision for the grouping, as at the end of a financial year, is the amount determined by multiplying X and Y.

  3. (3)

    For the purposes of (2):

    1. (a)

      X is the percentage specified in Table INSPRU 1.4.25 R in relation to the grouping; and

    2. (b)

      Y is the average of the amount of the annualised net written premiums for non-credit insurance business in the grouping carried on by the firm in each financial year of the relevant period.

  4. (4)

    Where Y is a negative amount, the maximum provision for that insurance business grouping is zero.

  5. (5)

    For the purposes of (3)(b), the relevant period is the five-year period comprising:

    1. (a)

      the financial year in (2); and

    2. (b)

      the previous four financial years.

INSPRU 1.4.25R

Table : Calculation of maximum provision for any insurance business grouping

Insurance Business Grouping

Percentage of average annualised net written premiums

A

20

B

20

C

40

D

600

E

75

The calculation: provisional transfers-in

INSPRU 1.4.26R

  1. (1)

    For the purposes of the calculation required by INSPRU 1.4.20 R, the amount of the provisional transfers-in for any insurance business grouping is to be determined in accordance with (2).

  2. (2)

    The amount of the provisional transfers-in for the grouping, as at the end of a financial year, is the amount determined by multiplying X and Y.

  3. (3)

    For the purposes of (2):

    1. (a)

      X is the percentage specified in Table INSPRU 1.4.27 R in relation to the grouping; and

    2. (b)

      Y is the amount of the net written premiums for non-credit insurance business in the grouping that was carried on by the firm in the financial year in (2), including adjustments in respect of previous financial years.

INSPRU 1.4.27R

Table : Provisional transfers-in for any insurance business grouping

Insurance Business Grouping

Percentage of net written premiums

A

3

B

3

C

6

D

75

E

11

INSPRU 1.4.28G

Since each insurance business grouping should be assessed individually, negative net written premiums in relation to any insurance business grouping should be transferred in to the non-credit equalisation provision.

The calculation: provisional transfers-out

INSPRU 1.4.29R

  1. (1)

    For the purposes of the calculation required by INSPRU 1.4.20 R, the amount of the provisional transfers-out for any insurance business grouping is to be determined in accordance with (2).

  2. (2)

    The amount of the provisional transfers-out for the grouping, as at the end of a financial year, is the lower of:

    1. (a)

      the amount of the maximum provision for the grouping under INSPRU 1.4.24 R for that financial year; and

    2. (b)

      the abnormal loss for the grouping under INSPRU 1.4.30 R for that financial year.

INSPRU 1.4.30R

R For each insurance business grouping, the abnormal loss as at the end of a financial year in relation to which an equalisation provision is calculated is:

  1. (1)

    (for business within the insurance business grouping accounted for on an accident year basis) the amount, if any, by which the amount of net claims incurred exceeds the greater of:

    1. (a)

      zero; and

    2. (b)

      the percentage of net earned premiums in that financial year specified in the Table in INSPRU 1.4.31 R; or

  2. (2)

    (for business within the insurance business grouping accounted for on an underwriting year basis) the amount, if any, by which the amount of net claims paid (plus adjustment for change in net technical provisions, other than any change in provisions for claims handling expenses or equalisation) exceeds the greater of:

    1. (a)

      zero; and

    2. (b)

      the percentage of net written premiums in that financial year specified in the Table in INSPRU 1.4.31 R.

INSPRU 1.4.31R

Table : Abnormal loss for any insurance business grouping

Insurance Business Grouping

Percentage of net written premiums

A

72.5

B

72.5

C

95

D

25

E

100

Adjustments to calculations

INSPRU 1.4.32R

Transfers of business from the firm

  1. (1)

    This rule applies to modify the application of INSPRU 1.4.24 R and INSPRU 1.4.26 R in any case where a firm has transferred to another undertaking any rights and obligations under general insurance contracts falling within any insurance business grouping.

  2. (2)

    As at the end of the financial year in which the transfer takes place, net written premiums in respect of the transferred contracts in any grouping must be deducted from total net written premiums for that grouping before calculating the maximum provision under INSPRU 1.4.24 R or provisional transfers-in under INSPRU 1.4.26 R.

INSPRU 1.4.33R

If all the rights and obligations of a firm in relation to non-credit insurance business in any insurance business grouping have been transferred, the maximum provision for the grouping under INSPRU 1.4.24 R is zero.

Transfers of business to the firm

INSPRU 1.4.34R

  1. (1)

    This rule applies to modify the application of INSPRU 1.4.24 R, INSPRU 1.4.26 R and INSPRU 1.4.29 R in any case where another undertaking has transferred to a firm any rights and obligations under general insurance contracts falling within any insurance business grouping.

  2. (2)

    As at the end of the financial year in which the transfer takes place a sum equal to that part of the consideration for the transfer that relates to business in an insurance business grouping must be:

    1. (a)

      excluded from net written premiums 2before performing the calculations required by INSPRU 1.4.24 R (maximum provision) and INSPRU 1.4.26 R (provisional transfers in);

      2
    2. (b)

      included in net premiums (written or earned) before performing the calculation required by INSPRU 1.4.30 R (abnormal loss); and

    3. (c)

      excluded from net claims (paid or incurred) before performing the calculation required by INSPRU 1.4.30 R (abnormal loss).

INSPRU 1.4.35G

For the purposes of INSPRU 1.4.34 R, the consideration payable should be apportioned between insurance business groupings according to the groupings within which the general insurance contracts which are the subject of the acquisition fall. In appropriate cases, apportionment may reflect the split of liabilities acquired, including unearned premium.

INSPRU 1.4.36G

Where business is accounted for on an accounting year basis, in any year following the transfer, net earned premiums must include an appropriate amount in respect of the transfer.

INSPRU 1.4.37G

INSPRU 1.4.32 R to INSPRU 1.4.34 R apply to transfers by way of transfer under Part VII of the Act and by novation.

Credit equalisation provisions

INSPRU 1.4.38R

Firms carrying on credit insurance business

INSPRU 1.4.39 R to INSPRU 1.4.47 G apply to any firm which carries on the business of effecting or carrying out general insurance contracts falling within general insurance business class 14 (which business is referred to in INSPRU 1.4 as "credit insurance business"), unless it is:

  1. (1)

    a non-directive insurer; or

  2. (2)

    a pure reinsurer which became a firm in run-off before 31 December 2006 and whose Part IV permission has not subsequently been varied to add back the regulated activity of effecting contracts of insurance.

INSPRU 1.4.39R

For the purposes of INSPRU 1.4.43 R and INSPRU 1.4.44 R, a firm whose head office is in the United Kingdom must take account of the credit insurance business carried on by it world-wide.

INSPRU 1.4.40R

  1. (1)

    For the purposes of INSPRU 1.4.43 R:

    1. (a)

      a Swiss general insurer or an EEA-deposit insurer must take account of the credit insurance business carried on by it in the United Kingdom; and

    2. (b)

      any other firm whose head office is outside the United Kingdom (including a UK-deposit insurer) must take account of the credit insurance business carried on by it world-wide.

  2. (2)

    For the purposes of INSPRU 1.4.44 R:

    1. (a)

      a UK-deposit insurer need only take account of the credit insurance business carried on by it in all EEA States, taken together; and

    2. (b)

      any other firm whose head office is outside the United Kingdom (including an EEA-deposit insurer and a Swiss general insurer) need only take account of the credit insurance business carried on by it in the United Kingdom.

INSPRU 1.4.41G

For firms whose head office is in the United Kingdom both calculations must be made in respect of world-wide business.

INSPRU 1.4.42G

The requirements of INSPRU 1.4.39 R and INSPRU 1.4.40 R are summarised in the table in INSPRU 1.4.7 G.

Requirement to maintain credit equalisation provision

INSPRU 1.4.43R

In respect of each financial year, a firm must, unless INSPRU 1.4.44 R applies:

  1. (1)

    calculate the amount of its credit equalisation provision as at the end of that year in accordance with INSPRU 1.4.45 R; and

  2. (2)

    maintain a credit equalisation provision calculated in accordance with INSPRU 1.4.45 R for the following financial year.

INSPRU 1.4.44R

INSPRU 1.4.43 R does not apply to a firm in respect of any financial year if, as at the end of that year, the annualised net written premiums for its credit insurance business are less than 4% of annualised net written premiums in that financial year in respect of all its general insurance business, if this amount is less than 2,500,000 Euro.

Calculating the amount of the provision

INSPRU 1.4.45R

  1. (1)

    The amount of a firm's credit equalisation provision as at the end of a financial year ("financial year A") is the higher of:

    1. (a)

      zero; and

    2. (b)

      whichever is the lower of:

      1. (i)

        150% of the highest amount of net written premiums for credit insurance business carried on by the firm in financial year A or in any of the previous four financial years; and

      2. (ii)

        the amount of the credit equalisation provision brought forward from the preceding financial year, after making either of the adjustments in (2).

  2. (2)

    The adjustments are:

    1. (a)

      the deduction of the amount of any technical deficit arising in financial year A; or

    2. (b)

      the addition of the lower of:

      1. (i)

        75% of the amount of any technical surplus arising in financial year A; and

      2. (ii)

        12% of the amount of the net written premiums for credit insurance business carried on by the firm in financial year A.

  3. (3)

    For the purposes of (2) the amount of technical deficit or technical surplus is to be determined in accordance with INSPRU 1.4.46 R.

INSPRU 1.4.46R

For the purposes of the adjustments in INSPRU 1.4.45R (2), technical surplus (or technical deficit) in respect of credit insurance business is the amount by which the aggregate of net earned premiums and other technical income exceeds (or falls short of) the sum of net claims incurred, claims management costs and any technical charges.

INSPRU 1.4.47G

The calculation of technical surplus or technical deficit should be made before tax and before any transfer to or from the credit equalisation provision. Investment income should not be included in these calculations.

Euro conversion

INSPRU 1.4.48R

For the purposes of INSPRU 1.4, the exchange rate from the Euro to the pound sterling for each year beginning on 31 December is the rate applicable on the last day of the preceding October for which the exchange rates for the currencies of all the European Union member states were published in the Official Journal of the European Union.

Application of INSPRU 1.4 to Lloyd's

INSPRU 1.4.49R

INSPRU 1.4 applies to the Society in accordance with INSPRU 8.1.2 R:

  1. (1)

    with the modification set out in INSPRU 1.4.50 R; and

  2. (2)

    except INSPRU 1.4.11 R to INSPRU 1.4.37 G.

INSPRU 1.4.50R

The Society must calculate a credit equalisation provision for the aggregate insurance business of all members; it is not required to calculate a credit equalisation provision separately for the business of each member.

INSPRU 1.4.51R

The Society must allocate the result of INSPRU 1.4.50 R between itself and each of the members on a fair and reasonable basis.