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INSPRU 1.5 Internal-contagion risk

Application

INSPRU 1.5.1RRP

INSPRU 1.5 applies to an insurer.

INSPRU 1.5.2R

INSPRU 1.5 does not apply, to the extent stated, to any insurer in (1) to (4):

  1. (1)

    none of the provisions apply to non-directive friendly societies;

  2. (2)

    none of the provisions, apart from INSPRU 1.5.33 R (payment of financial penalties) apply to firms which qualify for authorisation under Schedule 3 or 4 of the Act;

  3. (3)

    INSPRU 1.5.33 R (payment of financial penalties) does not apply to mutuals;

  4. (4)

    INSPRU 1.5.41 R to INSPRU 1.5.57 R (UK branches of certain non-EEA insurers) do not apply to:

    1. (a)

      UK insurers; or

    2. (b)

      non-EEA insurers whose insurance business in the United Kingdom is restricted to reinsurance; or

    3. (c)

      EEA-deposit insurers; or

    4. (d)

      Swiss general insurers.

INSPRU 1.5.3G

The scope of application of INSPRU 1.5 is not restricted to firms that are subject to the relevant EC directives.

INSPRU 1.5.4RRP

In its application to a firm with its head office in the United Kingdom, this section applies to the whole of the firm's business carried on world-wide.

INSPRU 1.5.5R

In the application of this section to activities carried on by a non-EEA insurer:

  1. (1)

    INSPRU 1.5.13 R to INSPRU 1.5.15 G and INSPRU 1.5.41 R apply in relation to the whole of its business carried on world-wide;

  2. (2)

    all other provisions of this section apply only in relation to:

    1. (a)

      in the case of any UK-deposit insurer, activities carried on from branches in any EEA State; and

    2. (b)

      in any other case, activities carried on from a branch in the United Kingdom.

INSPRU 1.5.6G

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.

INSPRU 1.5.7G

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

Purpose

INSPRU 1.5.8GRP

This section sets out requirements for a firm relating to 'internal-contagion risk'. This is the risk that losses or liabilities from one activity might deplete or divert financial resources held to meet liabilities from another activity. It arises where the two activities are carried on within the same firm. It may also arise from the combination of activities within the same group, but this aspect of internal-contagion risk falls outside the scope of this section. Requirements relevant to group contagion risk are set out in INSPRU 6.

INSPRU 1.5.9GRP

Internal-contagion risk includes in particular the risk that arises where a firm carries on:

  1. (1)

    both insurance and non-insurance activities; or

  2. (2)

    two or more different types of insurance activity; or

  3. (3)

    insurance activities from offices or branches located in both the United Kingdom and overseas.

INSPRU 1.5.10GRP

This section requires firms other than pure reinsurers to limit non-insurance activities to those that directly arise from their insurance business, e.g. investing assets, employing insurance staff etc. It also requires that an adequate provision be established for non-insurance liabilities. pure reinsurers must limit their activities to the business of reinsurance and related operations.

INSPRU 1.5.11GRP

This section also sets out requirements for the separation of different types of insurance activity. However, in most circumstances the combination of different types of insurance activity within the same firm is a source of strength. Adequate pooling and diversification of insurance risk is fundamental to sound business practice. The requirements, therefore, only apply in two specific cases where without adequate protection the combination might operate to the detriment of policyholders. They apply where a firm carries on both:

  1. (1)

    general insurance business and long-term insurance business;

  2. (2)

    linked and non-linked insurance business.

INSPRU 1.5.12GRP

Finally, the section sets out requirements to protect policyholders of branches of non-EEA firms where these are supervised by the FSA. These apply only to a non-EEA firm that has established a branch in the United Kingdom.

Requirements: Non-insurance activities

Restriction of business

INSPRU 1.5.13RRP

  1. (1)

    A firm other than a pure reinsurer must not carry on any commercial business other than insurance business and activities directly arising from that business.

  2. (2)

    (1) does not prevent a friendly society which was on 15 March 1979 carrying on long-term insurance business from continuing to carry on savings business.

INSPRU 1.5.13ARRP

A pure reinsurer must not carry on any business other than the business of reinsurance and related operations.

INSPRU 1.5.13BGRP

In INSPRU 1.5.13A R related operations include, for example, activities such as provision of statistical or actuarial advice, risk analysis or research for its clients. It may also include a holding company function and activities with respect to financial sector activities within the meaning of Article 2, point 8, of the Financial Groups Directive. But it does not allow the carrying on of, for example, unrelated banking and financial activities.

Financial limitation of non-insurance activities

INSPRU 1.5.14R

A firm must limit, manage and control its non-insurance activities so that there is no significant risk arising from those activities that it may be unable to meet its liabilities as they fall due.

INSPRU 1.5.15G

For the purpose of INSPRU 1.5.14 R a firm should consider how the financial impact of non-insurance activities might diverge from expectations. However, it need only take into account unexpected variations in amount and timing in so far as they are reasonably possible and may take into account effective mitigating factors.

Requirements: long-term insurance business

INSPRU 1.5.16GRP

INSPRU 1.5.18 R, INSPRU 1.5.21 R, INSPRU 1.5.30 R and INSPRU 1.5.31 R require a firm to identify the assets attributable to the receipts of the long-term insurance business, called long-term insurance assets, and only to apply those assets for the purpose of that business. This has the effect of prohibiting a composite firm from using long-term insurance assets to meet general insurance liabilities. It also keeps long-term insurance assets separate from shareholder funds.

Permissions not to include both types of insurance

INSPRU 1.5.17GRP
3
  1. (1)

    Under section 19 of the Act, a firm may not carry on a regulated activity unless it has permission to do so (or is exempt in relation to the particular activity). Both general insurance business and long-term insurance business are regulated activities and permission will extend to the effecting or carrying out of one or more particular classes of contracts of insurance.3

  2. (2)

    A firm's permission can be varied so as to add other classes. The permission of an existing composite firm may be varied by adding classes of both general insurance business and long-term insurance business. 3

  3. (3)

    It is FSA policy, in compliance with EC directives on insurance, not to grant or vary permission if that would allow a newly established firm, or an existing firm engaging solely in general insurance business or solely in long-term insurance business, to engage in both general insurance business and long-term insurance business. This does not apply where a firm's permission to carry on long-term insurance business is or is to be restricted to reinsurance. It also does not apply where a firm's permission to carry on general insurance business is or is to be restricted to effecting or carrying out accident or sickness contracts of insurance (see article 18(2) of the Consolidated Life Directive). 3

  4. (4)

    Where a firm's permission extends to effecting or carrying out life and annuity contracts of insurance this will normally include permission to effect or carry out accident contracts of insurance or sickness contracts of insurance on a supplementary basis (see article 2(1)(c) of the Consolidated Life Directive).3

Separately identify and maintain long term insurance assets

INSPRU 1.5.18RRP

A firm carrying on long-term insurance business must identify the assets relating to its long-term insurance business which it is required to hold by virtue of :3

3
  1. (1)

    in the case of a pure reinsurer:

    1. (a)

      INSPRU 1.1.20 R or INSPRU 1.1.21 R; and

    2. (b)

      INSPRU 3.1.61A R; and

      3
  2. (2)

    in any other case:3

    1. (a)

      INSPRU 1.1.20 R or INSPRU 1.1.21 R; and3

    2. (b)

      INSPRU 3.1.57 R and INSPRU 3.1.58 R.3

INSPRU 1.5.19GRP
3
  1. (1)

    INSPRU 1.1.16 R requires a firm to establish adequate technical provisions for its long-term insurance contracts. INSPRU 1.1.20 R requires a firm which is not a composite firm to hold admissible assets of a value at least equal to the amount of the technical provisions and its other long-term insurance liabilities. INSPRU 1.1.21 R ensures that a composite firm identifies separate admissible assets with a value at least equal to the technical provisions for long-term insurance business and its other long-term insurance liabilities as well as holding other admissible assets of a value at least equal to the amount of its technical provisions for general insurance business and its other general insurance liabilities.3

  2. (2)

    In the case of a firm carrying on long-term insurance business which is not a pure reinsurer, there are excluded from the scope of INSPRU 1.1.20 R and INSPRU 1.1.21 R property-linked liabilities and index-linked liabilities and the assets held to cover them under INSPRU 3.1.57 R and INSPRU 3.1.58 R. The latter two rules do not apply to a pure reinsurer (see INSPRU 3.1.58A R). However, a pure reinsurer is required by INSPRU 3.1.61A R to invest all its assets in accordance with the requirements of that rule.3

  3. (3)

    The overall impact of these provisions in INSPRU 1.1 and INSPRU 3.1, when read together with INSPRU 1.5.18 R, is that any firm writing long-term insurance business must identify separately assets of a value at least equal to the amount of its long-term insurance business technical provisions, including those in respect of any property-linked liabilities or index-linked liabilities, and its other long-term insurance liabilities.3

INSPRU 1.5.20GRP

INSPRU 1.5.18 R does not prohibit a firm from identifying other assets as being available to meet the liabilities of its long-term insurance business. It may transfer such other assets to a long-term insurance fund (see INSPRU 1.5.21 R and INSPRU 1.5.22 R ) and the transfer will take effect when it is recorded in the firm's accounting records (see INSPRU 1.5.23 R). After the transfer takes effect, a firm may not transfer the assets out of a long-term insurance fund except where they represent an established surplus (see INSPRU 1.5.27 R).

INSPRU 1.5.21RRP

  1. (1)

    A firm's long-term insurance assets are the items in (2), adjusted to take account of:

    1. (a)

      outgo in respect of the firm's long-term insurance business; and

    2. (b)

      any transfers made in accordance with INSPRU 1.5.27 R.

  2. (2)

    The items are:

    1. (a)

      the assets identified under INSPRU 1.5.18 R (including assets into which those assets have been converted) but excluding any assets identified as being held to cover liabilities in respect of subordinated debt3;

    2. (b)

      any other assets identified by the firm as being available to cover its long-term insurance liabilities (including assets into which those assets have been converted) including, if the firm so elects, assets which are excluded under (a)3;

    3. (c)

      premiums and other receivables in respect of long-term insurance contracts;

    4. (d)

      other receipts of the long-term insurance business; and

    5. (e)

      all income and capital receipts in respect of the items in (2).

INSPRU 1.5.22RRP

  1. (1)

    Unless (2) applies, all the long-term insurance assets of the firm constitute its long-term insurance fund.

  2. (2)

    Where a firm identifies particular long-term insurance assets in connection with different parts of its long-term insurance business, the assets identified in relation to each such part constitute separate long-term insurance funds of the firm.

INSPRU 1.5.23RRP

A firm must maintain a separate accounting record in respect of each of its long-term insurance funds (including any with-profits fund).

INSPRU 1.5.24GRP

Firms must ensure that long-term insurance assets are separately identified and allocated to a long-term insurance fund at all times. Assets in external accounts, for example at banks, custodians, or brokers should be segregated in the firm's books and records into separate accounts for long-term insurance business and general insurance business. Where a firm has more than one long-term insurance fund, a separate accounting record must be maintained for each fund. Accounting records should clearly document the allocation.

INSPRU 1.5.25GRP

Where the surplus arising from business is shared between policyholders and shareholders in different ways for different blocks of business, it may be necessary to maintain a separate fund to ensure that policyholders are, and will be, treated fairly. For example, if a proprietary company writes some business on a with-profits basis, this should be written in a with-profits fund separate from any business where the surplus arising from that business is wholly owned by shareholders.

INSPRU 1.5.26GRP

Where a firm merges separate funds for different types of business, it will need to ensure that the merger will not result in policyholders being treated unfairly. When considering merging the funds, the firm should consider the impact on its PPFM (see COBS 20.32) and on its obligations to notify the FSA (see SUP 15.3). In particular, a firm would need to consider how any inherited estate would be managed and how the fund would be run in future, such that policyholders are treated fairly.

2
INSPRU 1.5.27RRP

A firm may not transfer assets out of a long-term insurance fund unless:

  1. (1)

    the assets represent an established surplus; and

  2. (2)

    no more than three months have passed since the determination of that surplus.

INSPRU 1.5.28GRP

As a result of INSPRU 1.5.27R (2), an actuarial investigation undertaken to determine an established surplus remains in-date for three months from the date as at which the determination of the surplus was made. However, even where the investigation is still in-date, the firm should not make the transfer unless there is sufficient surplus at the time of the transfer to allow it to be made without breach of INSPRU 1.1.20 R or INSPRU 1.1.21 R.

INSPRU 1.5.29GRP

INSPRU 1.1.27 R and INSPRU 1.1.28 R provide further constraints on the transfer of assets out of a with-profits fund. INSPRU 1.1.27 R requires a firm to have admissible assets in each of its with-profits funds to cover the technical provisions and other long-term insurance liabilities relating to all the business in that fund. INSPRU 1.1.28 R requires a realistic basis life firm to ensure that the realistic value of assets for each of its with-profits funds is at least equal to the realistic value of liabilities of that fund.

Exclusive use of long-term insurance assets

INSPRU 1.5.30RRP

  1. (1)

    A firm must apply a long-term insurance asset only for the purposes of its long-term insurance business.

  2. (2)

    For the purpose of (1), applying an asset includes coming under any obligation (even if only contingently) to apply that asset.

INSPRU 1.5.31RRP

A firm must not agree to, or allow, any mortgage or charge on its long-term insurance assets other than in respect of a long-term insurance liability.

INSPRU 1.5.32GRP

The purposes of the long-term insurance business include the payment of claims, expenses and liabilities arising from that business, the acquisition of lawful access to fixed assets to be used in that business and the investment of assets. The payment of liabilities may include repaying a loan but only where that loan was incurred for the purpose of the long-term insurance business. The purchase or investment of assets may include an exchange at fair market value of assets (including money) between the long-term insurance fund and other assets of the firm. A firm may also lend securities held in a long-term insurance fund under a stock lending transaction or transfer assets as collateral for a stock lending transaction where the firm is the borrower, where such lending or transfer is for the benefit of the long-term insurance business.

Payment of financial penalties

INSPRU 1.5.33RRP

If the FSA imposes a financial penalty on a long-term insurer, the firm must not pay that financial penalty from a long-term insurance fund.

INSPRU 1.5.34G

INSPRU 1.5.2 R states that this provision applies to all firms, except mutuals, and includes firms qualifying for authorisation under Schedule 3 or 4 to the Act.

Requirements: property-linked funds

INSPRU 1.5.35GRP

INSPRU 3.1.57 R requires a firm to cover, as closely as possible, its property-linked liabilities by the property to which those liabilities are linked. In order to comply with this rule, a firm should identify the assets it holds to cover property-linked liabilities and should not apply those assets (as long as they are needed to cover the property-linked liabilities) for any purpose other than to meet those liabilities.

INSPRU 1.5.36RRP

A firm must select, allocate and manage the assets to which its property-linked liabilities are linked taking into account:

  1. (1)

    the firm's contractual obligations to holders of property-linked policies; and

  2. (2)

    its regulatory duty to treat customers fairly, including in the way it makes discretionary decisions as to how it selects, allocates and manages assets.

INSPRU 1.5.37GRP

Property-linked liabilities may be linked either to specified assets (with no contractual discretion given to the firm as to the choice of assets) or to assets of a specified kind where the selection of the actual assets is left to the firm.

Requirements: UK branches of certain non-EEA firms

INSPRU 1.5.38G

The purpose of the rules and guidance set out in INSPRU 1.5.38 G to INSPRU 1.5.57 R is to protect against the risk that the financial resources required in respect of the activities of the United Kingdom (or EEA) branch(es) might be depleted by the other activities of the non-EEA direct insurer.

INSPRU 1.5.39G

By virtue of INSPRU 1.5.2R (4), the rules in INSPRU 1.5.41 R to INSPRU 1.5.57 R apply to non-EEA direct insurers except for Swiss general insurers and EEA-deposit insurers. Responsibility for determining the adequacy of the world-wide financial resources of Swiss general insurers or EEA-deposit insurers rests exclusively with the Swiss authorities or the authorities in the EEA State (other than the United Kingdom) in which the deposit was made.

INSPRU 1.5.40G

  1. (1)

    INSPRU 1.5.41 R requires a non-EEA direct insurer to hold adequate world-wide resources to meet the needs of the world-wide business without the need to rely on UK or EEA branch assets other than to meet branch liabilities.

  2. (2)

    INSPRU 1.5.42 R to INSPRU 1.5.47 R require non-EEA direct insurers to calculate a local MCR and to hold assets representing that requirement in the EEA or the United Kingdom.

  3. (3)

    INSPRU 1.5.48 R to INSPRU 1.5.52 R require non-EEA direct insurers to hold a minimum level of assets in the United Kingdom or EEA.

  4. (4)

    INSPRU 1.5.54 R requires the deposit of a minimum level of assets in the United Kingdom.

  5. (5)

    INSPRU 1.5.56 R and INSPRU 1.5.57 R require non-EEA direct insurers to keep adequate accounting records in the United Kingdom.

Worldwide financial resources

INSPRU 1.5.41R

  1. (1)

    A non-EEA direct insurer must maintain adequate worldwide financial resources, to ensure that there is no significant risk that its liabilities cannot be met as they fall due.

  2. (2)

    For the purpose of (1):

    1. (a)

      a UK-deposit insurer must not rely upon the assets held under INSPRU 1.1.20 R as available to meet liabilities other than those arising from the activities of its branches in EEA States;

    2. (b)

      other non-EEA direct insurers to whom (1) applies must not rely upon the assets held under INSPRU 1.1.20 R as available to meet liabilities other than those arising from the activities of any UK branch.

UK or EEA MCR to be covered by admissible assets

INSPRU 1.5.42R

A non-EEA direct insurer must:

  1. (1)

    calculate a UK or EEA MCR in accordance with INSPRU 1.5.44 R to INSPRU 1.5.47 R; and

  2. (2)

    hold admissible assets (in addition to those required under INSPRU 1.1.20 R) to represent its UK or EEA MCR calculated under (1).

INSPRU 1.5.43R

The assets held under INSPRU 1.5.42R (2) must be identified and valued as if the non-EEA direct insurer was a firm with its head office in the United Kingdom.

INSPRU 1.5.44R

For the purposes of INSPRU 1.5.42 R, a non-EEA direct insurer (except a UK-deposit insurer) must calculate a UK MCR:

  1. (1)

    for long-term insurance business, in accordance with GENPRU 2.1.36 R1 but only in relation to business carried on by the firm in the United Kingdom;

  2. (2)

    for general insurance business, in accordance with GENPRU 2.1.34 R1 but only in relation to business carried on by the firm in the United Kingdom.

INSPRU 1.5.45R

For a composite firm, the UK MCR is the sum of the amounts arrived at under INSPRU 1.5.44R (1) and INSPRU 1.5.44R (2).

INSPRU 1.5.46R

For the purposes of INSPRU 1.5.42 R, a UK-deposit insurer must calculate an EEA MCR:

  1. (1)

    for long-term insurance business, in accordance with GENPRU 2.1.36 R1 but only in relation to business carried on by the firm in all EEA States, taken together;

  2. (2)

    for general insurance business, in accordance with GENPRU 2.1.34 R1 but only in relation to business carried on by the firm in all EEA States, taken together.

INSPRU 1.5.47R

For a composite firm, the EEA MCR is the sum of the amounts arrived at under INSPRU 1.5.46R (1) and INSPRU 1.5.46R (2).

Localisation of assets

INSPRU 1.5.48R

A non-EEA direct insurer (except a UK-deposit insurer) must hold:

  1. (1)

    admissible assets which are required to cover its technical provisions in accordance with INSPRU 1.1.20R (1) or INSPRU 1.1.21R (1)(a) and (2)(a); and

  2. (2)

    other admissible assets not required to cover property-linked liabilities or index-linked liabilities in accordance with INSPRU 3.1.57 R or INSPRU 3.1.58 R which represent its UK MCR as calculated in accordance with INSPRU 1.5.44 R;

as follows:

  1. (a)

    (where the assets cover the technical provisions and the guarantee fund) in the United Kingdom;

  2. (b)

    (where the assets represent the amount of the UK MCR in excess of the guarantee fund) in any EEA State.

INSPRU 1.5.49R

A UK-deposit insurer must hold:

  1. (1)

    admissible assets which are required to cover its technical provisions in accordance with INSPRU 1.1.20R (1) or INSPRU 1.1.21R (1)(a) and INSPRU 1.1.21R (2)(a); and

  2. (2)

    other admissible assets not required to cover property-linked liabilities or index-linked liabilities in accordance with INSPRU 3.1.57 R or INSPRU 3.1.58 R which represent its EEA MCR as calculated in accordance with INSPRU 1.5.46 R;

as follows:

  1. (a)

    (where the assets cover the technical provisions and the guarantee fund) within the EEA states where the firm carries on insurance business;

  2. (b)

    (where the assets represent the amount of the EEA MCR in excess of the guarantee fund) in any EEA State.

INSPRU 1.5.50R

INSPRU 1.5.48 R and INSPRU 1.5.49 R do not apply to assets covering technical provisions which are debts owed by reinsurers.

INSPRU 1.5.51G

The admissible assets in excess of the technical provisions and UK or EEA MCR may be held outside the EEA.

INSPRU 1.5.52R

For the purpose of INSPRU 1.5.48 R and INSPRU 1.5.49 R:

  1. (1)

    a tangible asset is to be treated as held in the country or territory where it is situated;

  2. (2)

    an admissible asset consisting of a claim3 against a debtor is to be regarded as held in any country or territory where it can be enforced by legal action;

    3
  3. (3)

    a security which is listed4 is to be treated as held in any country or territory where there is a regulated market in which the security is dealt; and

    4
  4. (4)

    a security which is not listed4 is to be treated as held in the country or territory in which the issuer has its head office.

    4
INSPRU 1.5.53G

INSPRU 3.1.53 R to INSPRU 3.1.55R (currency matching of assets and liabilities) apply to the assets held to match insurance liabilities calculated under INSPRU 1.1.12 R or INSPRU 1.1.16 R.

Deposit of assets as security

INSPRU 1.5.54R

A non-EEA direct insurer must keep assets of a value at least equal to one quarter of the base capital resources requirement on deposit in the United Kingdom with a BCD credit institution.

INSPRU 1.5.55G

The assets deposited as security may count towards the assets required under INSPRU 1.5.48 R and INSPRU 1.5.49 R. If, after the deposit is made, the value of the deposited assets falls below one quarter of the base capital resources requirement, the firm should deposit further admissible assets in order to comply with INSPRU 1.5.48 R and INSPRU 1.5.49 R. Deposited assets may be exchanged for other admissible assets and excess assets may be withdrawn, provided that the exchange or deposit does not cause a breach of INSPRU 1.5.48 R or INSPRU 1.5.49 R.

Branch accounting records in the United Kingdom

INSPRU 1.5.56R

A non-EEA direct insurer must maintain at a place of business in the United Kingdom adequate records relating to:

  1. (1)

    the activities carried on from its United Kingdom branch; and

  2. (2)

    if it is an EEA-deposit insurer, the activities carried on from the branches in other EEA States.

INSPRU 1.5.57R

The records maintained as required by INSPRU 1.5.56 R must include a record of:

  1. (1)

    the income, expenditure and liabilities arising from activities of the branch or branches; and

  2. (2)

    the assets identified under INSPRU 1.1.20 R as available to meet those liabilities.

Application of INSPRU 1.5 to Lloyd's

INSPRU 1.5.58R

INSPRU 1.5 applies to managing agents and to the Society in accordance with:

  1. (1)

    for managing agents, INSPRU 8.1.4 R; and

  2. (2)

    for the Society, INSPRU 8.1.2 R.

INSPRU 1.5.59R

The Society and managing agents must take all reasonable steps to ensure that:

  1. (1)

    a corporate member does not carry on any commercial business other than insurance business and activities arising directly from that business; and

  2. (2)

    individual members do not, in their capacity as underwriting members, carry on any commercial business other than insurance business and activities arising directly from that business.

INSPRU 1.5.60R

A managing agent must not permit both general insurance business and long-term insurance business to be carried on together through any syndicate managed by it.