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PRU 1.3 1 Valuation

Application

PRU 1.3.1 R

PRU 1.3 applies to an insurer, unless it is:

  1. (1)

    a non-directive friendly society; or

  2. (2)

    an incoming EEA firm; or

  3. (3)

    an incoming Treaty firm.

PRU 1.3.2 G

The scope of application of PRU 1.3 is not restricted to firms that are subject to relevant EC directives. It applies, for example, to pure reinsurers.

PRU 1.3.3 R
  1. (1)

    PRU 1.3 applies to a firm in relation to the whole of its business.

  2. (2)

    Where a firm carries on both long-term insurance business and general insurance business, PRU 1.3 applies separately to each type of business.

Purpose

PRU 1.3.4 G

PRU 1.3 sets out, for the purposes of PRU, rules and guidance as to how a firm should recognise and value assets, liabilities, equity and income statement items. Except where a rule in PRU makes different provision, PRU 1.3 applies whenever a rule in PRU refers to the value or amount of an asset, liability, equity or income statement item.

General requirements: accounting principles to be applied

PRU 1.3.5 R

Subject to PRU 1.3.5A R and PRU 1.3.5B R, except2 where a rule in PRU provides for a different method of recognition or valuation, whenever a rule in PRU refers to an asset, liability, equity or income statement item, a firm must, for the purpose of that rule, recognise the asset, liability, equity or income statement item and measure its value in accordance with:

2
  1. (1)

    the insurance accounts rules, or the Friendly Societies (Accounts and Related Provisions) Regulations 1994;

  2. (2)

    Financial Reporting Standards and Statements of Standard Accounting Practice issued or adopted by the Accounting Standards Board; and

  3. (3)

    Statements of Recommended Practice, issued by industry or sectoral bodies recognised for this purpose by the Accounting Standards Board; or2

  4. (4)

    international accounting standards;2

as applicable to the firm for the purpose of its external financial reporting2 (or as would be applicable if the firm were a company with its head office in the United Kingdom).

PRU 1.3.5A R

2For the purposes of PRU, except where a rule in PRU provides for a different method of recognition or valuation, when a firm, upon initial recognition, designates its liabilities as at fair value through profit or loss, it must adjust any value calculated in accordance with PRU 1.3.5 R by subtracting any unrealised gains or adding back in any unrealised losses which are not attributable to changes in a benchmark interest rate.

PRU 1.3.5B R

2For the purposes of PRU, except where a rule in PRU provides for a different method of recognition or valuation, in respect of a defined benefit occupational pension scheme:

  1. (1)

    a firm must derecognise any defined benefit asset;

  2. (2)

    a firm may substitute for a defined benefit liability the firm's deficit reduction amount.

PRU 1.3.5C R

2An election made under PRU 1.3.5B R (2) must be applied consistently for the purposes of PRU in respect of any one financial year.

PRU 1.3.5D R

2A firm should keep a record of and be ready to explain to its supervisory contacts in the FSA the reasons for any difference between the deficit reduction amount and any commitment the firm has made in any public document to provide funding in respect of a defined benefit occupational pension scheme.

PRU 1.3.6 G

PRU 1.3.5 R provides that unless a rule in PRU provides for a different method of recognition or valuation, the applicable provisions of the Companies Act 1985, the Companies Act (Northern Ireland) Order 1986 or the Friendly Societies (Accounts and Related Provisions) Regulations 1994, as supplemented by Financial Reporting Standards, Statements of Standard Accounting Practice, and Statements of Recommended Accounting Practice, or, where applicable, international accounting standards, 2should be used to determine the recognition and valuation of assets, liabilities, equity and income statement items for the purposes of PRU, including:

  1. (1)

    whether, and when, to recognise or de-recognise an asset or liability;

  2. (2)

    the amount at which to value an asset, liability, equity or income statement item;

  3. (3)

    which description to place on an asset, liability, equity or income statement item.

PRU 1.3.7 G

In particular, unless an exception applies, PRU 1.3.5 R should be applied for the purposes of PRU to determine how to account for:

  1. (1)

    netting of amounts due to or from the firm;

  2. (2)

    the securitisation of assets and liabilities (see also PRU 1.3.8 G);

  3. (3)

    leased tangible assets;

  4. (4)

    assets transferred or received under a sale and repurchase or stock lending transaction; and

  5. (5)

    assets transferred or received by way of initial or variation margin under a derivative or similar transaction.

PRU 1.3.8 G

Where assets or liabilities are securitised, PRU 1.3.5 R only permits de-recognition where Financial Reporting Standard 5 (or, where applicable, International Accounting Standard 39) 2permits either de-recognition or the linked presentation. However, the FSA will consider granting a waiver to permit de-recognition in other circumstances provided that the firm can demonstrate that securitisation has effectively transferred risk.

PRU 1.3.9 G

Specific provisions for the methods and assumptions to be used by a firm in calculating its mathematical reserves are made in PRU 7.3.

PRU 1.3.10 G

PRU 1.3.5 R implements the requirements of Articles 23.3(viii) and 24.2(iv) of the Consolidated Life Directive. These articles require assets of a firm that are managed on its behalf by a subsidiary undertaking to be taken into account for the purposes of determining the firm's admissible assets and its assets in excess of concentration limits. The application of PRU 1.3.5 R will result in such assets remaining on the balance sheet of the firm.

Investments, derivatives and quasi-derivatives

PRU 1.3.11 R

Subject to PRU 1.3.31 R, for the purposes of PRU, a firm must apply PRU 1.3.12 R to PRU 1.3.30 R in order to determine how to account for:

  1. (1)

    investments that are, or amounts owed arising from the disposal of:

    1. (a)

      debt securities, bonds and other money- and capital-market instruments; or

    2. (b)

      loans; or

    3. (c)

      shares and other variable yield participations; or

    4. (d)

      units in UCITS schemes, non-UCITS retail schemes, recognised schemes and any other collective investment scheme that invests only in admissible assets (including any derivatives or quasi-derivatives held by the scheme); and

  2. (2)

    derivatives and quasi-derivatives.

Marking to market

PRU 1.3.12 R

Wherever possible, a firm must use mark to market in order to measure the value of the investments referred to in PRU 1.3.11 R. Marking to market is valuation at readily available close out prices from independent sources.

PRU 1.3.13 G

For the purposes of PRU 1.3.12 R, examples of readily available close out prices include exchange prices, screen prices, or quotes from several independent reputable brokers.

PRU 1.3.14 R

When marking to market, a firm must use the more prudent side of bid/offer price unless the firm is a significant market maker in a particular position type and it can close out at the mid-market price.

Marking to model

PRU 1.3.15 R

Where marking to market is not possible, a firm must use mark to model in order to measure the value of the investments referred to in PRU 1.3.11 R. Marking to model is any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input.

PRU 1.3.16 R

When the model used is developed by the firm, that model must be:

  1. (1)

    based on appropriate assumptions which have been assessed and challenged by suitably qualified parties independent of the development process; and

  2. (2)

    independently tested, including validation of the mathematics, assumptions, and software implementation.

PRU 1.3.17 R

A firm must ensure that its senior management are aware of the positions which are subject to mark to model and understand the materiality of the uncertainty this creates in the reporting of the performance of the business of the firm and the risks to which it is subject.

PRU 1.3.18 R

A firm must source market inputs in line with market prices so far as possible and assess the appropriateness of the market inputs for the position being valued and the parameters of the model on each valuation date.

PRU 1.3.19 R

A firm must use generally accepted valuation methodologies for particular products where these are available.

PRU 1.3.20 R

A firm must establish formal change control procedures, hold a secure copy of the model, and periodically use that model to check valuations.

PRU 1.3.21 R

A firm must ensure that its risk management functions are aware of the weakness of the models used and how best to reflect those in the valuation output.

PRU 1.3.22 R

A firm must periodically review the model to determine the accuracy of its performance.

PRU 1.3.23 G

Examples of periodical review are assessing the continued appropriateness of the assumptions and comparison of actual close out values to model inputs.

Independent price verification

PRU 1.3.24 R

In addition to marking to market or marking to model, a firm must perform independent price verification. This is the process by which market prices or model inputs are regularly verified for accuracy and independence.

PRU 1.3.25 G

For independent price verification, where independent pricing sources are not available or pricing sources are more subjective, for example, only one available broker quote, prudent measures such as valuation adjustments may be appropriate.

Valuation adjustments or reserves

PRU 1.3.26 R

A firm must establish and maintain procedures for considering valuation adjustments or reserves. These procedures must be compliant with the requirements set out in PRU 1.3.29 R.

PRU 1.3.27 R

A firm using third-party valuations, or marking to model, must consider whether valuation adjustments are necessary.

PRU 1.3.28 R

A firm must consider the need for establishing reserves for less liquid positions and, on an ongoing basis, review their continued appropriateness in accordance with the requirements set out in PRU 1.3.29 R.

PRU 1.3.29 R

The requirements referred to in PRU 1.3.26 R and PRU 1.3.28 R are:

  1. (1)

    a firm must consider the following adjustments or reserves: unearned credit spreads, close-out costs, operational risks, early termination, investing and funding costs, future administrative costs and, where appropriate, model risk; and

  2. (2)

    a firm must consider several factors when determining whether a valuation reserve is necessary for less liquid items. These factors include the amount of time it would take to hedge out the position/risks within the position; the average and volatility of bid/offer spreads; the availability of market quotes (number and identity of market makers); and the average and volatility of trading volumes.

Valuation adjustments or reserves2

PRU 1.3.30 R

If the result of establishing adjustments or reserves under PRU 1.3.26 R to PRU 1.3.29 R is a valuation which differs from the fair value determined in accordance with PRU 1.3.5 R2, a firm must reconcile the two valuations.

2

Shares in, and debts due from, related undertakings

PRU 1.3.31 R

PRU 1.3.11 R does not apply to shares in, and debts due from, a related undertaking that is:

  1. (1)

    a regulated related undertaking; or

  2. (2)

    an ancillary services undertaking; or

  3. (3)

    any other subsidiary undertaking, the shares of which a firm elects to value in accordance with PRU 1.3.35 R.

PRU 1.3.32 G

The effect of PRU 1.3.31 R is that shares in, and debts due from, related undertakings of the types referred to are not valued on a mark to market basis. As a result, debts due from these undertakings, and shares in related undertakings which are ancillary services undertakings, are valued at their accounting book value in accordance with PRU 1.3.5 R. Shares in related undertakings referred to in PRU 1.3.31 R (1) or (3) are valued in accordance with PRU 1.3.33 R to PRU 1.3.38 R.

PRU 1.3.33 R

Except where the contrary is expressly stated in PRU, whenever a rule in PRU refers to shares held in, and debts due from, an undertaking referred to in PRU 1.3.31 R (1) or PRU 1.3.31R (3), a firm must value the shares held in accordance with PRU 1.3.35 R.

PRU 1.3.34 R

In relation to shares in, and debts due from, an undertaking referred to in PRU 1.3.31 R (1), PRU 1.3.33 R does not apply for the purposes of PRU 2.2.78 R and PRU 8.3.

PRU 1.3.35 R

For the purposes of PRU 1.3.33 R, the value of the shares held in an undertaking referred to in PRU 1.3.31 R (1) or PRU 1.3.31R (3) is the sum of:

  1. (1)

    the regulatory surplus value of that undertaking; less

  2. (2)

    for the purposes of PRU 2.2.90 R, the book value of the total investments in the tier one capital resources and tier two capital resources of that undertaking by the firm and its related undertakings; or

  3. (3)

    for other purposes in PRU, the sum of:

    1. (a)

      the book value of the investments by the firm and its related undertakings in the tier two capital resources of the undertaking; and

    2. (b)

      if the undertaking is an insurance undertaking, its ineligible surplus capital and any restricted assets of the undertaking which have been excluded under PRU 8.3.41 R (1).

PRU 1.3.36 R

For the purposes of PRU 1.3.35 R (1), the regulatory surplus value of an undertaking referred to in PRU 1.3.31 R (1) or PRU 1.3.31R (3) is, subject to PRU 1.3.37 R, the sum of:

  1. (1)

    the tier one capital resources of the undertaking; plus

  2. (2)

    the tier two capital resources of the undertaking; less

  3. (3)

    the individual capital resources requirement of the undertaking.

PRU 1.3.37 R
  1. (1)

    Subject to PRU 1.3.38 R, for the purposes of PRU 1.3.36 R, only the relevant proportion of the:

    1. (a)

      tier one capital resources of the undertaking;

    2. (b)

      tier two capital resources of the undertaking;

    3. (c)

      individual capital resources requirement of the undertaking;

    is to be taken into account.

  2. (2)

    In (1), the relevant proportion is the proportion of the total number of shares issued by the undertaking held, directly or indirectly, by the firm.

PRU 1.3.38 R

If the individual capital resources requirement of an undertaking in PRU 1.3.31 R (1) that is a subsidiary undertaking exceeds the sum of its tier one capital resources and tier two capital resources, the full amount of the items referred to in PRU 1.3.37 R (1) are to be taken into account for the purposes of PRU 1.3.36 R.

PRU 1.3.39 R

For the purposes of PRU 1.3.35 R to PRU 1.3.38 R:

  1. (1)

    in relation to an undertaking referred to in PRU 1.3.31 R (1):

    1. (a)

      individual capital resources requirement has the meaning given by PRU 8.3.34 R;

    2. (b)

      the following expressions are to be construed in accordance with PRU 8.3.37 R:

      1. (i)

        tier one capital resources; and

      2. (ii)

        tier two capital resources;

    3. (c)

      ineligible surplus capital has the meaning given by PRU 8.3.67 R;

  2. (2)

    in relation to an undertaking referred to in PRU 1.3.31 R (3), the following expressions are to be construed as if that undertaking were an insurance holding company:

    1. (a)

      individual capital resources requirement;

    2. (b)

      tier one capital resources; and

    3. (c)

      tier two capital resources.

PRU 1.3.40 G

PRU 1.3.35 R to PRU 1.3.39 R set out several different valuation bases for a firm's shares in related undertakings. The regulatory surplus value (defined in PRU 1.3.36 R) measures the related undertaking's own capital surplus or deficit. This is used: (i) in PRU 1.3.35 R as a basis for calculating the impact on the firm's position of its investments in related undertakings; and (ii) in PRU 8.3 as a starting point for the calculation of ineligible surplus capital.

PRU 1.3.41 G

PRU 1.3.35 R determines how, for the purposes of the solo capital adequacy calculation of a firm, that firm's capital resources should be adjusted to take into account its investments in related undertakings.

PRU 1.3.42 G

The rules that specify how, for the purposes of the adjusted solo capital calculation, a firm must incorporate its related undertakings into its capital resources and capital resources requirement are set out in PRU 8.3.

Community co-insurance operations: general insurance business

PRU 1.3.43 R

Where a relevant insurer determines the amount of a liability in order to make provision for outstanding claims under a Community co-insurance operation, then, if the leading insurer has informed the relevant insurer of the amount of the provision made by the leading insurer for such claims, the amount determined by the relevant insurer:

  1. (1)

    must be at least as great as the amount of the provision made by the leading insurer; or

  2. (2)

    in a case where it is not the practice in the United Kingdom to make such provision separately, must be sufficient, when all liabilities are taken into account, to include provision at least as great as that made by the leading insurer for such claims;

due regard being had in either case to the proportion of the risk covered by the relevant insurer and by the leading insurer respectively.