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PRU 4.2 Market risk in insurance

Application

PRU 4.2.1R

PRU 4.2 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 4.2.2G

The scope of application of PRU 4.2 is not restricted to firms that are subject to the relevant EC directives. It applies, for example, to pure reinsurers (with the exception of PRU 4.2.53 R).

PRU 4.2.3R

  1. (1)

    PRU 4.2 applies to a firm in relation to the whole of its business, except where a particular provision provides for a narrower scope.

  2. (2)

    Where a firm carries on both long-term insurance business and general insurance business, PRU 4.2 applies separately to each type of business.

Purpose

PRU 4.2.4G

This section sets out rules and guidance relating to market risk. Under PRU 7.2.20 R, a firm is required to hold admissible assets of a value sufficient to cover technical provisions. In addition, PRU 7.2.34 R sets the requirement that a firm must hold assets of appropriate amount, currency, term, safety and yield, to ensure that the cash inflows from those assets will be sufficient to meet expected cash outflows from its insurance liabilities as they are due.

PRU 4.2.5G

Market risk is the risk that as a result of market movements a firm may be exposed to fluctuations in the value of its assets, the amount of its liabilities, or the income from its assets. Sources of general market risk include movements in interest rates, equities, exchange rates and real estate prices. It is important to note that none of these sources of risk is independent of the others. For example, fluctuations in interest rates often have an impact upon equity and currency values and vice versa. Giving due consideration to these correlations is an important aspect of the prudent management of market risk.

PRU 4.2.6G

A firm may also be exposed to specific market risk, which is the risk that the market value of a specific asset, or income from that asset, may fluctuate for reasons that are not dependent on general market movements. The limits in PRU 3.2.22 R cover market risk as well as counterparty risk.

PRU 4.2.7G

PRU 4.2 addresses the impact of market risk on insurance business in the ways set out below:

  1. (1)

    Any firm that carries on long-term insurance business must comply with the resilience capital requirement. This requires the firm to hold capital to cover market risk. The resilience capital requirement is dealt with in PRU 4.2.9 G to PRU 4.2.26 R.

  2. (2)

    For a firm that carries on long-term insurance business, the assets that it must hold must be of a value sufficient to cover the firm's mathematical reserve requirements. PRU 7.3 contains rules and guidance as to the methods and assumptions to be used in calculating these mathematical reserves. One of these assumptions is the assumed rate of interest to be used in calculating the present value of future payments by or to a firm. PRU 4.2.28 R to PRU 4.2.48 G set out the methodology to be used in relation to long-term insurance liabilities.

  3. (3)

    Firms carrying on either long-term insurance business or general insurance business are also subject to currency risk. That is, the risk that fluctuations in exchange rates may impact adversely on a firm. PRU 4.2.49 G to PRU 4.2.56 G set out the requirements a firm must meet so as to cover this risk.

  4. (4)

    For a firm carrying on general insurance business, the Enhanced Capital Requirement already captures some elements of market risk. In addition, the requirements as to the assumed rate of interest used in calculating the present value of general insurance liabilities are contained in the insurance accounts rules, and these requirements are outlined in PRU 4.2.27 G.

  5. (5)

    Firms carrying on long-term insurance business that have property-linked liabilities or index-linked liabilities must cover these liabilities by holding appropriate assets. PRU 4.2.57 R and PRU 4.2.58 R set out these cover requirements.

Definitions

PRU 4.2.8R

For the purposes of PRU 4.2:

  1. (1)

    real estate means an interest in land, buildings or other immovable property;

  2. (2)

    a significant territory is any country or territory in which more than 2.5% of a firm's long-term insurance assets (by market value), excluding assets held to cover index-linked liabilities or property-linked liabilities (see PRU 4.2.57 R and PRU 4.2.58 R), are invested; and

  3. (3)

    the long term gilt yield means the annualised equivalent of the fifteen year gilt yield for the United Kingdom Government fixed-interest securities index jointly compiled by the Financial Times, the Institute of Actuaries and the Faculty of Actuaries.

Resilience capital requirement (applicable to long-term insurance business only)

PRU 4.2.9G

The resilience capital requirement forms part of the calculation of the capital resources requirement for all firms carrying on long-term insurance business. PRU 2.1.15 R to PRU 2.1.20 R set out the different elements of this calculation. These include the Minimum Capital Requirement and the Enhanced Capital Requirement. The resilience capital requirement forms part of both of these requirements (see PRU 2.1.22 R (2)and PRU 2.1.34 R (2)).

PRU 4.2.10R

  1. (1)

    A firm that carries on long-term insurance business must calculate a resilience capital requirement in accordance with (2) to (5).

  2. (2)

    From amongst its long-term insurance assets, the firm must identify assets which, after applying the scenarios in (3), have a value that is equal to the firm's long-term insurance liabilities under those scenarios.

  3. (3)

    For the purpose of (2), the scenarios are:

    1. (a)

      for those assets invested in the United Kingdom, the market risk scenario set out in PRU 4.2.16 R;

    2. (b)

      subject to (c) and to PRU 4.2.26 R, for those assets invested outside of the United Kingdom, the market risk scenario set out in PRU 4.2.23 R; and

    3. (c)

      where the assets in (b) are:

      1. (i)

        held to cover index-linked liabilities or property-linked liabilities; or

      2. (ii)

        not invested in a significant territory outside the United Kingdom;

      the market risk scenario set out in PRU 4.2.16 R.

  4. (4)

    The resilience capital requirement is the result of deducting B from A, where:

    1. (a)

      A is the value of the assets which will produce the result described in (2); and

    2. (b)

      B is the firm's long-term insurance liabilities.

  5. (5)

    In calculating the value of the firm's long-term insurance liabilities under any scenario, a firm is not required to adjust the provision made under PRU 1.3.5 R in respect of a defined benefits pension scheme.

PRU 4.2.11G

The purpose of the resilience capital requirement is to cover adverse deviation from:

  1. (1)

    the value of long-term insurance liabilities;

  2. (2)

    the value of assets held to cover long-term insurance liabilities; and

  3. (3)

    the value of assets held to cover the resilience capital requirement;

arising from the effects of market risk for equities, real estate and fixed interest securities. Other risks are not explicitly addressed by the resilience capital requirement.

PRU 4.2.12G

The amount of the resilience capital requirement calculated by the firm will depend on the firm's choice of assets held to cover the resilience capital requirement. The resilience capital requirement is held to cover not only the shortfall between the change in the value of long-term insurance liabilities and the change in the value of the assets identified to cover those liabilities, but also the change in the value of the assets identified to cover the resilience capital requirement itself.

PRU 4.2.13G

As part of the assessment of the financial resources a firm needs to hold to comply with PRU 1.2.22 R, PRU 1.2.35 R requires a firm to carry out stress tests and scenario analyses appropriate to the major sources of risk to its ability to meet its liabilities as they fall due identified in accordance with PRU 1.2.31 R. In considering the stress tests and scenario analyses relevant to the major sources of risk in the category of market risk, a firm should consider the extent to which the market risk scenarios set out in PRU 4.2.16 R to PRU 4.2.26 R are appropriate to the nature of its asset portfolio. A firm may judge that given the nature of its portfolio, a more severe stress should be adopted. The firm may also wish to bring in other asset classes, such as index-linked bonds, which should be stressed on appropriate bases, and to consider the impact of currency mismatching and any derivative positions held.

PRU 4.2.14G

The resilience capital requirement requires firms to assume different adverse market risk scenarios for equities, real estate and fixed interest securities (see PRU 4.2.16 R and PRU 4.2.23 R) to those required by PRU 7.4.68 R (UK and certain other assets) and PRU 7.4.73 R (non-UK assets) in relation to the calculation of the risk capital margin for a with-profits fund by a realistic basis life firm calculating its with-profits insurance capital component.

PRU 4.2.15G

Where the resilience capital requirement is affected by the presence of derivative or quasi-derivative instruments, the firm will need to consider whether the protection afforded is of suitable length or security. The firm should include the exposure to counterparties in the credit considerations of PRU 4.2.41 R both before and after calculating the resilience capital requirement.If the derivative protection is very short term the firm should consider whether issues arise under PRU 7.3.26 R (Avoidance of future valuation strain); when a derivative expires the financial position of the firm may deteriorate as a result of, for example, falls in asset values. Unless the firm holds a further reserve, the firm is likely to need to have either undertaken a fresh protection strategy or carried through the alternative to the derivative protection (such as selling equities in place of a put option) if the existing protection expires before the financial year end. If the existing derivative protection continues beyond the time of financial year end the firm must have sufficient confidence that it can renew its derivative protection or an alternative to achieve the same effect.

Market risk scenario for assets invested in the United Kingdom

PRU 4.2.16R

In PRU 4.2.10 R (3)(a), the market risk scenario for assets invested in the United Kingdom and for assets (including assets invested outside the United Kingdom) held to cover index-linked liabilities or property-linked liabilities which a firm must assume is:

  1. (1)

    a fall in the market value of equities of at least 10% or, if greater, the lower of:

    1. (a)

      a percentage fall in the market value of equities which would produce an earnings yield on the FTSE Actuaries All Share Index equal to 4/3 rds of the long-term gilt yield; and

    2. (b)

      a fall in the market value of equities of 25% less the equity market adjustment ratio (see PRU 4.2.19 R);

  2. (2)

    a fall in real estate values of 20% less the real estate market adjustment ratio for an appropriate real estate index (see PRU 4.2.21 R);

  3. (3)
    1. (a)

      the more onerous of either a fall or rise in yields on all fixed interest securities by the percentage point amount determined in (b);

    2. (b)

      for the purpose of (a), the percentage point amount is equal to 20% of the long-term gilt yield.

PRU 4.2.17R

For the purposes of PRU 4.2.16 R (1) and PRU 4.2.16R (2), a firm must:

  1. (1)

    assume that earnings for equities and rack rents for real estate fall by 10%, but dividends for equities remain unaltered (see PRU 4.2.36 R to PRU 4.2.38 R); and

  2. (2)

    model a fall in equity and real estate markets as if the fall occurred instantaneously.

PRU 4.2.18G

An example of PRU 4.2.16 R (3) is that, where the long-term gilt yield is currently 6%, a firm would assume an increase of 20% in that yield, that is, a change of 1.2 percentage points. For the purpose of the scenario in PRU 4.2.16 R (3)(a), the firm would assume a fall or rise of 1.2 percentage points in yields on all fixed interest securities.

Equity market adjustment ratio

PRU 4.2.19R

The equity market adjustment ratio referred to in PRU 4.2.16 R (1)(b) is:

  1. (1)

    if the ratio calculated in (a) and (b) lies between 75% and 100%, the result of 100% less the ratio (expressed as a percentage) of:

    1. (a)

      the current value of the FTSE Actuaries All Share Index; to

    2. (b)

      the average value of the FTSE Actuaries All Share Index over the preceding 90 calendar days;

  2. (2)

    0%, if the ratio calculated in (1)(a) and (b) is more than 100%; and

  3. (3)

    25%, if the ratio calculated in (1)(a) and (b) is less than 75%.

PRU 4.2.20R

In PRU 4.2.19 R, the average value of the FTSE Actuaries All Share Index over any period of 90 calendar days means the arithmetic mean based on levels at the close of business on each of the days in that period on which the London Stock Exchange was open for trading.

Real estate market adjustment ratio

PRU 4.2.21R

The real estate market adjustment ratio for a real estate index referred to in PRU 4.2.16 R (2) and PRU 4.2.23 R (2) is:

  1. (1)

    if the ratio calculated in (a) and (b) lies between 90% and 100%, the result of 100% less the ratio (expressed as a percentage) of:

    1. (a)

      the current value of the real estate index; to

    2. (b)

      the average value of that real estate index over the three preceding financial years;

  2. (2)

    0%, if the ratio calculated in (1)(a) and (b) is more than 100%; and

  3. (3)

    10%, if the ratio calculated in (1)(a) and (b) is less than 90%.

PRU 4.2.22G

For the purpose of calculating the real estate market adjustment ratio in PRU 4.2.21 R, a firm should select an appropriate index of real estate values such that:

  1. (1)

    the constituents of the index are reasonably representative of the nature and territory of the real estate included in the range of assets identified in accordance with PRU 4.2.10 R; and

  2. (2)

    the frequency of, and historical data relating to, published values of the index are sufficient to enable an average value(s) of the index to be calculated over the three preceding financial years.

Market risk scenario for assets invested outside the United Kingdom

PRU 4.2.23R

In PRU 4.2.10 R (3)(b), subject to PRU 4.2.26 R, the market risk scenario for assets invested outside the United Kingdom (other than assets held to cover index-linked liabilities or property-linked liabilities) which a firm must assume is, for each significant territory in which assets are invested outside the United Kingdom:

  1. (1)

    an appropriate fall in the market value of equities invested in that territory, which is at least equal to the percentage fall determined in PRU 4.2.16 R;

  2. (2)

    a fall in real estate values in that territory of 20% less the real estate market adjustment ratio for an appropriate real estate index for that territory (see PRU 4.2.21 R); and

  3. (3)
    1. (a)

      the more onerous of either a fall or a rise in yields on all fixed interest securities by the percentage point amount determined in (b);

    2. (b)

      for the purpose of (a), the percentage point amount is equal to 20% of the nearest equivalent (in respect of the method of calculation) to the long term gilt yield.

PRU 4.2.24R

For the purposes of PRU 4.2.23 R (1), an appropriate fall in the market value of equities invested in a significant territory must be determined having regard to:

  1. (1)

    an appropriate equity market index for that territory; and

  2. (2)

    the historical volatility of the equity market index selected in (1).

PRU 4.2.25G

For the purpose of PRU 4.2.24 R (1), an appropriate equity market index for a territory is such that:

  1. (1)

    the constituents of the index are reasonably representative of the nature of the equities held in that territory which are included in the range of assets identified in accordance with PRU 4.2.10 R; and

  2. (2)

    the frequency of, and historical data relating to, published values of the index are sufficient to enable an average value(s) and historical volatility of the index to be calculated over at least the three preceding financial years.

PRU 4.2.26R

Where the assets of a firm invested in a significant territory of a kind referred to in PRU 4.2.23 R (1), PRU 4.2.23 R (2) or PRU 4.2.23 R (3)(a) represent less than 0.5% of the firm's long-term insurance assets (excluding assets held to cover index-linked liabilities or property-linked liabilities), measured by market value, the firm may assume for those assets the market risk scenario for assets of that kind invested in the United Kingdom set out in PRU 4.2.16 R instead of the market risk scenario set out in PRU 4.2.23 R.

Interest rates: general insurance liabilities

PRU 4.2.27G

The rates of interest to be used for the calculation of the present values of general insurance liabilities are specified in the insurance accounts rules. These state that the rate of interest to be used must not exceed the lowest of:

  1. (1)

    a rate prudently estimated by the firm to be earned by assets of the firm that are appropriate in magnitude and nature to cover the provisions for claims being discounted, during the period necessary for the payment of such claims;

  2. (2)

    a rate justified by the performance of such assets over the preceding five years; and

  3. (3)

    a rate justified by the performance of such assets during the year preceding the balance sheet date.

Interest rates: long-term insurance liabilities

PRU 4.2.28R

The rates of interest to be used for the calculation of the present value of a long-term insurance liability must not exceed 97.5% of the risk-adjusted yield (see PRU 4.2.30 R to PRU 4.2.48 G) that is expected to be achieved on:

  1. (1)

    the assets allocated to cover that liability;

  2. (2)

    the reinvestment of sums expected to be received from those assets (see PRU 4.2.45 R to PRU 4.2.48 G); and

  3. (3)

    the investment of future premium receipts (see PRU 4.2.45 R to PRU 4.2.48 G).

PRU 4.2.29R

For the purposes of PRU 4.2.28 R, the rates of interest assumed must allow appropriately for the rates of tax that apply to the investment return on policyholder assets. The rates of tax assumed must be such that the firm's total implied liability for tax arising from the allocation of assets to liabilities is not less than the firm's actual expected liability for tax for the period in respect of which tax is to be assessed.

Risk-adjusted yield

PRU 4.2.30R

A risk-adjusted yield on an asset must be calculated by:

  1. (1)

    taking the asset together with any covering derivatives, forward transactions and quasi-derivatives;

  2. (2)

    assuming that the factors which affect the yield will remain unchanged after the valuation date (see PRU 4.2.33 R);

  3. (3)

    valuing the asset (together with any offsetting transaction) in accordance with PRU 1.3 (Valuation);

  4. (4)

    making reasonable assumptions as to whether, and if so when, any options or other rights embedded in the asset (or in any offsetting transaction) will be exercised.

PRU 4.2.31G

Examples of calculating a combined yield for the purposes of PRU 4.2.30 R (1):

  1. (1)

    1000 £1 shares (fully paid) of ABC plc covered by a sold future on the shares. Calculating the combined yield effectively results in a position that behaves like cash (with dividend income but no capital gain or loss on the value of the assets); and

  2. (2)

    where a covering derivative contains an option exercisable by the firm (e.g. a bought put option or receiver swaption), the calculation of the risk adjusted yield should take into account the fact that on the valuation assumptions any time value will reduce over time (known as the 'wasting' nature of the time value of the option), for example, an at-the money option will expire worthless and hence the covering derivative will effectively be a negative yielding asset. There are various ways of allowing for this, for example a firm could treat the covering derivative and the asset as a single asset and calculate an internal rate of return on this combined asset. Alternatively, an explicit reserve could be set up equal and opposite to the time value of the covering derivative which would be written off in the same way as the time value on the covering derivative.

PRU 4.2.32G

The requirements in relation to offsetting transactions are set out in PRU 4.3. The options and other rights referred to in PRU 4.2.30 R (4) include those exercisable by the firm as well as those exercisable by other parties.

PRU 4.2.33R

For the purpose of PRU 4.2.30 R (2), the factors that affect yield should be ascertained as at the valuation date (that is, the date to which present values of cash flows are being calculated). All changes known to have occurred by that date must be taken into account including:

  1. (1)

    changes in the rental income from real estate;

  2. (2)

    changes in dividends or audited profit on equities;

  3. (3)

    known or forecast changes in dividends which have been publicly announced by the issuer by the valuation date;

  4. (4)

    known or forecast changes in earnings which have been publicly announced by the issuer by the valuation date;

  5. (5)

    alterations in capital structure; and

  6. (6)

    the value (at the most recent date at or before the valuation date for which it is known) of any determinant of the amount of any future interest or capital payment.

PRU 4.2.34R

The risk-adjusted yield is either:

  1. (1)

    (for equities and real estate) a running yield (see PRU 4.2.36 R to PRU 4.2.38 R, PRU 4.2.41 R and PRU 4.2.44 R); or

  2. (2)

    (for all other assets) the internal rate of return (see PRU 4.2.39 R, PRU 4.2.41 R and PRU 4.2.44 R).

PRU 4.2.35R

The risk-adjusted yield on a basket of assets is the arithmetic mean of the risk-adjusted yield on each asset weighted by that asset's market value.

The running yield for real estate

PRU 4.2.36R

For real estate the running yield is the ratio of:

  1. (1)

    the rental income arising from the real estate over the previous 12 months; to

  2. (2)

    the market value of the real estate.

The running yield for equities

PRU 4.2.37R

For equities the running yield is:

  1. (1)

    the dividend yield, if the dividend yield is more than the earnings yield;

  2. (2)

    otherwise, the sum of the dividend yield and the earnings yield, divided by two.

PRU 4.2.38R

For the purposes of PRU 4.2.37 R:

  1. (1)

    the dividend yield is the ratio (expressed as a percentage) of dividend income over the previous 12 months from the equities for which the running yield is being calculated ("the relevant equities") to the market value of those equities;

  2. (2)

    the earnings yield is the ratio (expressed as a percentage) of the audited profit (including exceptional items and extraordinary items) for the preceding financial year of the issuer of the relevant equities to the market value of those equities;

  3. (3)

    the earnings yield must be calculated in accordance with whichever is most appropriate (to the issuer of the relevant equities) of United Kingdom, US or international generally accepted accounting practice.

The internal rate of return

PRU 4.2.39R

The internal rate of return on an asset is the annual rate of interest which, if used to calculate the present value of future income (before deduction of tax) and of repayments of capital (before deduction of tax) would result in the sum of those amounts being equal to the market value of the asset.

PRU 4.2.40G

The risk adjusted yield for a collective investment scheme may be determined as the weighted average of the yields on each of the investments held by the collective investment scheme.

Credit risk

PRU 4.2.41R

In both the running yield and internal rate of return the yield must be reduced to exclude that part of the yield that represents compensation for credit risk arising from the asset.

PRU 4.2.42G

An allowance for credit risk should be made for all securities except risk-free securities.

PRU 4.2.43G

Provision for credit risk for credit-rated securities may be made by reference to historic default rates of securities with a similar credit rating. However, allowance should be made both for any recent or expected changes in market conditions that may invalidate historic default rates and for the likelihood that the credit ratings on securities may deteriorate or (following such deterioration) that the issuer may default.

PRU 4.2.44R

Provision for credit risk for securities that are not credit-rated must be made on principles at least as prudent as those adopted for credit-rated securities.

Investment and reinvestment

PRU 4.2.45R

Except as provided in PRU 4.2.46 R:

  1. (1)

    the risk-adjusted yield assumed for the investment or reinvestment of sterling sums (other than sums expected to be received within the next three years) must not exceed the lowest of:

    1. (a)

      the long-term gilt yield;

    2. (b)

      3% per annum, increased by two thirds of the excess, if any, of the long-term gilt yield over 3% per annum; and

    3. (c)

      6.5% per annum; and

  2. (2)

    the risk-adjusted yield assumed for the investment or reinvestment of those sterling sums expected to be received within the next three years must not exceed the risk-adjusted yield on the assets actually held adjusted linearly over the three-year period to the risk-adjusted yield determined under (1).

PRU 4.2.46R

For the with-profits insurance contracts of a realistic basis life firm, the risk-adjusted yield assumed for the investment or reinvestment of sums denominated in sterling must be no more than rates derived from the forward gilts yield.

PRU 4.2.47R

The risk-adjusted yield assumed for the investment or reinvestment of non-sterling sums must be at least as prudent as in PRU 4.2.45 R and PRU 4.2.46 R.

PRU 4.2.48G

The purpose of PRU 4.2.45 R to PRU 4.2.47 R is to help protect against 'reinvestment risk'. Reinvestment risk is the risk that, when the sums are actually received, interest rates (and so yields available on assets) might have fallen below current expectations.

Currency risk

PRU 4.2.49G

Fluctuations in foreign exchange rates may impact adversely upon a firm, including where it holds an open position in a foreign currency. This is where future cash outflows (that is liabilities) in one currency are matched by future cash inflows (that is assets) in a different currency. The circumstances in which this could arise include where the firm:

  1. (1)

    has entered into contracts for the purchase or sale of foreign currency; or

  2. (2)

    has entered into contracts of insurance under which claims are payable in, or determined by reference to a value or price expressed in, a foreign currency; or

  3. (3)

    holds assets denominated in a foreign currency.

Cover for spot and forward currency transactions

PRU 4.2.50R

A firm must cover a contract providing for the purchase or sale of foreign currency by:

  1. (1)

    holding the currency that must be paid by the firm under the contract; or

  2. (2)

    being subject to an offsetting transaction.

PRU 4.2.51G

The requirements in relation to cover and offsetting transactions are set out in PRU 4.3.

Currency matching of assets and liabilities

PRU 4.2.52G

PRU 7.2.34 R requires a firm to cover its liabilities with assets that enable it to match, in timing, amount and currency, the cash inflows and outflows from those assets and liabilities. This permits some currency mismatching of assets and liabilities, but only if sufficient excess assets are held to cover the exposure arising from such mismatching. The level of permitted currency mismatching is also limited by PRU 4.2.53 R.

PRU 4.2.53R

Subject to PRU 4.2.54 R, a firm must hold admissible assets in each currency of an amount equal to at least 80% of the amount of its liabilities (excluding, for a firm that carries on general insurance business, any equalisation provision) in that currency, except where the amount of those assets does not exceed 7% of the assets in other currencies.

PRU 4.2.54R

PRU 4.2.53 R does not apply to:

  1. (1)

    a pure reinsurer; or

  2. (2)

    assets held to cover index-linked liabilities or property-linked liabilities.

PRU 4.2.55R

For the purpose of PRU 4.2.53 R, the currency of the liability under a contract of insurance is the currency in which the cover under the contract of insurance is expressed or, if the contract does not specify a currency:

  1. (1)

    the currency of the country or territory in which the risk is situated; or

  2. (2)

    if the firm on reasonable grounds so decides, the currency in which the premium payable under the contract is expressed; or

  3. (3)

    if, taking into account the nature of the risks insured, the firm considers it more appropriate:

    1. (a)

      the currency (based on past experience) in which it expects the claims to be paid; or

    2. (b)

      if there is no past experience, the currency of the country or territory in which the firm or relevant branch is established:

      1. (i)

        for contracts covering risks falling within general insurance business classes 4, 5, 6, 7, 11, 12 and 13 (producer's liability only); and

      2. (ii)

        for contracts covering risks falling within any other general insurance business class where, in accordance with the nature of the risks, the firm's liabilities are liabilities to be provided in a currency other than that which would result from the application of (1) or (2); or

  4. (4)

    (where a claim has been notified to the firm and the firm's liability in respect of that claim is payable in a currency other than that which would result from the application of (1), (2) or (3)) the currency in which the claim is to be paid; or

  5. (5)

    (where a claim is assessed in a currency known to the firm in advance and is a currency other than that which would result from the application of (1), (2), (3) or (4)) the currency in which the claim is to be assessed.

PRU 4.2.56G

The reasonable grounds in PRU 4.2.55 R (2) include if, from the time the contract is entered into, it appears likely that a claim will be paid in the currency of the premium and not in the currency of the country in which the risk is situated.

Covering linked liabilities

PRU 4.2.57R

A firm must cover its property-linked liabilities with:

  1. (1)

    (as closely as possible) the assets to which those liabilities are linked; or

  2. (2)

    a property-linked reinsurance contract; or

  3. (3)

    a combination of (1) and (2).

PRU 4.2.58R

A firm must cover its index-linked liabilities with:

  1. (1)

    either:

    1. (a)

      the assets which represent that index; or

    2. (b)

      assets of appropriate security and marketability which correspond, as closely as possible, to the assets which are comprised in, or which form, the index or other reference of value to which those liabilities are linked; or

  2. (2)

    a portfolio of assets whose value or yield is reasonably expected to correspond closely with the index-linked liability; or

  3. (3)

    an index-linked reinsurance contract; or

  4. (4)

    an index-linked approved derivative; or

  5. (5)

    an index-linked approved quasi-derivative; or

  6. (6)

    a combination of any of (1) to (5).

PRU 4.2.59G

For the purposes of PRU 4.2.57 R and PRU 4.2.58 R, a firm is not permitted to hold different assets and to cover the mismatch by holding excess assets.

PRU 4.2.60G

If a firm has incurred a policy liability which cannot be exactly matched by appropriate assets (for example the Limited Price Index (LPI) and Earnings Index), the firm should seek to match assets that at least cover the liabilities. For example, an LPI limited to 5% per annum may be matched by a 5% fixed interest bond or a RPI bond.

PRU 4.2.61G

In selecting the appropriate cover, the firm should ensure that both credit risk, and the risk that the value or yield in the assets will not, in all circumstances, match fluctuations in the relevant index, are within acceptable limits. Rules and guidance relating to credit risk are set out in PRU 3.2.