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

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

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

1. (1)

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

2. (2)

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

   1. (a)

      approved securities;

   2. (b)

      listed securities;

   3. (c)

      permitted unlisted securities;

   4. (d)

      permitted land and property;

   5. (e)

      permitted loans;

   6. (f)

      permitted deposits;

   7. (g)

      permitted scheme interests;

   8. (h)

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

      4
   9. (i)

      cash;

   10. (j)

       permitted units;

   11. (k)

       permitted stock lending; 7

   12. (l)

       permitted derivatives contracts; and7

   13. (m)

       conditional permitted links.7

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

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

1. (1)

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

2. (2)

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

3. (3)

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

4. (4)

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

1. (1)

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

2. (2)

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

   1. (a)

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

   2. (b)

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

3. (3)

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

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

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

1. (1)

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

   1. (a)

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

   2. (b)

      the counterparty is:

      1. (i)

         an authorised person; or

      2. (ii)

         a person authorised in an EEA State6; or

      3. (iii)

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

      4. (iv)

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

         1. (A)

            [deleted]5;

         2. (B)

            the Federal Deposit Insurance Corporation;

         3. (C)

            the Board of Governors of the Federal Reserve System; and

         4. (D)

            the Office of Thrift Supervision; and

   3. (c)

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

      1. (i)

         acceptable to the firm;

      2. (ii)

         adequate; and

      3. (iii)

         sufficiently immediate; and

   4. (d)

      for the purposes of property-linked assets only:

      1. (i)

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

      2. (ii)

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

      3. (iii)

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

2. (2)

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

3. (3)

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

1. (1)

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

   1. (a)

      transferred to the firm or the firm's agent;

   2. (b)

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

   3. (c)

      in the form of one or more of:

      1. (i)

         cash;

      2. (ii)

         a certificate of deposit;

      3. (iii)

         a letter of credit;

      4. (iv)

         a readily realisable security;

      5. (v)

         commercial paper with no embedded derivative content;

      6. (vi)

         a qualifying money market fund.

2. (2)

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

   1. (a)

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

   2. (b)

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

3. (3)

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

4. (4)

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

4A permitted derivatives contract is one which:

1. (1)

   for a Solvency II firm, is effected or issued:

   1. (a)

      on or under the rules of a regulated market; or

   2. (b)

      off-market with an approved counterparty; and

   satisfies COBS 21.3.14 G; and

2. (2)

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

3. (3)

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

7A conditional permitted link is any of the following property where the conditions in COBS 21.3.16R are met:

1. (1)

   conditional permitted unlisted securities;

2. (2)

   conditional permitted immovables;

3. (3)

   conditional permitted loans;8

4. (4)

   conditional permitted scheme interests;

   8
5. (5)

   conditional permitted long-term asset funds; and9

   8
6. (6)

   9(only in respect of a linked fund included in the default arrangement of a qualifying scheme) conditional permitted illiquid assets.

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

1. (-1)

   9(only in respect of conditional permitted long-term asset funds to be held other than in connection with a qualifying scheme) the policyholder has received:

   1. (a)

      a personal recommendation, or investment management services, from a firm, as to the suitability of the investment for the policyholder; or

   2. (b)

      (where the policyholder has not received any of the services in (a)) an assessment from a firm (which could be the insurer, and where the circumstances are appropriate, the firm may rely on assessments made by another person on whom it is reasonable for the firm to rely) that the investment is appropriate for the policyholder in accordance with COBS 21.3.16AR;

2. (1)

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

   1. (a)

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

   2. (b)

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

3. (2)

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

   1. (a)

      circumstances where investment risk is borne by a linked policyholder;

   2. (b)

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

   3. (c)

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

4. (3)

   (only in respect of conditional permitted illiquid assets) the linked fund investing in conditional permitted illiquid assets may only be included in the default arrangements of a qualifying scheme.9

   8

1. (1)

   9The appropriateness assessment in COBS 21.3.16R(-1)(b) must be done in accordance with the rules in either COBS 10 or COBS 10A.

2. (2)

   The effect of (1) is that if the rules in COBS 10 or COBS 10A do not apply to a firm, the assessment the policyholder has received must be undertaken by the firm as if the rules in COBS 10 or COBS 10A applied.

3. (3)

   Where (2) applies, the condition in COBS 21.3.16R(-1)(b) will be met where a firm has conducted the appropriateness assessment in accordance with either:

   1. (a)

      COBS 10 as it would apply to a firm that arranges or deals in relation to a unit in a long-term asset fund; or

   2. (b)

      COBS 10A as it would apply to a firm that either:

      1. (i)

         provides investment services in relation to a unit in a long-term asset fund; or

      2. (ii)

         carries on insurance distribution in relation to an insurance-based investment product (taking into account the guidance in COBS 10A 2.12G as if it referred to investment in conditional permitted long-term asset funds), and

   the firm must apply the set of rules in either (a), (b)(i) or (b)(ii)) which are the most:

   1. (c)

      consistent with the firm’s understanding and experience; and

   2. (d)

      appropriate for the policyholder.

4. (4)

   The appropriateness assessment must ensure (but is not limited to ensuring) that the total exposure the policyholder has or would have to conditional permitted long-term asset funds, at the point the investment is made and based on expected contributions at the time, is not greater than 10% of:

   1. (a)

      (in relation to a policy held by an individual policyholder who is a natural person) the person’s exposure to permitted links in the policy;

   2. (b)

      (other than in (a) and (c) and where the investment risk is borne by a policyholder who is a natural person) that natural person’s individual exposure to permitted links in the policy; or

   3. (c)

      (where the policy is used by the holder of the policy for the purposes of providing benefits under a pension scheme, other than a qualifying scheme, and the investment risk is borne by a member of the scheme who is a policyholder and a natural person), the value of that natural person’s benefits under the pension scheme.

The assessment in COBS 21.3.16R(2), in relation to a linked fund which is included in an individual pension arrangement under a qualifying scheme in circumstances where the member self-selects the linked assets, must include ensuring that the total exposure of that individual pension arrangement to conditional permitted long-term asset funds is not greater than the higher of:

1. (1)

   the exposure to conditional permitted long-term asset funds and/or conditional permitted illiquid assets which would be considered suitable and appropriate if that member were invested only in the qualifying scheme’s default arrangement; or

2. (2)

   10% of the total value of the benefits in that individual pension arrangement under the qualifying scheme.

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

1. (1)

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

2. (2)

   conditional permitted links.

8The gross assets that a linked fund invests in conditional permitted long-term asset funds (when included in a qualifying scheme) or conditional permitted illiquid assets (when included in the default arrangement of a qualifying scheme) 9must not be included in any part of the calculation when working out whether the limit set out in COBS 21.3.19R has been exceeded.

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

1. (1)

   an explanation of the risks associated with any conditional permitted links and/or gross assets in permitted scheme interests in (b)(v) of the Glossary definition of that term8 exceeding 20%, how these might crystallise and how they might impact on a linked policyholder;

2. (2)

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

3. (3)

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

4. (4)

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