1There is no overall application statement for GENPRU. Each chapter or section has its own application statement.

Broadly speaking however, GENPRU applies to:

1. (1)

   an insurer;

2. (2)

   a bank;

3. (3)

   a building society;

4. (4)

   a BIPRU investment firm; and

5. (5)

   groups containing such firms.

5In relation to:

1. (1)

   a BIPRU firm;

2. (2)

   an incoming EEA firm which:

   1. (a)

      is a full BCD credit institution; and

   2. (b)

      has a branch in the United Kingdom; and

3. (3)

   a third country BIPRU firm which:

   1. (a)

      is a bank; and

   2. (b)

      has a branch in the United Kingdom;

BIPRU 12 contains rules and guidance in relation to the adequacy of that firm's liquidity resources.

The guidance in this section is drafted with respect to a firm to which this section and the other provisions of GENPRU and BIPRU (except BIPRU 12) 5referred to in this section apply in full.

The scope of application of this section is not restricted to insurers that are subject to the relevant EU4 Directives.

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 and so this section applies to a firm in relation to the whole of its business. In the case of a UCITS investment firm this means that this section is not limited to designated investment business excluding scheme management activity. It also applies to scheme management activity and to activities that are not designated investment business.

Adequate financial resources and adequate systems and controls are necessary for the effective management of prudential risks. This section therefore has requirements relating to both of these topics.

This section amplifies Principle 4, under which a firm must maintain adequate financial resources. It is concerned with the adequacy of the financial resources that a firm needs to hold in order to be able to meet its liabilities as they fall due. These resources include both capital and liquidity resources. As noted in GENPRU 1.2.3A G, however, the FSA'srules and guidance in relation to the adequacy of the liquidity resources of a BIPRU firm are set out in BIPRU 12.5

In the case of a bank or building society this section implements Article 123 and (in part) Annex XI of the Banking Consolidation Directive. In the case of a BIPRU investment firm this section implements Article 34 of the Capital Adequacy Directive so far as that Article applies Article 123 of the Banking Consolidation Directive.

This section also has rules requiring a firm to identify and assess risks to its being able to meet its liabilities as they fall due, how it intends to deal with those risks, and the amount and nature of financial resources that the firm considers necessary. GENPRU 1.2.60 R provides that a firm should document that assessment. The FSA will review that assessment as part of its own assessment of the adequacy of a firm's capital under its supervisory review and evaluation process (SREP). When forming a view of any individual capital guidance to be given to the firm, the FSA will also review the ARROW risk assessment and any other issues arising from day-to-day supervision. 2

This section also has rules requiring a firm to carry out appropriate stress tests and scenario analyses for the risks it has previously identified and to establish the amount of financial resources needed in each of the circumstances and events considered in carrying out the stress tests and scenario analyses. In the case of a BIPRU firm, the FSA will consider as part of its SREP whether the BIPRU firm should hold a capital planning buffer and, in such a case, the amount and quality of that buffer. The capital planning buffer is an amount separate, though related to, the individual capital guidance, insofar as its purpose is to ensure that a BIPRU firm is able to continue to meet the overall financial adequacy rule throughout the relevant capital planning period in the face of adverse circumstances, after allowing for realistic management actions. Therefore, when forming its view on a BIPRU firm'scapital planning buffer, the FSA will take into account the assessment made in relation to the firm'sICG.8

The basic requirements in this section are drafted to apply to a firm on a solo basis. This section then goes on to describe when its requirements do and do not apply on a solo basis and on a consolidated basis (see GENPRU 1.2.45 R to GENPRU 1.2.47 R and GENPRU 1.2.57 R to GENPRU 1.2.58 R). It also sets out some details about how the solo requirements are adjusted when they are applied on a consolidated basis (see GENPRU 1.2.48 R to GENPRU 1.2.56 G and GENPRU 1.2.29 G).

GENPRU 2.1 sets out the minimum capital resources requirements for a firm. GENPRU 2.2 sets out how capital resources are defined and measured for the purpose of meeting the requirements of GENPRU 2.1.

1. (1)

   BIPRU 2.2 (Internal capital adequacy standards) and INSPRU 7.1 (Individual capital assessment) set out detailed guidance on how a firm should carry out the assessment referred to in GENPRU 1.2.15 G. The more thorough, objective, and prudent a firm's assessment is, and can be demonstrated as being, the more reliance the FSA will be able to place on the results of that assessment.

2. (2)

   BIPRU 2.2 and INSPRU 7.1also have information on how the FSA will review and respond to the assessments referred to in GENPRU 1.2.15 G and, in the case of BIPRU firms, in GENPRU 1.2.16 G.8 In particular they deal with the giving of individual capital guidance8 to a firm, which is guidance about the amount and quality of capital resources that the FSA thinks a firm should hold at all times8 under the overall financial adequacy rule as it applies on a solo level and a consolidated level. BIPRU 2.2. also deals with the giving of a capital planning buffer to a BIPRU firm on a solo level and a consolidated level.8

   8

SYSC sets out general rules and guidance on the establishment and maintenance of systems and controls.

1. (1)

   SYSC 11 sets out material on systems and controls that apply specifically to liquidity risk as that concept relates to an insurer.5

   5
2. (2)

   [deleted]5

   5
3. (2A)

   BIPRU 12 sets out material on systems and controls that apply specifically to liquidity risk in relation to a BIPRUfirm, a branch of an incoming EEA firm that is a full BCD credit institution and a branch of a third country BIPRU firm that is a bank.5

4. (3)

   [deleted]5

   5
5. (4)

   SYSC 11.1.21 E is an evidential provision relating to the general stress and scenario testing rule concerning stress testing and scenario analyses. SYSC 11.1.24 E is an 5evidential provision relating to the overall Pillar 2 rule about contingency funding plans. Both of these evidential provisions apply only to an insurer to which that section of SYSC applies.5

6. (5)

   GENPRU 2.2 (Adequacy of financial resources) requires certain BIPRU investment firms to deduct illiquid assets when calculating their capital resources.

BIPRU 2.3 contains rules and guidance on interest rate risk in the non-trading book. That material elaborates on the general obligation in the overall Pillar 2 rule.

For a BIPRU firm using a VaR modelBIPRU 7.10.72 R (Risk management standards: Stress testing) sets out certain stress tests that the firm should carry out.

BIPRU 10.2.22 R 7 7 (Stress testing of credit risk concentrations) sets out further stress tests that a firm should carry out if it uses certain approaches to collateral for the purposes of the rules about large exposures.7

For a BIPRU firm using the IRB approachBIPRU 4.3.39 R to BIPRU 4.3.40 R set out a recession credit rating migration stress test that the firm should carry out. Further rules and guidance on such stress tests are set out in BIPRU 2.2 (Internal capital adequacy standards).

5 BIPRU 12 contains rules and guidance in relation to the adequacy of a BIPRU firm's liquidity resources. Consistent with GENPRU 1.2.2A R, in assessing the adequacy of its liquidity resources, a BIPRU firm should do so by reference to the overall liquidity adequacy rule, rather than the overall financial adequacy rule.

The liabilities referred to in the overall financial adequacy rule include a firm's contingent and prospective liabilities. They exclude 6liabilities that might arise from transactions that a firm has not entered into and which it could avoid, for example, by taking realistic management actions such as ceasing to transact new business after a suitable period of time has elapsed.6 They include 6liabilities or costs that arise both in scenarios where the firm is a going concern and those where the firm ceases to be 6a going concern. They6also include 6claims that could be made against a firm, which ought to be paid in accordance with fair treatment of customers, even if such claims could not be legally enforced.

A firm should therefore make its assessment of adequate financial resources on realistic valuation bases for assets and liabilities taking into account the actual amounts and timing of cash flows under realistic adverse projections.

Risks may be addressed through holding capital to absorb losses that unexpectedly materialise. The ability to pay liabilities as they fall due also requires liquidity. Therefore, in assessing the adequacy of a firm's financial resources, both capital and liquidity needs should be considered. A firm should also consider the quality of its financial resources such as the loss-absorbency of different types of capital and the time required to liquidate different types of asset. SYSC 11.1.24 E is an evidential provision relating to the overall financial adequacy rule concerning contingency funding plans.

1. (1)

   This paragraph gives guidance on some of the terms used in the overall Pillar 2 rule.

2. (2)

   Insurance risk refers to the inherent uncertainties as to the occurrence, amount and timing of insurance liabilities.

3. (3)

   Interest rate risk in the non-trading book is explained in BIPRU 2.3 (Interest rate risk in the non-trading book).

4. (4)

   In a narrow sense, business risk is the risk to a firm that it suffers losses because its income falls or is volatile relative to its fixed cost base. However, in a broader sense, it is exposure to a wide range of macro-economic, geopolitical, industry, regulatory and other external risks that might deflect a firm from its desired strategy and business plan. GENPRU 1.2.73 G provides further guidance on business risk.

5. (5)

   Further material on pension obligation risk can be found in GENPRU 1.2.79 G – GENPRU 1.2.86 G.

6. (6)

   6Group risk is the risk that the financial position of a firm may be adversely affected by its relationships (financial or non-financial) with other entities in the same group or by risks which may affect the financial position of the whole group, for example reputational contagion. Further guidance on group risk can be found in GENPRU 1.2.87 G to GENPRU 1.2.91 G.

In the overall Pillar 2 rule , internal capital refers to the financial resources of a firm which it treats as being held against the risks listed in the overall Pillar 2 rule. The obligation in that rule to assess the distribution of such capital refers, in relation to a firm making an assessment on a solo basis, for example, to the need to take account of circumstances where part of a firm's financial resources are held by a branch of that firm which are subject to restrictions on its ability to transfer that capital. An assessment of internal capital distribution might also take account of such of a firm's financial resources as may be ring-fenced in the event of its insolvency.

Certain risks such as systems and controls weaknesses may not be adequately addressed by, for example, holding additional capital and a more appropriate response would be to rectify the weakness. In such circumstances, the amount of financial resources required to address these risks might be zero. However, a firm should consider whether holding additional capital might be an appropriate response until the identified weaknesses are rectified. A firm, should, in accordance with GENPRU 1.2.60 R (Documentation of risk assessments), document the approaches taken to manage these risks.

A firm should carry out assessments of the sort described in the overall Pillar 2 rule and GENPRU 1.2.39 R at least annually, or more frequently if changes in the business, strategy, nature or scale of its activities or operational environment suggest that the current level of financial resources is no longer adequate. The appropriateness of the internal process, and the degree of involvement of senior management in the process, will be taken into account by the FSA when reviewing a firm's assessment as part of the FSA's own assessment of the adequacy of a firm's financial resources. The processes and systems should ensure that the assessment of the adequacy of a firm's financial resources is reported to its senior management as often as is necessary.

The assessments undertaken by firms in run-off may not need to be as comprehensive or frequent compared to a firm not in run off since this may better reflect the reduced nature and complexity of its business and reduced access to new capital. Whilst a firm in run-off will still need to carefully monitor the progress of the run off, a more comprehensive assessment may only be appropriate on commencement of the run off or when considering a reduction in capital through the payment of a dividend or other capital distribution or if the firm's circumstances change materially.

6In order to comply with the general stress and scenario testing rule, a firm should undertake a broad range of stress tests which reflect a variety of perspectives, including sensitivity analysis, scenario analysis and stress testing on an individual portfolio as well as a firm-wide level.

6A BIPRU firm with an IRB permission which has any material credit exposures excluded from its IRB models should also include these exposures in its stress and scenario testing to meet its obligations under the general stress and scenario testing rule. A BIPRU firm without an IRB permission, or an insurer that has any material credit and counterparty credit risk exposures, should conduct analyses to assess risks to the credit quality of its counterparties, including any protection sellers, considering both on and off-balance sheet exposures.

6An insurer may choose to carry out its ICA through the use of stress testing and scenario analyses (see INSPRU 7.1.10 G and INSPRU 7.1.68 G). If it does so, in carrying out the stress tests and scenario analyses referred to in GENPRU 1.2.42 R, an insurer should take into account the stress tests it uses for its ICA.

6In carrying out the stress tests and scenario analyses required by GENPRU 1.2.42R (1), a firm should also consider any impact of the adverse circumstances on its capital resources. In particular, a firm should consider the capital resources gearing rules where its tier one capital is eroded by the event.

6A firm should assign adequate resources, including IT systems, to stress testing and scenario analysis, taking into account the stress testing techniques employed, so as to be able to accommodate different and changing stress tests at an appropriate level of granularity.

6 GENPRU 1.2.63 G to GENPRU 1.2.78 G provide additional guidance on stress testing and scenario analyses. In particular, GENPRU 1.2.73A G provides specific guidance on capital planning.

Stress tests and scenario analyses should be carried out at least annually. A firm should, however, consider whether the nature of the major sources of risks identified by it in accordance with GENPRU 1.2.30R (2) (Main requirement relating to risk processes, strategies and systems) and their possible impact on its financial resources suggest that such tests and analyses should be carried out more frequently. For instance, a sudden change in the economic outlook may prompt a firm to revise the parameters of some of its stress tests and scenario analyses. Similarly, if a firm has recently become exposed to a particular sectoral concentration, it may wish to add some stress tests and scenario analyses in order to reflect that concentration. SYSC 11.1.21 E is an evidential provision relating to the general stress and scenario testing rule concerning scenario analysis in relation to liquidity risk.

1. (1)

   GENPRU 1.2.45 R – GENPRU 1.2.56 G explain when the ICAAP rules apply on a solo basis and when they apply on a consolidated basis. This material also explains how the ICAAP rules are adjusted to apply on a consolidated basis.

2. (2)

   GENPRU 1.2.57 R – GENPRU 1.2.59 R provide that the overall financial adequacy rule always applies on a solo basis. They also explain when and how it applies on a consolidated basis.

GENPRU 1.2.49 R means that non-financial members of the firm's group are excluded from the group assessment. Notwithstanding the scope of GENPRU 1.2.49 R, a firm should nevertheless take account of risks arising from the activities of those excluded members in its overall assessment of risk.

A firm to which the ICAAP rules apply on a consolidated basis need not prepare a consolidated basis assessment if such an assessment has been prepared by another member of its group. Where that is the case, a firm may adopt such an assessment as its own. A firm nevertheless remains responsible for the assessment.

The purpose of GENPRU 1.2.51 R – GENPRU 1.2.53 R is to enable the FSA to assess the extent, if any, to which a firm's assessment, calculated on a consolidated basis, is lower than it would be if each separate legal entity were to assess the amount of capital it would require to mitigate its risks (to the same level of confidence) were it not part of a group subject to consolidated supervision under BIPRU 8 (Group risk - consolidation) or INSPRU 6.1 (Group risk: Insurance groups). The reason the FSA wishes to make this assessment is so that individual capital guidance which it gives is fair and comparable as between different firms and groups. Group diversification benefits which a firm might assert exist can be a material consideration in a capital adequacy assessment. Understanding the methods used to aggregate the different risks (for example, the correlation assumptions) is crucial to a proper evaluation of such benefits.

Whereas a single legal entity can generally use its capital to absorb losses wherever they arise, there are often practical and legal restrictions on the ability of a group to do so. For instance:

1. (1)

   capital which is held by overseas regulated firms may not be capable of being remitted to a firm in the UK which has suffered a loss;

2. (2)

   a firm which is insolvent or likely to become so may be obliged to look to the interests of its creditors first before transferring capital to other group companies; and

3. (3)

   a parent company may have to balance the interests of its shareholders against the protection of the creditors of a subsidiary undertaking which is or might become insolvent and may, rationally, conclude that a subsidiary undertaking should be allowed to fail rather than provide capital to support it.

Where a firm assesses the adequacy of its CRR in its particular circumstances in accordance with BIPRU 2.2 (Internal capital adequacy standards) and INSPRU 7.1 (Individual capital assessment) as a basis for deciding what financial resources are adequate, it should include this in the documentation produced in accordance with GENPRU 1.2.60 R.

The general stress and scenario testing rule requires a firm to carry out stress tests and scenario analyses as part of its obligations under the overall Pillar 2 rule. 6Both stress tests and scenario analyses are 6undertaken by a firm to further a better understanding of the vulnerabilities that it faces under adverse 6conditions. They are based on the analysis of the impact of a range of events of varying nature, severity and duration6. These events can be financial, operational or legal or relate to any other risk that might have an economic impact on the firm.

Stress testing typically refers to shifting the values of individual parameters that affect the financial position of a firm and determining the effect on the firm's financial position.

Scenario analysis typically refers to a wider range of parameters being varied at the same time. Scenario analyses often examine the impact of adverse events on the firm's financial position, for example, simultaneous movements in a number of risk categories affecting all of a firm's business operations, such as business volumes, investment values and interest rate movements.

There are three broad purposes of stress testing and scenario analysis. Firstly, it can be used as a means of quantifying how much capital might be absorbed if an adverse event or events occurred. As such it represents a simple ‘what if’ approach to estimating exposure to risks. This might be a proportionate approach to risk management for an unsophisticated business. Secondly, it can be used to provide a check on the outputs and accuracy of risk models; particularly, in identifying non-linear effects when aggregating risks. Thirdly, it can be used to explore the sensitivities in longer term business plans and how capital needs might change over time.

Subject to GENPRU 1.2.76 G, the purpose of stress tests and scenario analyses under the general stress and scenario testing rule is to test the adequacy of overall financial resources. Scenarios need only be identified, and their impact assessed, in so far as this facilitates that purpose. In particular, the nature, depth and detail of the analysis depend, in part, upon the firm's capital strength and the robustness of its risk prevention and risk mitigation measures.

Both stress testing and scenario analyses are forward-looking analysis techniques, which seek to anticipate possible losses that might occur if an identified risk crystallises. In applying them, a firm should decide how far forward to look. This should depend upon:

1. (1)

   how quickly it would be able to identify events or changes in circumstances that might lead to a risk crystallising resulting in a loss; and

2. (2)

   after it has identified the event or circumstance, how quickly and effectively it could act to prevent or mitigate any loss resulting from the risk crystallising and to reduce exposure to any further adverse event or change in circumstance.

Where a firm is exposed to market risk, the6 time horizon over which stress tests and scenario analyses 6should be carried out will 6depend on, among other things,6 the maturity and liquidity of the positions stressed. For example, for the market risk arising from the holding of investments, this will 6depend upon:

1. (1)

   the extent to which there is a regular, open and transparent market in those assets, which would allow fluctuations in the value of the investment to be more readily and quickly identified; and

2. (2)

   the extent to which the market in those assets is sufficiently liquid (and would remain liquid in the changed circumstances contemplated in the stress test or scenario analysis) to allow the firm, if needed, to sell, hedge or otherwise mitigate the risks relating to its holding so as to prevent or reduce exposure to future price fluctuations. In devising stress tests and scenario analyses for market risk, a BIPRU firm should also take into account BIPRU 7.1.17 R to BIPRU 7.1.20 G.6

In identifying scenarios, and assessing their impact, a firm should take into account, where material, how changes in circumstances might impact upon:

1. (1)

   the nature, scale and mix of its future activities; and

2. (2)

   the behaviour of counterparties, and of the firm itself, including the exercise of choices (for example, options embedded in financial instruments or contracts of insurance).

In determining whether it would have adequate financial resources in the event of each identified realistic adverse scenario, a firm should:

1. (1)

   only include financial resources that could reasonably be relied upon as being available in the circumstances of the identified scenario; and

2. (2)

   take account of any legal or other restriction on the use of financial resources.

1. (1)

   6In identifying an appropriate range of adverse circumstances and events in accordance with GENPRU 1.2.42R (2):

   1. (a)

      a firm will need to consider the cycles it is most exposed to and whether these are general economic cycles or specific to particular markets, sectors or industries;

   2. (b)

      for the purposes of GENPRU 1.2.42R (2)(a), the amplitude and duration of the relevant cycle should include a severe downturn scenario based on forward looking hypothetical events, calibrated against the most adverse movements in individual risk drivers experienced over a long historical period;

   3. (c)

      the adverse scenarios considered should in general be acyclical and, accordingly, the scenario should not become more severe during a downturn and less severe during an upturn. However, the FSA does expect scenarios to be updated with relevant new economic data on a pragmatic basis to ensure that the scenario continues to be relevant; and

   4. (d)

      the adverse scenarios considered should reflect a firm's risk tolerance of the adverse conditions through which it expects to remain a going concern.

2. (2)

   6In making the estimate required by GENPRU 1.2.42R (3), a firm should project both its capital resources and its required capital resources over a time horizon of 3 to 5 years, taking account of its business plan and the impact of relevant adverse scenarios. In making the estimate, the firm should consider both the capital resources required to meet its CRR and the capital resources needed to meet the overall financial adequacy rule. The firm should make these projections in a manner consistent with its risk management processes and systems as set out in GENPRU 1.2.37 R.

3. (3)

   6In projecting its financial position over the relevant time horizon, the firm should:

   1. (a)

      reflect how its business plan would “flex” in response to the adverse events being considered, taking into account factors such as changing consumer demand and changes to new business assumptions;

   2. (b)

      consider the potential impact on its stress testing of dynamic feedback effects and second order effects of the major sources of risk identified in accordance with GENPRU 1.2.30R (2);

   3. (c)

      estimate the effects on the firm's financial position of the adverse event without adjusting for management actions;

   4. (d)

      separately, identify any realistic management actions that the firm could and would take to mitigate the adverse effects of the stress scenario; and

   5. (e)

      estimate the effects of the stress scenario on the firm's financial position after taking account of realistic management actions.

4. (4)

   6A firm should identify any realistic management actions intended to maintain or restore its capital adequacy. These could include ceasing to transact new business after a suitable period has elapsed, balance sheet shrinkage, restricting distribution of profits or raising additional capital. A firm should reflect management actions in its projections only where it could and would take such actions, taking account of factors such as market conditions in the stress scenario and any effects upon the firm's reputation with its counterparties and investors. The combined effect on capital and retained earnings should be estimated. In order to assess whether prospective management actions in a stress scenario would be realistic and to determine which actions the firm would and could take, the firm should take into account any preconditions that might affect the value of management actions as risk mitigants and analyse the difference between the estimates in (3)(c) and (3)(e) in sufficient detail to understand the implications of taking different management actions at different times, particularly where they represent a significant divergence from the firm's business plan.

5. (5)

   6The firm should document its stress testing and scenario analysis policies and procedures, as well as the results of its tests in accordance with GENPRU 1.2.60 R. These records should be included within the firm'sICAAP or ICA submission document.

6. (6)

   6The FSA will review the firm's records referred to in (5) as part of its SREP. The purpose of examining these is to enable the FSA to judge whether a firm will be able to continue to meet its CRR and the overall financial adequacy rule throughout the projection period.

7. (7)

   6If, after taking account of realistic management actions, a firm's stress testing management plan shows that the firm's projected capital resources are less than those required to continue to meet its CRR or less than those needed to continue to meet the overall financial adequacy rule over the projection period, the FSA may require the firm to set out additional countervailing measures and off-setting actions to reduce such difference or to restore the firm's capital adequacy after the stress event.

8. (8)

   6The firm's senior management or governing body should be actively involved and engaged in all relevant stages of the firm's stress testing and scenario analysis programme. This would include establishing an appropriate stress testing programme, reviewing the programme’s implementation (including the design of scenarios) and challenging, approving and actioning the results of the stress tests.

9. (9)

   6For an insurer:

   1. (a)

      the treatment of new business when making capital projections is likely to be different from its ICA. In projecting its financial position, an insurer should take account of new business based on the firm's business plan, but flexed to take account of potential changes in trading conditions and strategy. When assessing its current capital adequacy under its ICA, an insurer should take account of the effects of closure to new business (see GENPRU 1.2.27 G, GENPRU 1.2.73AG (3) and (4)and INSPRU 7.1.16 G to INSPRU 7.1.19 G). Also, an insurer may use methods that are more approximate than used for its ICA (for example, in projecting the with-profits insurance capital component for realistic basis life firms and the capital resources needed to meet the overall financial adequacy rule); and

   2. (b)

      where management discretion is exercised as a normal part of an insurer's business (for example, in changing bonus rates or surrender values in accordance with the PPFM for with-profits business), under (3)(c) the insurer does not need to estimate the effect of an adverse event on its financial position without adjusting for such changes. However, the effect on the financial position of varying such actions should be estimated and understood.

6The FSA may formulate macroeconomic and financial market scenarios which a firm may use as an additional input to its ICAAP or ICA submission. In addition, the FSA may also ask a firm to apply specific scenarios directly in its ICAAP or ICA submission.

A firm may consider scenarios in which expected future profits will provide capital reserves against future risks. However, it would only be appropriate to take into account profits that can be foreseen with a reasonable degree of certainty as arising before the risk against which they are being held could possibly arise. In estimating future reserves, a firm should deduct future dividend payment estimates from projections of future profits.

1. (1)

   [deleted]6

   6
2. (2)

   Stress and scenario analyses should, in the first instance, be aligned with the risk appetite of the firm, as well as the nature, scale and complexity of its business and of the risks that it bears. The6 calibration of the 6stress and scenario analyses should be reconciled to a clear statement setting out the premise upon which the firm's internal capital assessment under the overall Pillar 2 rule is based.

   66
3. (3)

   [deleted]6

   6
4. (4)

   In identifying adverse circumstances and events in accordance with GENPRU 1.2.42R (2), a firm should consider the results of any reverse stress testing conducted in accordance with SYSC 20. Reverse stress testing may be expected to provide useful information about the firm's vulnerabilities and variations around the most likely ruin scenarios for the purpose of meeting the firm's obligations under GENPRU 1.2.42 R. In addition, such a comparison may help a firm to assess the sensitivity of its financial position to different stress calibrations.6

   6

A firm should use the results of its stress testing and scenario analysis not only to assess capital needs, but also to decide if measures should be put in place to minimise the adverse effect on the firm if the risk covered by the stress or scenario test actually materialises. Such measures might be a contingency plan or might be more concrete risk mitigation steps.

Additional guidance on stress tests and scenario analyses for the assessment of capital resources is available in BIPRU 2.2 (Internal capital adequacy standards) and INSPRU 7.1 (Individual capital assessment).

Additional guidance in relation to stress tests and scenario analysis for liquidity risk as that concept relates to an insurer5is available in SYSC 11 (Liquidity risk systems and controls). BIPRU 12 sets out the main Handbook provisions in relation to liquidity risk for a BIPRUfirm.5

GENPRU 1.2.80 G to 6GENPRU 1.2.86 G contain guidance on the assessment required by GENPRU 1.2.30R (2)(k) for a firm exposed to pension obligation risk as defined in GENPRU 1.2.31R (5).6

The pension scheme itself (i.e. the scheme's assets and liabilities) is not the focus of the risk assessment but rather 6the firm's obligations towards the pension scheme . A firm should include in its estimate of financial resources both its expected obligations to the pension scheme and any increase in obligations that may arise in a stress scenario.6

If a firm has a current funding obligation in excess of normal contributions or there is a risk that such a funding obligation will arise then, when calculating available capital resources, it should reverse out any accounting deficit and replace this in its capital adequacy assessment with its best estimate, calculated in discussion with the scheme's actuaries or trustees, of the cash that will need to be paid into the scheme in addition to normal contributions over the foreseeable future. This may differ from the approach taken in assessing pension scheme risks for the purposes of calculating resources to meet the CRR, where a firm may not need to consider funding obligations beyond the next five years.

1A firm should also 6assess the risks that may 6increase its current funding 6obligations towards the pension scheme and 6that might lead to the firm not being able to pay its other liabilities as they fall due.

A firm may wish to consider the following scenarios:

1. (1)

   one in which the firm gets into difficulties with an effect on its ability to fund the pension scheme; and

2. (2)

   one in which the pension scheme position deteriorates (for example, because investment returns fall below expected returns or because of increases in life expectancy) with an effect on the firm's funding obligations; taking into account the management actions the firm could and would take.

6A firm is expected to determine where the scope of any stress test impacts upon its pension obligation risk and estimate how the relevant measure of pension obligation risk will change in the scenario in question. For example, in carrying out stress tests under GENPRU 1.2.42 R a firm must consider how a stress scenario, such as an economic recession, would impact on the firm's current obligations towards its pension scheme and any potential increase in those obligations. Risks such as interest rate risk or reduced investment returns may have a direct impact on a firm's financial position as well as an indirect impact resulting from an increase in the firm's pension scheme obligations. Both effects should be taken into account in a firm's estimate of financial resources under GENPRU 1.2.30 R.

Scenarios in which a firm's employees suffer a loss or members of a pension scheme suffer a loss do not necessarily affect the firm's ability to pay its liabilities as they fall due.

A firm should consider issues such as:

1. (1)

   the extent to which trustees of the pension scheme or a pension regulator (such as the one created under the Pensions Act 2004) can compel a certain level of contributions or a one-off payment in adverse financial situations or in order to meet the minimum legal requirements under the scheme's trust deed and rules or under the applicable laws relating to the pension scheme;

2. (2)

   whether the valuation bases used to set pension scheme contribution rates are consistent with the firm's current business plans and anticipated changes in the workforce; and

3. (3)

   which valuation basis is appropriate given the expected investment return on scheme assets and actions the firm can take if those returns do not materialise.

A firm should carry out analyses only to a degree of sophistication and complexity which is commensurate with the materiality of its pension risks.

6 GENPRU 1.2.88G to GENPRU 1.2.91G contain additional guidance on the assessment required by GENPRU 1.2.30R (2)(l)10 (Group risk).

6A firm should include in the written record referred to in GENPRU 1.2.60 R a description of the broad business strategy ofthe insurance group, the UK consolidation group or the non-EEA sub-group of which it is a member, the group’s view of its principal risks and its approach to measuring, managing and controlling the risks. This description should include the role of stress testing, scenario analysis and contingency planning in managing risk at the solo and consolidated level.

6A firm should satisfy itself that the systems (including IT) ofthe insurance group, the UK consolidation group or the non-EEA sub-group of which it is a member are sufficiently sound to support the effective management and, where applicable, the quantification of the risks that could affectthe insurance group, the UK consolidation group or the non-EEA sub-group, as the case may be.

6In performing stress tests and scenario analyses, a firm should take into account the risk that its group may have to bring back on to its consolidated balance sheet the assets and liabilities of off-balance sheet entities as a result of reputational contagion, notwithstanding the appearance of legal risk transfer.

6A firm should carry out stress tests and scenario analyses to a degree of sophistication which is commensurate with the complexity of its group and the nature of its group risk.

This section sets out, for the purposes of GENPRU, BIPRU and INSPRU, rules and guidance as to how a firm should recognise and value assets, liabilities, exposures, equity and income statement items.

1. (1)

   In the case of a BIPRU firm, this section implements Article 74 of the Banking Consolidation Directive, Articles 64(4) and 64(5)9 of the Banking Consolidation Directive (Own funds) and Article 33 and Part B of Annex VII of the Capital Adequacy Directive.

   9
2. (2)

   In the case of an insurer, GENPRU 1.3.4 R implements the requirements of Articles 23.3(viii) and 24.2(iv) of the Consolidated Life Directive.

Except where a rule in GENPRU, BIPRU or INSPRU makes different provision, GENPRU 1.3.4 R applies whenever a rule in GENPRU, BIPRU or INSPRU refers to the value or amount of an asset, liability, exposure, equity or income statement item, 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, exposure, equity or income statement item; and

3. (3)

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

In particular, unless an exception applies, GENPRU 1.3.4 R should be applied for the purposes of GENPRU, BIPRU or INSPRU 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 GENPRU 1.3.7 G);

3. (3)

   leased tangible assets;

4. (4)

   assets transferred or received under a sale and repurchase3 or stock lending transaction; and

5. (5)

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

In the case of an insurer or a UK ISPV, where assets or liabilities are securitised, GENPRU 1.3.4 R only permits de-recognition where Financial Reporting Standards7 (or, where applicable, International Accounting Standards) permit7 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

Articles 23.3(viii) and 24.2(iv) of the Consolidated Life Directive require assets of an insurer that are managed on its behalf by a subsidiary undertaking to be taken into account for the purposes of determining the insurer'sadmissible assets and its assets in excess of concentration limits. The application of GENPRU 1.3.4 R will result in such assets remaining on the balance sheet of the insurer.

A 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.

The provisions of GENPRU 1.3.9 R to GENPRU 1.3.10 R and GENPRU 1.3.36 R apply only to the extent that the items referred to in those paragraphs would otherwise be recognised under the accounting requirements applicable to the firm. Some of those requirements may only be relevant to a firm subject to international accounting standards.

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.

Reconciliation differences under GENPRU 1.3.34 R should not be reflected in the valuations under GENPRU 1.3 but should be disclosed to the FSA in prudential returns.10Firms which are subject to the reporting requirement under SUP 16.16 should disclose those reconciliation differences in the Prudent Valuation Return which they are required to submit to the FSA under SUP 16.16.4 R.

UK banks and BIPRU 730k firms are reminded that they may, in respect of their prudent valuation assessments under GENPRU 1.3.4 R and GENPRU 1.3.14 R to GENPRU 1.3.34 R, be subject to the requirement under SUP 16.16.4 R to submit a Prudent Valuation Return to the FSA.

Provisions for equity instruments held in the available-for-sale category can be found in GENPRU 2.2.185 R.

The effect of GENPRU 1.3.43 R is that shares in, and debts3 due from, related undertakings of the types referred to are not valued on a mark to market basis by insurers. As a result, debts3 due from these undertakings, and shares in related undertakings which are ancillary services undertakings, are valued at their accounting book value in accordance with GENPRU 1.3.4 R. shares in related undertakings referred to in GENPRU 1.3.43R (1) or (3) are valued by insurers in accordance with GENPRU 1.3.45 R to GENPRU 1.3.50 R.

GENPRU 1.3.47 R to GENPRU 1.3.51 R set out several different valuation bases for an insurer'sshares in related undertakings. The regulatory surplus value5(defined in GENPRU 1.3.48 R) measures the related undertaking's own capital surplus or deficit. This is used: (i) in GENPRU 1.3.47 R as a basis for calculating the impact on the firm's position of its investments in related undertakings; and (ii) in INSPRU 6.1 as a starting point for the calculation of ineligible surplus capital.

GENPRU 1.3.47 R determines how, for the purposes of the solo capital adequacy calculation of an insurer, that insurer'scapital resources should be adjusted to take into account its investments in related undertakings.

The rules that specify how, for the purposes of the adjusted solo capital calculation, an insurer should incorporate its related undertakings into its capital resources and capital resources requirement are set out in INSPRU 6.1.

An insurer may value amounts recoverable from an ISPV if it obtains a waiver of GENPRU 1.3.55 R under section 148 of the Act. The conditions that will need to be met, in addition to the statutory tests under section 148(4) of the Act, before the FSA will consider granting such a waiver are set out in INSPRU 1.6.13 G to INSPRU 1.6.18 G.

The insurance market direction in GENPRU 1.5.5 D is given under section 316(1) of the Act (Direction by Authority) and applies to members.

The purpose of the insurance market direction in GENPRU 1.5.5 D is to enable the FSA to make the rule in GENPRU 1.5.7 R applying to members, in order to:

1. (1)

   protect policyholders against the risk that members may not have adequate financial resources to meet liabilities under or in respect of contracts of insurance as they fall due;

2. (2)

   promote confidence in the market at Lloyd's by requiring members to maintain financial resources which are adequate to meet their liabilities.

Part X of the Act is a core provision specified in section 317(1) of the Act (The core provisions). Section 317(2) provides that references in an applied core provision to an authorised person are to be read as references to a person in the class to which the insurance market direction applies. From 1 January 2005, references in Part X of the Act are to be read as references to members for the purposes of GENPRU 1.5.7 R to GENPRU 1.5.9 G.

Under GENPRU:

1. (1)

   managing agents must ensure that adequate financial resources are available to support the insurance business carried on through each syndicate that they manage; and

2. (2)

   the Society must, having regard to the availability and value of the central assets, ensure that the financial resources supporting the insurance business of each member are adequate at all times.

In practice, compliance with the requirements described in GENPRU 1.5.8 G is likely to have the effect that members comply with GENPRU 1.5.7 R.

The FSA would normally expect not less than six months' notice under GENPRU 1.5.19 R.

The liabilities to be valued under GENPRU 1.5.21 R and deducted under GENPRU 1.5.23 R include:

1. (1)

   amounts owing to members' agents;

2. (2)

   amounts owing to the Society;

3. (3)

   an appropriate accrual for tax payable on any profits;

4. (4)

   (where required under any applicable accounting principle in accordance with GENPRU 1.3.4 R), any contingent liability relating to liabilities reinsured into Equitas Reinsurance Ltd; and

5. (5)

   amounts apportioned to members in respect of the credit equalisation provision in INSPRU 1.4.

There may be contingent liabilities associated with the reinsurance into Equitas. GENPRU 1.3 requires managing agents and the Society to treat those contingent liabilities in accordance with applicable accounting principles: see GENPRU 1.3.4 R. Depending on the circumstances, managing agents or the Society may need to disclose or account for such a liability.