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Timeline guidance

INSPRU 3.1 Market risk in insurance

INSPRU 3.1.1RRP

1INSPRU 3.1 applies to an insurer, unless it is:

  1. (1)

    a non-directive friendly society; or

  2. (2)

    [deleted]9

  3. (3)

    [deleted]9

    77
  4. (4)

    a Solvency II firm.7

Purpose

INSPRU 3.1.7GRP

INSPRU 3.1 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 is required8 to hold capital to cover market risk. INSPRU 3.1.26R makes particular provision for assets invested outside the UK.8

    2
  2. (2)

    Firms carrying on long-term insurance business that have property-linked liabilities or index-linked liabilities must cover these liabilities by holding appropriate assets. INSPRU 3.1.57R and INSPRU 3.1.58R set out these cover requirements.8

  3. (3)

    INSPRU 3.1.61AR(1) applies to pure reinsurers "prudent person" investment principles in relation to the investment of their assets.8

2

Market risk scenario for assets invested outside the United Kingdom

INSPRU 3.1.26RRP

Where the assets of a firm invested in a significant territory for the purposes of PRA Rulebook: Non-Solvency II firms: Capital Resources Requirements, 20.10,8 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 in8 PRA Rulebook: Non-Solvency II firms: Capital Resources Requirements, 20.10 instead of the other market risk scenarios set out in that provision8.

Covering linked liabilities

INSPRU 3.1.57RRP

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).

INSPRU 3.1.58RRP

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).

INSPRU 3.1.59GRP

For the purposes of INSPRU 3.1.57 R and INSPRU 3.1.58 R, a firm is not permitted to hold different assets and to cover the mismatch by holding excess assets.

INSPRU 3.1.60GRP

If a firm has incurred a policy liability which cannot be exactly matched by appropriate assets (for example the Limited Price Index (LPI)), 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 an RPI bond or a fixed interest investment matching cash flows increasing at 5% per annum compound. Orders made by the Department for Work and Pensions under section 148 of the Social Security Administration Act 1992, and which are limited to 5% per annum, may also be matched by a fixed interest investment matching cash flows increasing at 5% per annum compound8.

4
INSPRU 3.1.61GRP

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.8

INSPRU 3.1.61-AGRP

4Where liabilities are linked to orders made under section 148 of the Social Security Administration Act 1992 the risks associated with the business8 may be mitigated by holding assets to cover an alternative index which is reasonably expected to at least cover the section 148 order (e.g. RPI plus a margin) over the duration of the link. The firm's exposure to an order under section 148 exceeding this index should be appropriately limited by putting a cap on the liabilities linked to the order so that risks are within acceptable limits.

1010

Pure reinsurers

INSPRU 3.1.61ARRP

A pure reinsurer must invest its assets in accordance with the following requirements:

  1. (1)

    the assets must take account of the type of business carried out by the firm, in particular the nature, amount and duration of expected claims payments, in such a way as to secure the sufficiency, liquidity, security, quality, profitability and matching of its investments;

  2. (2)

    the firm must ensure that the assets are diversified and adequately spread and allow the firm to respond adequately to changing economic circumstances, in particular developments in the financial markets and real estate markets or major catastrophic events; the firm must assess the impact of irregular market circumstances on its assets and must diversify the assets in such a way as to reduce such impact;

  3. (3)

    investment in assets which are not admitted to trading on a regulated market must be kept to prudent levels;

  4. (4)

    investment in derivatives and quasi-derivatives must contribute to a reduction of investment risks or facilitate efficient portfolio management and such investments must be valued on a prudent basis, taking into account the underlying assets, and included in the valuation of the firm's assets. The firm must avoid excessive risk exposure to a single counterparty and to other derivative or quasi-derivative operations;

  5. (5)

    the assets must be properly diversified in such a way as to avoid:

    1. (a)

      excessive reliance on any one particular asset, issuer or group of undertakings; and

    2. (b)

      accumulations of risk in the portfolio as a whole.

    Investments in assets issued by the same issuer or by issuers belonging to the same group must not expose the firm to excessive risk concentration; and

  6. (6)

    (5) does not apply to investment in government bonds.