LLD 19.4 Individual capital assessment

PRU 1.2 requires firms to carry out assessments of the adequacy of their financial resources. Financial resources include capital resources and liquidity resources. PRU 5 contains guidance on liquidity stress tests. Managing agents should manage liquidity risk affecting each syndicate they manage and the Society should manage liquidity risk affecting funds at Lloyd's and central assets, including the risk that it cannot make liquid assets available to support syndicates on a timely basis.

PRU 2 sets out provisions that deal specifically with the adequacy of that part of a firm's financial resources that consists of capital resources. PRU 2.3 sets out guidance on how firms should assess the adequacy of their capital resources. The relevant requirements for Lloyd's are that:

1. (1)

   the Society should carry out regular assessments of the adequacy of the capital resources available to support each member's insurance business; and

2. (2)

   managing agents should carry out regular assessments of the adequacy of capital resources held at syndicate level in respect of the insurance business carried on through each syndicate.

Responsibility for:

1. (1)

   managing the risks associated with the insurance business; and

2. (2)

   holding the capital resources that support those risks;

is divided between managing agents and the Society. To clarify the respective responsibilities of managing agents and the Society for ensuring the adequacy of financial resources, the FSA distinguishes between the managing agents' responsibility to carry out capital adequacy assessments for each syndicate that they manage, and the Society's responsibility to carry out an assessment for each member.

In assessing the adequacy of the capital resources supporting the insurance business of each member, the Society should consider the risks, controls and financial resources relevant to the totality of the member's insurance business, including:

1. (1)

   the adequacy of syndicate ICAs;

2. (2)

   the member's share of syndicate ICAs;

3. (3)

   adjustments in respect of risks and controls relating to funds at Lloyd's, central assets and the interaction of risks underwritten by the member through different syndicates and in respect of different syndicate years; and

4. (4)

   the ongoing validity of any relevant assumptions it makes.

The Society should be able to justify any reliance it places on a syndicate ICA, for example by being able to demonstrate that it has carried out appropriate checks.

In taking account of a syndicate ICA under LLD 19.4.8 R:

1. (1)

   if the Society considers a syndicate ICA to be adequate, it should use the managing agent's risk and capital assessments in carrying out its individual capital assessment in relation to any member of that syndicate , or it should be able to justify why it will not; and

2. (2)

   if the Society considers a syndicate ICA to be less than adequate, the Society should increase the syndicate ICA so that it is adequate for the purpose of carrying out its individual capital assessment in relation to the members of that syndicate.

The assessment of capital adequacy for a member will rarely equal the proportionate share of a syndicate ICA (or sum of those shares, where the member participates on more than one syndicate) as attributed to that member, because, in determining the capital assessments for each member, the Society may make adjustments to take account of:

1. (1)

   risks and controls associated with funds at Lloyd's and central assets, which can increase the member's individual capital assessment;

2. (2)

   diversification effects, including as a result of members' participations on more than one syndicate year, which can reduce the member's individual capital assessment; and

3. (3)

   its own assessment of syndicate risks, which can be higher than the managing agent's and so increase the member's individual capital assessment.

Capital resources to meet each syndicate ICA could be:

1. (1)

   held within a syndicate and managed by the managing agent; or

2. (2)

   held and managed by the Society; or

3. (3)

   not needed in full, because of effects such as diversification that the Society takes into account.

The balancing amount is a function of the relationship between the syndicate ICA and the amount of assets held within the syndicate. As illustrations:

1. (1)

   if the syndicate holds no capital resources (but its liabilities are fully covered by relevant assets), the balancing amount equals the syndicate ICA (as there are no capital resources at syndicate level, all the capital resources must be held as funds at Lloyd's or central assets);

2. (2)

   if capital resources held at syndicate level are negative (i.e. if relevant assets do not fully cover liabilities for the syndicate), the balancing amount should be higher than the syndicate ICA by an amount corresponding to the negative capital resources held by managing agents on behalf of the syndicate; and

3. (3)

   conversely, if a syndicate holds positive capital resources for the syndicate, the balancing amount should be lower than the syndicate ICA by a corresponding amount.

Managing agents should submit syndicate ICAs and notify balancing amounts to the Society as part of the annual capital-setting process at Lloyd's. The submission of the syndicate ICA and notification of the balancing amount should be made in good time for the Society to review them and place appropriate reliance on them when it determines the capital assessments for each member.

When communicating the syndicate ICA and balancing amount for each syndicate to the Society, managing agents should agree with the Society an allocation of the syndicate ICA between syndicate years. The purpose of the allocation is to ensure that there is an appropriate matching of assets to risk and liabilities and an equitable treatment between the members reflecting the provision of capital in each syndicate year.

Under LLD 19.4.23 R, a managing agent has a continuing obligation to communicate to the Society a revised syndicate ICA and, where appropriate, a revised balancing amount, if it considers that the syndicate ICA and balancing amount communicated in the capital-setting process are no longer adequate in the light of the risks to which the syndicate business is exposed.

For the purposes of complying with their obligations under PRU, managing agents may assume that any balancing amount confirmed by the Society under LLD 19.4.17 R is supported by capital resources held as funds at Lloyd's and central assets.

Following initial confirmation of a balancing amount by the Society, assumptions made about risks and controls may change or risks may crystallise, affecting:

1. (1)

   the syndicate ICA (and hence, possibly, the balancing amount); or

2. (2)

   the relationship between a syndicate ICA and a member's individual capital assessment; or

3. (3)

   the amount of capital resources available.