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TITLE IU.K. [X1VALUATION AND RISK-BASED CAPITAL REQUIREMENTS (PILLAR I), ENHANCED GOVERNANCE (PILLAR II) AND INCREASED TRANSPARENCY (PILLAR III)]

CHAPTER IIIU.K. RULES RELATING TO TECHNICAL PROVISIONS

SECTION 4 U.K. Relevant risk-free interest rate term structure

Subsection 1 U.K. General provisions
[F1 Article 43 U.K. General provisions

1 . The rates of the basic risk-free interest rate term structure shall meet all of the following criteria:

( a ) insurance and reinsurance undertakings are able to earn the rates in a risk-free manner in practice;

( b ) the rates are reliably determined based on financial instruments traded in a deep, liquid and transparent financial market.

The rates of the relevant risk-free interest rate term structure shall be calculated separately for each currency and maturity, based on all information and data relevant for that currency and that maturity.

2 . The techniques, data specifications and parameters used for determining the technical information on the relevant risk-free interest rate term structure F2..., including the ultimate forward rate, the last maturity for which the relevant risk-free interest rate term structure is not being extrapolated and the duration of its convergence towards the ultimate forward rate, shall be transparent, prudent, reliable, objective and consistent over time.

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Textual Amendments

Subsection 2 U.K. Basic risk free interest rate term structure
Article 44U.K.Relevant financial instruments to derive the basic risk-free interest rates

1.For each currency and maturity, the basic risk-free interest rates shall be derived on the basis of interest rate swap rates for interest rates of that currency, adjusted to take account of credit risk.

2.For each currency, for maturities where interest rate swap rates are not available from deep, liquid and transparent financial markets the rates of government bonds issued in that currency, adjusted to take account of the credit risk of the government bonds, shall be used to derive the basic risk free-interest rates, provided that, such government bond rates are available from deep, liquid and transparent financial markets.

Article 45U.K.Adjustment to swap rates for credit risk

The adjustment for credit risk referred to in Article 44(1) shall be determined in a transparent, prudent, reliable and objective manner that is consistent over time. [F4The adjustment is to be calculated to reflect the level of credit risk inherent in a financial instrument which is used to derive the basic risk-free interest rate. If a relevant financial instrument contains negligible credit risk, the adjustment may be zero.]

Textual Amendments

Article 46U.K.Extrapolation

1.The principles applied when extrapolating the relevant risk free interest rate term structure shall be the same for all currencies. This shall also apply as regards the determination of the longest maturities for which interest rates can be observed in a deep, liquid and transparent market and the mechanism to ensure a smooth convergence to the ultimate forward rate.

2.Where insurance and reinsurance undertakings apply Article 77d of Directive 2009/138/EC, the extrapolation shall be applied to the risk-free interest rates including the volatility adjustment referred to in that Article.

3.Where insurance and reinsurance undertakings apply [F5a matching adjustment], the extrapolation shall be based on the risk-free interest rates without a matching adjustment. The matching adjustment F6... shall be applied to the extrapolated risk-free interest rates.

Textual Amendments

Article 47U.K.Ultimate forward rate

1.For each currency, the ultimate forward rate referred to in paragraph 1 of Article 46 shall be stable over time and shall only change as a result of changes in long-term expectations. The methodology to derive the ultimate forward rate shall be clearly specified in order to ensure the performance of scenario calculations by insurance and reinsurance undertakings. It shall be determined in a transparent, prudent, reliable and objective manner that is consistent over time.

2.For each currency the ultimate forward rate shall take account of expectations of the long-term real interest rate and of expected inflation, provided those expectations can be determined for that currency in a reliable manner. The ultimate forward rate shall not include a term premium to reflect the additional risk of holding long-term investments.

Article 48U.K.Basic risk-free interest rate term structure of currencies pegged to the euro

1.For a currency pegged to the euro, the basic risk-free interest rate term structure for the euro, adjusted for currency risk, may be used to calculate the best estimate with respect to insurance or reinsurance obligations denoted in that currency, provided that all of the following conditions are met:

(a)the pegging ensures that the exchange rate between that currency and the euro stays within a range not wider than 20 % of the upper limit of the range;

(b)the economic situation of the euro area and the area of that currency are sufficiently similar to ensure that interest rates for the euro and that currency develop in a similar way;

(c)the pegging arrangement ensures that the relative changes in the exchange rate over a one-year-period do not exceed the range referred to in point (a) of this paragraph, in the event of extreme market events, that correspond to the confidence level set out in [F7rules 3.3 and 3.4 of the Solvency Capital Requirement – General Provisions part of the PRA Rulebook];

(d)one of the following criteria is complied with:

(i)

participation of that currency in the European Exchange Rate Mechanism (ERM II);

(ii)

existence of a decision from the Council which recognizes pegging arrangements between that currency and the euro;

(iii)

establishment of the pegging arrangement by the law of the country establishing that country's currency.

For the purpose of point (c), the financial resources of the parties that guarantee the pegging shall be taken into account.

2.The adjustment for currency risk shall be negative and shall correspond to the cost of hedging against the risk that the value in the pegged currency of an investment denominated in euro decreases as a result of changes in the level of the exchange rate between the euro and the pegged currency. The adjustment shall be the same for all insurance and reinsurance undertakings.

Textual Amendments

Subsection 3 U.K. Volatility adjustment
Article 49U.K.Reference portfolios

1.The reference portfolios referred to in Article 77d(2) and (4) of Directive 2009/138/EC shall be determined in a transparent, prudent, reliable and objective manner that is consistent over time. The methods applied when determining the reference portfolios shall be the same for all currencies and countries.

2.For each currency and each country, the assets of the reference portfolio shall be valued in accordance with Article 10(1) and shall be traded in markets that, except in periods of stressed liquidity, comply with Article 40(3). Financial instruments traded in markets that temporarily cease to comply with Article 40(3) may only be included in the portfolio where that market is expected to comply with the criteria again within a reasonable period.

3.For each currency and each country, the reference portfolio of assets shall meet all of the following requirements:

(a)for each currency, the assets are representative of the investments made by insurance and reinsurance undertakings in that currency to cover the best estimate for insurance and reinsurance obligations denominated in that currency; for each country, the assets are representative of the investments made by insurance and reinsurance undertakings in that country to cover the best estimate for insurance and reinsurance obligations sold in the insurance market of that country and denominated in the currency of that country;

(b)where available the portfolio is based on relevant indices which are readily available to the public and published criteria exist for when and how the constituents of those indices will be changed;

(c)the portfolio of assets includes all of the following assets:

For the purposes of points (a) and (b), investments of insurance and reinsurance undertakings in collective investment undertakings and other investments packaged as funds shall be treated as investments in the underlying assets.

Article 50U.K.Formula to calculate the spread underlying the volatility adjustment

For each currency and each country the spread referred to in Article 77d(2) and (4) of Directive 2009/138/EC shall be equal to the following:

where:

(a)

wgov denotes the ratio of the value of government bonds included in the reference portfolio of assets for that currency or country and the value of all the assets included in that reference portfolio;

(b)

Sgov denotes the average currency spread on government bonds included in the reference portfolio of assets for that currency or country;

(c)

wcorp denotes the ratio of the value of bonds other than government bonds, loans and securitisations included in the reference portfolio of assets for that currency or country and the value of all the assets included in that reference portfolio;

(d)

Scorp denotes the average currency spread on bonds other than government bonds, loans and securitisations included in the reference portfolio of assets for that currency or country.

For the purposes of this Article, ‘government bonds’ means exposures to central governments and central banks.

Article 51U.K.Risk-corrected spread

The portion of the average currency spread that is attributable to a realistic assessment of expected losses, unexpected credit risk or any other risk referred to in Article 77d(3) and (4) of Directive 2009/138/EC shall be calculated in the same manner as the fundamental spread referred to in Article 77c (2) of Directive 2009/138/EC and Article 54 of this Regulation [F8as if Article 54 had not been revoked].

Textual Amendments

Subsection 4U.K.Matching adjustment
F9Article 52U.K.Mortality risk stress

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Textual Amendments

F9Regulation revoked (30.6.2024 for the revocation of Arts. 52-54) by Financial Services and Markets Act 2023 (c. 29), s. 86(3), Sch. 1 Pt. 3 (with s. 1(4)); S.I. 2023/1382, reg. 5(c)(i)

F9Article 53U.K.

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Textual Amendments

F9Regulation revoked (30.6.2024 for the revocation of Arts. 52-54) by Financial Services and Markets Act 2023 (c. 29), s. 86(3), Sch. 1 Pt. 3 (with s. 1(4)); S.I. 2023/1382, reg. 5(c)(i)

F9Article 54U.K.

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Textual Amendments

F9Regulation revoked (30.6.2024 for the revocation of Arts. 52-54) by Financial Services and Markets Act 2023 (c. 29), s. 86(3), Sch. 1 Pt. 3 (with s. 1(4)); S.I. 2023/1382, reg. 5(c)(i)

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