Insurance (Amendment) (Valuation of Liabilities Rates of Interest) Regulations 2015 CONSULTATION PAPER CP15-01

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1 Insurance (Amendment) (Valuation of Liabilities Rates of Interest) Regulations 2015 CONSULTATION PAPER CP15-01

2 This Consultation Paper is issued by the Insurance and Pensions Authority ( the Authority ), the regulatory authority responsible for the supervision of the insurance and pensions sectors in the Isle of Man. What is it for? This paper sets out the detail of, and rationale for, proposed changes to the Insurance (Valuation of Liabilities) Regulations These changes clarify how insurers may make assumptions for unit growth rates in the valuation of their liabilities, and also amends the way in which the valuation rate of interest may be set for non-linked contracts whose liability cash flows are illiquid and predictable, such as immediate whole life annuities. Who is affected by it? This document will be of direct interest to all existing and prospective insurance companies undertaking long term insurance business in or from the Isle of Man. In particular, it will be of interest to those with functional responsibility and oversight of the actuarial and finance functions and all Appointed Actuaries within those companies. Issue date 16 April 2015 Closing dates for comment 28 May 2015

3 1 Introduction The Insurance and Pensions Authority has drafted the Insurance (Amendment) (Valuation of Liabilities Rates of Interest) Regulations 2015 (the draft Regulations ) which clarify the expectations of the Authority in respect of the unit growth rates assumptions used by insurers in the valuation of unit-linked long term insurance liabilities. In addition, the draft Regulations introduce a new permitted approach to the derivation of the valuation rate of interest for non-linked contracts which are not cancellable by the policyholder, where the cash flows of the liabilities are predictable and can be determined with reasonable certainty and where the cash flows of assets and liabilities are, and will remain, closely matched. A copy of the draft Regulations are attached as an appendix to this document and comments are invited from interested parties. 2 Purpose of the Draft Regulations The purpose of the draft regulations is to amend Regulation 17 of the Insurance (Valuation of Long Term Liabilities) Regulations 2007, to a) clarify the expectations of the Authority in respect of the unit growth rate assumptions used by insurers in the valuation of unit-linked long term insurance liabilities; and b) set out a new permitted approach to the derivation of the valuation rate of interest for non-linked contracts which are not cancellable on the option of the policyholder, where the cash flows of the liabilities are predictable and can be determined with reasonable certainty, and where the cash flows of assets and liabilities are, and will remain, closely matched. In addition the above amendments will more closely align the current regulations with the approach likely to be adopted by the Authority in its new regulatory framework currently being tested in the QIS1 exercise. Item a) above clarifies the Authority s expectation that the unit growth rates (before charges) assumed for the valuation of unit-linked business may be no higher than the yields which could be earned on risk-free investments (unless higher rates would be more prudent). Item b) permits the valuation rates of interest to be higher than those determined from riskfree investments in respect of non-linked contracts of insurance (such as whole-life immediate annuities) where (a) the insurance contracts, for which the expected liability cash-flow present value is being calculated, are not able to be surrendered on the option of the policyholder, or in the case of an annuity contract may only be surrendered for an amount no greater than the market value of the assets backing the contract; and 1

4 (b) the expected liability cashflows for which a present value is being calculated are predictable and may not be varied by the policyholder other than as in (a) above; and (c) the expected cash flows of the assets backing these liabilities are closely matched with the expected liability cash flows and will remain so throughout the remainder of the lifetime of the insurance contracts. The rationale for this change is that for such contracts the company will not need to sell the underlying assets and can hold them to maturity, and as such can take credit for any illiquidity premium priced in to the assets. The valuation rate of interest continues to be subject to the requirement of prudence. The revised Regulation 17 is set out in the Appendix. 3 Comments and Timing The Authority invites comments on the proposed draft Regulations by 28 May 2015, though earlier submission would be welcome. Respondents are asked to provide evidence and/or reasoning, where appropriate, to support their responses. The Authority will seek to respond to any comments or questions as soon as is practicable following their receipt. Respondents must please identify themselves and provide contact details with their submissions. Please note that anonymous submissions will be disregarded. A summary of responses will be posted on the Authority s website at Please note that, whilst the Authority will give careful consideration to all responses received, a response to this consultation does not guarantee a change to the proposed Regulations. 4 Contact Any questions or correspondence on this should be addressed in the first instance to: Neil Taverner The Insurance and Pensions Authority Ground Floor, Finch Hill House Bucks Road Douglas Isle of Man IM1 3DF neil.taverner@ipa.gov.im 2

5 Regulation 17 of Insurance (Valuation of Long Term Liabilities) Regulations 2007 as amended by the draft Insurance (Amendment) (Valuation of Liabilities Rates of Interest) Regulations 2015 Rates of interest, including unit growth rates 17. (1) The rates of interest and unit growth rates to be used in calculating the present value of future payments by or to an insurance company shall be determined as a prudent assessment of the yields on existing assets attributed to the long-term business, net of tax and any charges, and, to the extent appropriate, the yields which it is expected will be obtained on sums to be invested in the future, net of tax and any charges. Subject to sub-paragraph (3), this prudent assessment should not be less prudent than the yields that could be obtained from risk free investments of similar terms denominated in a similar currency, net of tax and any charges. (2) For the purpose of determining the rates of interest and unit growth rates to be used in valuing a particular category of contracts the assets may, where appropriate, be notionally apportioned between different categories of contracts. (3) Where, in respect of a group of non-linked insurance contracts for which the present value of the expected liability cash flows is being calculated (in this paragraph the insurance contracts ),: (a) each of the insurance contracts may not be surrendered by the policyholder, or in the case of an annuity contract, may only be surrendered for an amount no greater than the market value of the assets backing the contract; and (b) the expected liability cash flows are predictable and may not be varied by the policyholder other than as in (a) above; and (c) the expected cash flows of the assets backing the long-term liability of the insurance contracts are closely matched to the expected liability cash flows and will remain so throughout the remainder of the lifetime of the insurance contracts, in determining under sub-paragraph (1) what constitutes a prudent assessment of the yields on existing assets attributed to the long-term business, and the yields which it is expected will be obtained on sums to be invested in future, such prudent assessment may be higher than the yields obtained from risk free investments, subject to the prudence requirements of Regulations 9 and 10. (4) The allowance for prudence for each group of contracts in determining the valuation rates of interest in sub-paragraphs (1) and (3) above shall take the form of an addition or a deduction to the yield, depending on whether the net cash flow being discounted is positive or negative, respectively. 3

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