Determination of liabilities

Part

LLD Lloyd's

Chapter

Determination of liabilities

Printed on: 05/07/2024

Rulebook at: 31/12/2004

LLD 12

Determination of liabilities

LLD 12.1

Application and purpose

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Application

LLD 12.1.1

This chapter applies to the Society.

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LLD 12.1.2

A contravention of the rules in this chapter does not give rise to a right of action by a private person under section 150 of the Act (Actions for damages) and each of those rules is specified under section 150(2) of the Act as a provision giving rise to no such right of action.

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Purpose

LLD 12.1.3

These requirements provide safeguards against the risk that insurance liabilities will be underestimated (see also LLD 9.1.4 G).

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LLD 12.1.4

Under LLD 9.4.1 R, subject to LLD 9 to LLD 15, the insurance accounts rules and generally accepted accounting practice apply to the valuation of assets and the determination of liabilities.

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LLD 12.2

Requirement to determine liabilities

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LLD 12.2.1

The Society must:

(1) identify and attribute a value to its liabilities; and

(2) take all reasonable steps to ensure that the liabilities of its members arising out of the insurance business which they carry on at Lloyd's are identified and attributed a value, under LLD 12.3, LLD 12.4 and LLD 12.5.

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LLD 12.2.2

Members are organised into syndicate years, each of which is managed by a managing agent. For the Society to comply with the requirements of this chapter, it needs to ensure that managing agents effectively apply the rules in this chapter to individual syndicate years.

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LLD 12.2.3

In general terms, the liabilities for the purposes of this chapter are:

(1) the member's share of the insurance business liabilities which fall to be identified and valued for each syndicate year;

(2) any liabilities of a member, not covered by (1), arising from the insurance business that he carries on at Lloyd's; and

(3) any liabilities of the Society, other than liabilities that are subordinated to the interests of policyholders.

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LLD 12.2.4

For credit insurance business of members, the Society must determine the equalisation reserve that would apply if all the members taken together constituted a single insurer subject to IPRU(INS).

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LLD 12.2.5

The Society may:

(1) allocate the equalisation reserve under LLD 12.2.4 R between open syndicate years and members in any way it considers appropriate; and

(2) choose not to allocate all or any part of it to members but instead treat it as a liability of the Society.

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Provision for related insurance undertakings

LLD 12.2.6

Subject to LLD 12.2.7 R, if a related undertaking is an insurance undertaking which has a deficit in the assets available to cover its liabilities or to cover the notional required minimum margin, the Society must make provision for:

(1) its proportionate share of that deficit; or

(2) in the case of a subsidiary undertaking, the whole of that deficit.

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LLD 12.2.7

For the purposes of LLD 12.2.6 R, the identification and valuation of assets must be determined, and the deficit must be valued, in accordance with LLD 13.15.4 R, except that any liability which is a debt to the Society need not be valued at more than the value placed on that debt as an asset of the Society.

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LLD 12.3

Members' liabilities

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LLD 12.3.1

For open syndicate years, a member's liabilities are the aggregate of:

(1) his proportionate share of the liabilities of each open syndicate year in which he participates, including:

(a) liabilities associated with earlier syndicate years that have been closed into that year; and
(b) any equalisation reserve allocated to him for the syndicate year by the Society under LLD 12.2.5 G; and

(2) for open syndicate years through which he carries on general insurance business taken together, if A+B exceeds C, A+B-C, where:

(a) A is the total of his proportionate shares for each syndicate year of the accumulated excess of income over outgoings;
(b) B is the amount of any unpaid additional contributions he is required to make to the funds maintained for the syndicate years by the managing agents; and
(c) C is the total of his proportionate shares of the liabilities net of reinsurance recoveries.

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LLD 12.3.2

For the purpose of LLD 14.3 (Currency matching and l (Localisation (UK firms only)), the amounts in:

(1) LLD 12.3.1 R (2), which are intended to prevent the premature release of profits; and
(2) LLD 12.2.4 R (the equalisation reserve);

may be left out of account.

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LLD 12.3.3

For the purposes of this chapter the following liabilities may be left out of account:

(1) liabilities of a member for guarantees or letters of credit issued to support the insurance business he carries on at Lloyd's, where the guarantor or issuer has no recourse to premium trust funds or funds at Lloyd's;

(2) liabilities which have been covered by a reinsurance to close with reinsurers who were members when the reinsurance to close was effected;

(3) liabilities of a member, which arise other than in connection with the insurance business he carries on at Lloyd's or his membership of the Society, and cannot be met from his funds at Lloyd's until those funds are released to him; and

(4) liabilities for 1992 and prior general insurance business reinsured by Equitas Reinsurance Ltd.

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LLD 12.3.4

LLD 12.3.1 R requires the aggregate net surplus (if any) in a member's participations in open general insurance business syndicates to be treated as part of his liabilities. This is analogous to the treatment of open years for an insurer using the fund basis of accounting. LLD 12.3.3 R allows liabilities not relevant to the solvency of the Lloyd's market and (to prevent double-counting) amounts covered by reinsurance to close to be left out of account.

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LLD 12.4

General insurance business technical provisions

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LLD 12.4.1

This section relates only to liabilities arising in general insurance business syndicates. Each member is liable for his share of the liabilities of each syndicate year in which he participates. Provisions for these liabilities include technical provisions for insurance liabilities and provisions for any other liabilities. This section also provides guidance on the valuation of reinsurance recoveries.

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LLD 12.4.2

The gross technical provisions set for general insurance business liabilities arising in any syndicate year (other than the equalisation reserve arising under LLD 12.2.5 G) must not be less than the best estimate of the monetary amount expected ultimately to be payable to discharge all liabilities for that syndicate year not covered by other provisions, before taking reinsurance into account, less a prudent allowance for future premiums not yet accrued.

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LLD 12.4.3

The managing agent will normally set the technical provisions for a syndicate year. The Society will need to take all reasonable steps to ensure that the provisions comply with these rules. LLD 10.9 (Requirements relating to the role of actuaries) requires that the year end provisions be verified by an actuary appointed by the managing agent or that the Lloyd's actuary sets the provisions.

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LLD 12.4.4

The gross technical provisions in LLD 12.4.2 R should include:

(1) gross notified outstanding claims;

(2) incurred but not reported losses;

(3) unexpired risks (including potential losses on insurance business still to be written under binding agreements and similar arrangements); and

(4) future claims-handling costs, including the costs of managing the run-off of the insurance business.

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LLD 12.4.5

The guidance in LLD 12.4.4 G is not intended to require separate identification of these amounts beyond that required for reporting purposes, except to the extent necessary for proper estimation of the total.

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LLD 12.4.6

The prudent allowance for future premiums in LLD 12.4.2 R should allow for anti-selection by policyholders. Except to the extent that there is a legitimate set off against other liabilities, it should not be assumed that the liabilities arising from future premiums to be received on any group of contracts are less than those premiums.

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LLD 12.4.7

The technical provisions (net of reinsurance) for any syndicate year being closed by reinsurance to close must at least equal the part of the reinsurance to close premium that relates to those provisions.

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LLD 12.4.8

Discounting must not be applied when calculating technical provisions.

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LLD 12.4.9

The provisions for incurred but not reported losses and unexpired risks should allow for a syndicate's exposure to losses arising from one or more known major catastrophes or from a known potential cause of loss (including post balance sheet date losses).

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LLD 12.4.10

Where it is reasonable and prudent to do so, the provision for unallocated future claims-handling costs should be calculated on the practical assumption that each syndicate is a going concern. Otherwise, provision should be made on the basis that the syndicate has ceased or will cease trading, in whole or part, as appropriate. The gross provision for unallocated claims-handling costs should include costs of handling reinsurance recoveries as well as the costs of handling gross claims.

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LLD 12.4.11

The value of reinsurance recoveries should be the net monetary amounts expected ultimately to be received for each syndicate year, net of future reinsurance premiums and other liabilities under the reinsurance contract, with:

(1) an appropriate provision for potential reinsurance bad debts; and

(2) an allowance for any costs of borrowing necessary to cope with delays in reinsurance recoveries.

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LLD 12.4.12

The provision for future reinsurance premiums should be made irrespective of the syndicate year to which the reinsurance premiums will be charged. Where the reinsurance has not yet been purchased, the appropriate provision should be no less than the reduction in liabilities assumed from that reinsurance cover.

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LLD 12.4.13

LLD 12.4.12 G is intended to ensure that an adequate provision is set up, where the reinsurance premium is to be charged to a syndicate year other than that to which the recoveries will accrue. The provision may not be avoided by charging the premium to a future syndicate year. This could be particularly important where reinsurance is placed on the basis of losses which occur during the year of account, or where policies are written for periods in excess of one year, or under binding arrangements. Where it is intended that the premium will be charged to a future syndicate year, stop loss and similar protections applicable to the current syndicate year would not normally cover it.

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LLD 12.4.14

To avoid double-counting of liabilities, reinsurance with other syndicate years must be treated as 100% recoverable, except that allowance must be made for reinsurance disputes.

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LLD 12.4.15

When making allowance for reinsurance disputes under LLD 12.4.14 R, the scope for unidentified and potential disputes should be considered in addition to known disputes.

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LLD 12.4.16

Contracts of reinsurance should be assessed in accordance with the Principles of Financial Reporting Standard 5 (as issued in April 1994 and amended in December 1998). That is, if the contract has the characteristics of an investment it must be treated as such and valued for solvency purposes under LLD 13 (Assets: valuation and realisability risk) and LLD 14 (Assets: market and credit risk).

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LLD 12.5

Long-term liabilities

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Application

LLD 12.5.1

This section applies to the long-term insurance business liabilities of members. The requirements of this section are comparable with those that apply to insurers carrying on long-term insurance business.

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LLD 12.5.2

The requirements of this section take account of the fact that the Society restricts the types of long-term insurance business carried on at Lloyd's to term insurance of no more than 25 years duration.

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LLD 12.5.3

LLD 10.9.4 R (1) requires the Society to require each syndicate to have a syndicate actuary. LLD 15 (Reporting by the Society) requires a certificate from each syndicate actuary of a long-term insurance business syndicate in the specified format. This should attest to, among other things, compliance with the valuation and reporting requirements of LLD 9 to LLD 15.

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Determination of liabilities

LLD 12.5.4

The determination of the amount of long-term insurance business liabilities (other than those that have fallen due for payment before the valuation date) must:

(1) be made on actuarial principles that have due regard to the reasonable expectations of policyholders; and

(2) make proper provision for all liabilities, on prudent assumptions that include appropriate allowance for adverse deviation of any relevant factors.

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LLD 12.5.5

The determination under LLD 12.5.4 R must take account of all prospective liabilities as determined by the conditions of each existing contract of insurance, taking credit for premiums payable after the valuation date.

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LLD 12.5.6

In valuing liabilities, account should be taken of the following factors:

(1) all guaranteed benefits, including guaranteed surrender values;

(2) all options available to the policyholder under the terms of the contract;

(3) expenses, including commissions; and

(4) any rights or obligations under contracts of reinsurance in respect of long-term insurance business.

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LLD 12.5.7

While the limitation on long-term insurance business described in LLD 12.5.2 G remains in place the 'gross premium' method of valuation should generally be the most appropriate. However, the syndicate actuary may use an alternative method where he considers this to be more appropriate to the particular circumstances of the syndicate.

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Method of calculation

LLD 12.5.8

Subject to LLD 12.5.9 R to LLD 12.5.11 R, the amount of the liabilities for each long-term insurance contract must be determined separately by a prospective calculation.

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LLD 12.5.9

A retrospective calculation may be used to determine the liabilities where a prospective method cannot be used for a particular type of long-term insurance contract or benefit under the contract, or where it can be demonstrated that the resulting amount of the liabilities would be no lower than would be the case with a prudent prospective calculation.

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LLD 12.5.10

Appropriate approximations or generalisations may be made where they are likely to provide the same, or a higher, result than separate calculations of the liabilities for each long-term insurance contract.

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LLD 12.5.11

Where appropriate, additional provision must be established on an aggregated basis for general risks that are not individualised.

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LLD 12.5.12

The method for calculating the amount of the liabilities and the assumptions used must not be subject to discontinuities from year to year arising from arbitrary changes and must recognise the distribution of profits in an appropriate way over the duration of each contract.

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Avoidance of future valuation strain

LLD 12.5.13

The total amount of the liability for a group of similar long-term insurance contracts must not be less than an amount which, if the assumptions adopted for the valuation remained unaltered and were fulfilled in practice, would enable similarly determined liabilities to be covered at all times in the future from resources which arise only from the contracts and assets covering the amount of the liability determined at the current valuation.

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LLD 12.5.14

The mathematical reserves and other insurance and non-insurance liabilities for any syndicate year being closed by reinsurance to close must be at least equal to the reinsurance to close premium.

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Rates of interest

LLD 12.5.15

The rates of interest used to calculate the present value of future payments by or to the fund maintained for the syndicate year by the managing agent must be no greater than the rates of interest determined:

(1) from a prudent assessment, under LLD 12.5.17 R, of the yields on existing assets in the premium trust fund; and

(2) to the extent appropriate, from the yields assumed, under LLD 12.5.16 R and LLD 12.5.23 R, on sums to be invested in the future.

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LLD 12.5.16

(1) Subject to (2), when the value of assets in the premium trust fund is less than the mathematical reserves and other insurance and non-insurance liabilities using a gross valuation interest rate under LLD 12.5.15 R, the shortfall is assumed to be met by contributions by members invested at a yield not exceeding the long term reinvestment rate in LLD 12.5.24 R (1).

(2) If the weighted average, using asset values and contribution amounts as weights, of:

(a) the yield on the assets in the premium trust fund backing mathematical reserves calculated under LLD 12.5.15 R (1); and

(b) the yield on contributions from members assumed under (1);

is less than the gross valuation interest rate, the gross valuation interest rate must be reduced and additional contributions assumed from members until this test is satisfied.

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LLD 12.5.17

For the purposes of LLD 12.5.15 R, the yield (before any adjustment to take account of the effect of taxation) must not exceed the yield on that asset, calculated under LLD 12.5.18 R to LLD 12.5.22 R reduced by 2.5% of that yield.

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LLD 12.5.18

When calculating the yield on an asset under LLD 12.5.17 R, the future income from any asset required to be taken into account (whether interest, dividends or repayment of capital) must be reduced by a proportion corresponding to such of the excess exposure to assets of that description as may reasonably be attributed to those assets.

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LLD 12.5.19

Subject to LLD 12.5.23 R, the yield on fixed interest securities must be the annual rate of interest which, if used to calculate the present value of future interest payments before the deduction of tax and the present value of any repayments of capital, would result in the sum of those amounts being equal to the value of the asset.

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LLD 12.5.20

Subject to LLD 12.5.22 R, the yield on equity shares or land (other than fixed interest securities) must be the ratio to the value of the asset of the income before deduction of tax that would be received within 12 months following the valuation date, on the assumption that the asset will be held throughout that period and that the factors that affect income will remain unchanged, taking account of any changes in those factors known to have occurred by the valuation date including:

(1) any known changes in the rental income from land or in dividends on equity shares;

(2) any forecast changes in dividends that have been publicly announced by the valuation date;

(3) the effect of any alterations in capital structure; and

(4) the value (at the most recent date for which it is known at the valuation date) of any determinant of the amount of any future interest payment, and this value must be treated as remaining unaltered in the future.

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LLD 12.5.21

Subject to LLD 12.5.22 R, the yield on investments other than equity shares, land or fixed interest securities must be the annual rate of interest which, if it were used to calculate the present value of future interest payments (before the deduction of tax) and the present value of any repayments of capital, would result in the sum of these amounts being equal to the value of the asset, on the assumption that:

(1) the value of any determinant of the amount of the next interest payment and capital repayment made during the following 12 months will be the value of that determinant at the most recent date for which it is known at the valuation date;

(2) the amount of future interest payments and capital repayments will take account, where appropriate, of:

(a) the right of either party to have the investment repaid; and

(b) an assumed yield on other comparable investments made in the future not exceeding an amount determined under LLD 12.5.23 R to LLD 12.5.25 R; and

(3) indices and all other factors that affect future income payments or capital repayments will remain unchanged after the valuation date.

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LLD 12.5.22

In calculating the yield on an asset:

(1) if the asset is not equity shares or land:

(a) a prudent adjustment must be made to exclude that part of the yield estimated to represent compensation for the risk that the income from the asset might not be maintained or that capital repayments might not be received as they fall due; and

(b) in making that adjustment, regard must be had wherever possible to the yields on risk-free investments of a similar term in the same currency;

(2) if the asset is equity shares or land, adjustments to yields must be made, as appropriate, to exclude that part of the yield from each category of asset needed to compensate for the risk that the aggregate income from that category of asset, taking one year with another, might not be maintained;

(3) in (2), a 'category of asset' comprises assets of a similar nature, type and degree of risk.

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LLD 12.5.23

Where it is necessary to make an assumption about the yields on sums to be invested in the future, other than sums representing a shortfall referred to in LLD 12.5.16 R, yields must be determined under LLD 12.5.24 R and LLD 12.5.25 R.

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LLD 12.5.24

Where LLD 12.5.23 R applies and liabilities are denominated in sterling, the yield (before any adjustment to take account of the effect of taxation) assumed:

(1) on any investment to be made more than three years after the valuation date, must not exceed the lowest of:

(a) the long term gilt yield current on the valuation date; or

(b) 3% per annum, increased by two thirds of the excess, if any, of the long term gilt yield current on the valuation date over 3% per annum; or

where 'the long term gilt yield' means the annualised equivalent of the 15 year yield for United Kingdom Government fixed-interest securities jointly compiled by the Financial Times, the Institute of Actuaries and the Faculty of Actuaries; and

(2) on any investment to be made not more than three years after the valuation date must not exceed the assumed yield determined under LLD 12.5.17 R adjusted linearly over the three years to the yield determined in accordance with (1).

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LLD 12.5.25

Where LLD 12.5.23 R applies and liabilities are denominated in currencies other than sterling, the yield must be determined on assumptions that are as prudent as those under LLD 12.5.24 R.

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LLD 12.5.26

(1) A rate of interest determined for the purposes of LLD 12.5.15 R must not exceed the adjusted overall yield on assets calculated as the weighted average of the reduced yields on the individual assets, calculated under LLD 12.5.17 R.

(2) When the weighted average in (1) is calculated, the weight given to each investment must be its value as an asset determined under LLD 13 (Assets: valuation and realisability risk) and LLD 14 (Assets: market and credit risk).

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LLD 12.5.27

For the purpose of determining the rates of interest to be used in valuing different categories or types of long-term insurance contract, the assets may, where appropriate, be notionally apportioned between the different categories or types of contract.

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Rates of mortality and disability

LLD 12.5.28

Where relevant, the amount of the liability for any category or type of long-term insurance contract must be determined on the basis of prudent rates of mortality and disability.

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Expenses

LLD 12.5.29

(1) The provision (including any implicit provision) for expenses must be not less than the amount required, on prudent assumptions, to meet the total cost (net of the effect of taxation) likely to be incurred in fulfilling long-term insurance contracts if the syndicate were to cease to transact new business 12 months after the valuation date.

(2) Allowance must be made for the effect of inflation on future expenses, on prudent assumptions about the future rates of increase in prices and earnings.

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LLD 12.5.30

For an individual syndicate year, the provision for expenses under LLD 12.5.29 R (1) should take into account fair apportionments of:

(1) the overall syndicate expenses for the year following the valuation;

(2) any costs which would be incurred in closing the syndicate to new business; and

(3) the cost of running off the syndicate on a care and maintenance basis, allowing for a prudent level of new business being written in the year following the valuation.

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Options

LLD 12.5.31

Provision must be made on prudent assumptions to cover any increase in liabilities caused by policyholders exercising options under their contracts of insurance.

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LLD 12.5.32

Where a long-term insurance contract includes an option for the policyholder to secure a guaranteed cash payment within 12 months following the valuation date, provision for that option must ensure that the value placed on the contract is not less than the provision needed to meet that option, if exercised.

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Long-term insurance contracts not to be treated as assets

LLD 12.5.33

Long-term insurance contracts, except reinsurance covering the syndicate year, must not be treated as assets.

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No credit for profits from voluntary discontinuance

LLD 12.5.34

Allowance must not be made for the voluntary discontinuance of any long-term insurance contract, if the allowance would reduce the amount of the liability.

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Nature and term of assets

LLD 12.5.35

The determination of the amount of long-term insurance business liabilities must take account of the nature and term of the assets representing those liabilities, and the value placed upon them, and must include prudent provision against the effects of possible future changes in the value of the assets on:

(1) the ability of syndicate members to meet their obligations arising under long-term insurance contracts as they arise; and

(2) the adequacy of the assets to meet the liabilities, as determined under LLD 12.5.8 R to LLD 12.5.33 R.

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