Inceptum Insurance Company Limited Solvency and Financial Condition Report ( SFCR ) (for the financial year ended 31 Dec 2016)

Transcription

1 Inceptum Insurance Company Limited Solvency and Financial Condition Report ( SFCR ) (for the financial year ended 31 Dec 2016) Page 1 of 47

2 Contents Summary Directors Responsibilities Statement Independent Auditors Report A. Business and Performance A.1 Business A.2 Underwriting Performance A.3 Investment Performance A.4 Performance of Other Activities A.5 Any Other Information B. System of Governance B.1 General Information on the System of Governance B.2 Fit and Proper requirements B.3 Risk Management System including the Own Risk and Solvency Assessment B.4 Internal Control System B.5 Internal Audit Function B.6 Actuarial Function B.7 Outsourcing B.8 Any Other Information C. Risk Profile C.1 Underwriting Risk C.2 Market Risk C.3 Credit Risk C.4 Liquidity Risk C.5 Operational Risk C.6 Other Material Risk C.7 Any other information D. Valuation for Solvency Purposes D.1 Assets D.2 Technical Provisions D.3 Other Liabilities D.4 Alternative Methods for Valuation E. Capital Management E.1 Own Funds E.2 Solvency Capital Requirement ( SCR ) and Minimum Capital Requirement E.3 Any Other Information E.4 Differences between the Standard Formula and any Internal Model used E.5 Non-compliance E.6 Additional Information ANNEX: Annual Quantitative Reporting Templates (QRT s) Page 2 of 47

3 Summary Inceptum Insurance Company Limited (the Company) has its origins as HSBC Insurance (UK) Limited ( HIUK ), a subsidiary of HSBC Bank plc ( HSBC ). HIUK wrote personal and commercial UK motor business until 2009, when a desire by HSBC to return to core business, combined with deteriorating results, led to the cessation of underwriting. A small volume of household and schools business was also underwritten. In 2011 the business was acquired in its entirety by Syndicate Holding Corp. (SHC), a Puerto Rican holding company. The Company has now been managed by the same management team since This is the first Solvency and Financial Condition Report (SFCR) of the Company under the Solvency II Directive and the enacted legislation in January The prior Solvency I margins were replaced by the Solvency Capital Requirements (SCR) and the Minimum Capital Requirements (MCR) using the standard formula (see Section E). Performance The Company made a slightly larger profit in 2016 compared to the profit in 2015 due largely to increased investment return driven by the unwinding of unrealised gains and losses from Governance The system of governance is appropriate and proportionate to the size, nature and complexity of the Company. The Senior Insurance Managers Regime (SIMR) came into force in March 2016 and was adopted from this date. The Company produces an Own Risk and Solvency Assessment (ORSA) that is approved by the Board. Many key functions are retained within the Group via an outsourcing arrangement with Vibe Services Management Limited (VSML), a related party, where it is deemed to have the requisite skillset. The Company recognises that to achieve economies of scale certain specialist functions have to be outsourced. Further details on this and the Company s system of governance can be found in Section B to this report. Risk Profile There have been no material changes to the Company s risk profile during Having ceased underwriting in 2009, reserving risk continues to present the most significant risk to the Company. The Company also faces potential financial risks through its financial and re assets. Further information regarding the risk profile of the Company can be found in Section C to this report. Valuation The valuation of assets at the reporting date was 118,486k for the Company whilst the valuation of Technical Provisions at the reporting date was 106,002k. The valuation of other liabilities together with further information regarding the valuation of assets and liabilities of the Company can be found in Section D to this report. Page 3 of 47

4 Capital Management The Company has been in full compliance of its capital requirements since the introduction of the Solvency II regime on 1 January The Company s SCR surplus at the reporting date was 7,799k (Day 1: 20,896k unaudited). The Company expects to remain in compliance for the foreseeable future as its business is run-off. Further details of the Company s capital management can be found in Section E to this report. The Company s financial year runs to 31 December each year and its functional and presentational currency is GBP (Pounds Sterling). Page 4 of 47

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10 A: Business and Performance A.1 Business Inceptum Insurance Company is a limited liability company incorporated in England. The Company s operating address and registered office is: 5 th Floor, 90 Fenchurch Street, London, EC3M 4ST. The Company s Bankers are Lloyds Bank PLC Address is: PO Box 72, Bailey Drive, Gillingham Business Park, Gillingham, Kent ME8 0LS, The Company s external auditor is Ernst & Young LLP, 25 Churchill Place, Canary Wharf, London, E14 5EY. The Company s Supervisory Authorities are: The Prudential Regulatory Authority (PRA): 20 Moorgate, London, EC2R 6DA and The Financial Conduct Authority, 25 The North Colonnade, London E14 5HS. The Company is wholly owned by Syndicate Holding Corp ( SHC ), a company incorporated in Puerto Rico. The most recent set of SHC Group accounts is available on request. Page 10 of 47

11 All shareholdings are 100% unless otherwise stated. The Company s financial year end is 31 December each year. The Company is closed to new business and the company s principal activities during the year continued to be the runoff of general business, settling claims and expenses within the established reserves and settling claims fairly within the spirit of treating customers fairly (TCF) principles. Prior to moving into run-off, the principal activity of the company was underwriting general business. All employees are employed by the Vibe Services Management Ltd ( VSML ), a related party. Page 11 of 47

12 A.2 Underwriting Performance The key financial and other performance indicators prepared (UK GAAP) during the year were as follows: Change % Net claims paid 3,309 6,966-52% Technical account for general business (323) (157) 105% Investment return % Profit after tax % Shareholders funds 16,834 26,637-37% Net technical provisions 6,100 9,092-33% Number of outstanding claims % Net claims paid in the year were in line with expectations with the technical account showing a small loss which is more than offset by the investment return. Existing Policyholders are located principally in the UK and there were no new premiums received during the year. An analysis of the underwriting result before investment return is set out below: 2016 Gross premium Gross claims incurred Gross operating expenses Re balance Total Net technical provisions General business Motor - (15,318) (6) 15,003 (321) 5,986 Household - (2) - - (2) 114 Accident & health Total - (15,320) (6) 15,003 (323) 6,100 ===== ===== ===== ===== ===== ===== Page 12 of 47

13 2015 Gross premium Gross claims incurred Gross operating expenses Re balance Total Net technical provisions General business Motor - 3,526 (197) (3,480) (151) 8,753 Household - (157) (6) 339 Accident & health Total - 3,369 (197) (3,329) (157) 9,092 ===== ===== ===== ===== ===== ===== A.3 Investment Performance The company earns interest on fixed income instruments, cash and cash equivalents as well as gains on fixed income instruments. Interest is accrued up to the balance sheet date. All investment income, including realised and unrealised gains and losses on investments, is reported in the non-technical account and is all in GBP. Investment return increased by 111% compared with the prior year due largely to a fall in investment return due to the smaller investment portfolio caused by the payment of claims and a dividend. This was more than offset by the reversal of 2015 s unrealised loss due to a fall in interest rates over The Company s financial investments consist of listed investments and deposits with credit institutions, and it classifies these as financial assets at fair value through profit or loss. There are no investments in securitisations. Page 13 of 47

14 Non-technical account Balance on the technical account - general business (323) (157) Investment income Unrealised gains on investments 25 (587) Investment expenses and charges (80) (102) Profit on ordinary activities before tax A.4 Performance of Other Activities The company was placed into run-off in September 2009 and the company s sole business is the settlement of claims. Operating costs of the Company continue in line with expectations. Admin expenses are net of transfers to the claims handling provision and have reduced as time charged by VSML staff to Inceptum in the year has also reduced as the business continues to run off. Results and Dividends The profit and total comprehensive income after tax for the year was 0.2m (2015: 0.1m). The Company paid a net dividend of 10m during the year and the directors expect that a dividend will be paid in the second quarter of 2017 but at the current time no formal proposal has been made. A.5 Any Other Information All material information regarding the business and performance of the Company has been disclosed in section A.1 to A.4 above. Page 14 of 47

15 B: System of Governance B.1 General Information on the System of Governance B.1.1 Overview: The risk management strategy is designed to ensure that policyholders are appropriately protected by ensuring that capital is held at suitable levels via its Own Economic Capital Assessment (OECA) and that risks are identified, assessed and managed appropriately. The Company has established a risk management function with clear terms of reference from the Board of Directors and its committees. This is supplemented with a clear organisational structure with documented delegated authorities and responsibilities from the Board of Directors to committees and senior managers. The Company has an articulated risk appetite which has been approved by the Company s Board. Actual performance is reviewed against the stated appetite using supporting metrics. Performance and risk exposure against tolerance levels is monitored regularly by management and the board. The Board of Directors approves the risk management policies and meets regularly to approve any commercial, regulatory and organisational requirements of such policies and associated strategy and business plans to ensure that they remain aligned. The company regularly undertakes an Own Risk and Solvency Assessment (ORSA) which is reviewed and approved by the Board. The Company is subject to capital requirements imposed by the Prudential Regulation Authority (PRA). Capital requirements are calculated in accordance with the Solvency II standard formula. Board of Directors: T J Leggett Non-Executive Chairman D J Gately Chief Executive Officer R Katzenberg Chief Financial Officer M R Gates (Resigned 29 th February 2016) P S Donovan Executive Director A Fridlyand Non-Executive Director N C Krenteras Non-Executive Director P A Flamank Non-Executive Director Company Secretary: P Box The internal governance framework consists of a small number of committees: Board Executive Committee Audit and Risk Committee Investment Committee Page 15 of 47

16 Given the size and nature of the business, the structure shown above is considered to be adequate and appropriate. All committees have Board approved Terms of Reference. The Company is managed by a Board of Directors. The day to day management of the business is delegated to an Executive Committee (chaired by the CEO) and various Committees. The Audit & Risk Committee ensures that the findings and recommendations of Internal Audit are reported to the Board. The Audit & Risk Committee is responsible for: Assessing the effectiveness of Internal Audit; Approving the audit plan and monitoring delivery of the audit plan; Reviewing and challenging Internal Audit reports; Providing input to scope of audit work; and Determining if audit resources are adequate. The Investment Committee oversees the execution and management of the investment strategy. In February 2017, as a result of the steady reduction in the numbers of open claims (which are below 60) and to aid proportionality of governance arrangements, the Board made the decision to cease operating an Audit and Risk Committee and to subsume the responsibilities of this committee directly into the Board. There have been no other material changes to the system of governance. The business is broken down into separate Functions, which include: Operations - Re - Claims - Management Information - Information Technology Finance (inc Actuarial) Human Resources Compliance and Risk Management Page 16 of 47

17 The Company has adopted a 3 lines of defence model as indicated below: 1 st Line of Defence Day-to-day running of operations and management control 2 nd Line of Defence Risk oversight policy and methodologies (continual monitoring) 3 rd Line of Defence Independent assurance (periodic checking) Exco (Senior mgmt) Board Audit and Risk Committee BUSINESS UNITS Re Actuarial Claims Operations Finance, HR, IT Risk Management Compliance Function Internal Audit As depicted in the diagram above, internal controls designed into the systems, processes and procedures utilised by operational management constitute the first line of defence. Whilst the Board decides the overall strategy/policy, Exco and other committees have day to day management responsibility for carrying it out, as part of the first line of defence. The 1 st Line of Defence role is to review and challenge the risk information received, escalating issues to the Risk committee and/or Exco and the Board as necessary. B.1.2 Control Functions: The Company has established the four control functions required under Solvency II - risk management, compliance, actuarial and internal audit. These functions are responsible for providing oversight of and challenge to the business and for providing assurance to the Board in relation to the Company s control framework. B.1.2.1: Risk Management Function: The Risk Function is led by the Head of Risk Management and is responsible for establishing an integrated risk management framework for all aspects of risk areas across the Company. The Head of Risk Management co-ordinates the Company s Risk Function and is accountable to both Exco and the Board. The Head of Risk Management also acts as Compliance Officer. The Role of the Function The role of the Head of Risk Management / Risk Function is divided into three areas: Risk Management System including Governance and Internal Controls: Lead establishment and assist the Board and wider business in relation to setting risk strategy and appetite; Assist the Board and business units in the development of the Risk Management System; Page 17 of 47

18 Monitor the integrity of the risk management system; Monitor and report the aggregate risk profile; Assist in the development of policies and processes for identifying, classifying, assessing, monitoring and managing risks; Ensure policies are regularly reviewed and where necessary propose modifications to Company s policies based on new developments (e.g. internal and external changes). Instils risk management principles and raises awareness of risk management; Ensures that the risks and activities undertaken by the Company are appropriately challenged and continually developed in accordance with current and future regulatory standards; Manages the activities of the Risk Function, ensuring adequacy of resource; Formulates and supports risk management governance through committee structures and processes; Ensures that risk management is embedded in management processes and closely linked to the achievement of management objectives; and Develops a culture of managed risk taking. Own Risk and Solvency Assessment (ORSA): Develops the Policy and process for undertaking the ORSA; Develops and maintains the documentation in respect of the ORSA process and develops and maintains the process to deliver the ORSA; Manages a clearly defined governance structure around the ORSA process including report production and sign off; and Reports the ORSA outcome to the Board and reporting critical risk exposures; Link with Internal Audit, Actuarial and Compliance Functions The Risk Function meets regularly with the Audit Function, who highlight any significant observations raised in individual audit reports related to the Company s control, risk management, and compliance processes, including potential improvements to those processes. At all times, the independence of the Audit Function is respected. The Actuarial Function can be called upon to answer questions regarding capital assessments, as well as for information about reserve adequacy. The Risk Function relies on Compliance to keep up-to-date regarding the regulatory environment and to disseminate information to staff as appropriate. Additionally, it relies upon Compliance to continuously check on adherence to policies, processes and procedures. Link with Board, Exco and Committees The Head of Risk Management is a member of the Exco, and is responsible for preparing a regular risk report to the Board. As a member of the Exco, he/she is privy to timely information about all issues facing the Company. B.1.2.2: Compliance Function: The Compliance Officer (CO) heads the Compliance Function which is responsible for overseeing and managing compliance issues, ensuring the Company complies with all Page 18 of 47

19 relevant laws and regulations, specifically the rules and requirements of the PRA/FCA. The CO has unfettered access to all appropriate records in order to enable him/her to carry out the role in an effective and timely manner. Role of the Function The role of the Function is to monitor the regulatory environment and disseminate relevant updates to interested parties within the organisation. In addition, the Function is responsible for preparing, monitoring and maintaining the annual Compliance Timetable to ensure all legal and regulatory deadlines are met. As a control function, Compliance is involved in the risk management system. Several policies fall within the domain of Compliance and are prepared by and owned by the CO, including Financial Crime, Conflicts of Interest and Fit and Proper. Link with the Board, Exco and Committees Reports on compliance matters are delivered regularly at Exco and at Board meetings. Link with the Risk Management, Actuarial and Internal Audit Functions The Head of Risk Management and Compliance Officer roles are held by the same individual. This is considered appropriate as both Risk Management and Compliance are control functions. Resources and Skills The Compliance Officer is assisted by a Compliance Manager and a Compliance Administrator. B.1.2.3: Actuarial Function Responsibilities of the Chief Actuary As a report of the CFO, the Chief Actuary has primary responsibility for overseeing the Actuarial Function in providing actuarial support in the following areas: reserving, re, financial reporting, capital assessment and planning. Role of the Function The role of the Actuarial Function is to provide statistical and actuarial analysis across the Company (e.g. for reserves and IBNR movements, adequacy of reserves, re cover and technical provisions). The Actuarial Function facilitates the quantification of risk and determines the level of capital required to support the Company s business activities. It also liaises with Finance to ensure the correct integration of SII balance sheet requirements. Link with the Risk Management, Compliance and Internal Audit Functions The Actuarial Function contributes to the ORSA process and assessment of the risks facing the business. Additionally, the Function assists with the development of the Company s actuarial processes and procedures to ensure regulatory compliance. Page 19 of 47

20 Link with the Board, Exco and Committees The Chief Actuary is a member of Exco and the CFO represents the Actuarial Function on the Board. The Chief Actuary can be and is called upon to attend committee meetings and the Board as required. Resources and Skills The Function currently consists of a number of experienced qualified (3) and part qualified Actuaries (2). External actuarial assistance may be called upon as necessary. B.1.2.4: Internal Audit Function: Responsibilities of Internal Auditors The Internal Audit Function is responsible for auditing underwriting, claims and non-claims aspects of corporate governance including compliance of activities with strategies, policies and reporting procedures. Answerable directly to the Audit & Risk Committee and its Chairman, the function conducts reviews of the control environment, discusses the findings with senior managers and submits a report (with agreed senior management actions) to the Audit & Risk Committee. The Function is outsourced. Role of the Function The objective of Internal Audit is to provide independent assurance over the effectiveness of operations within the Company, with particular emphasis on systems of control and the control environment. It aims to help the Company accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes. Link with the Risk Management, Actuarial and Compliance Functions Internal Audit coordinates its activities with the other control functions, including risks or control concerns identified by management (including Compliance) as appropriate. The Internal Audit function contributes to the effective implementation of the risk management system through its reviews of the control environment (e.g. how investments are handled by the outsourced entity). Reports sent to the Audit & Risk Committee are also copied to the Head of Risk Management. With respect to the Actuarial Function, Internal Audit must assess the processes and procedures carried out by the Actuarial Function, e.g. the calculation of technical provisions. Link with the Board and Audit & Risk Committee The Internal Audit Function is outsourced and provides assurance to management and the Board through the Audit Committee. The Audit Committee is chaired by an Independent Non-Executive Director (NED), is comprised entirely of NEDs and is a sub-committee of the Board. It is responsible for ensuring that management has developed and followed an adequate system of internal control. Resources and Skills Following agreement in 2015, the function has been outsourced to a consulting / accounting firm which provides these Internal Audit services. Page 20 of 47

21 B.1.4 Remuneration, Employee Benefits and Practices The Company does not employ any staff. Vibe Services Management Ltd ( VSML ), a related party, employs staff to deliver the required services. The remuneration for VSML employees is determined by the Remuneration Committee and based on performance appraisals. In the case of persons holding Senior Insurance Management Functions (SIMF see below) and roles requiring Fit and Proper (see below) remuneration is subject to ongoing compliance with those regimes. B.1.5 Material Transactions Other than recharges of costs from VSML, there were no material transactions. B.2 Fit and Proper Requirements Persons holding specified management positions are required to meet a Fit and Proper Test for the roles which they perform. The regulator s Fit and Proper Test ( FIT ) is one of the regulator s high level standards, applying to all regulated firms. Individual elements of FIT are outlined below. In broad terms, regulated firms must ensure that they employ personnel with the knowledge, skills and expertise necessary to discharge the responsibilities allocated to them. Some roles are specified as being either Senior Insurance Management Functions (SIMF s) or Controlled Functions. These are designed to cover those persons who effectively run the business or have responsibility for important or critical areas of the business. In addition a specific set of Conduct Standards have been applied to all SIMF s and Controlled Function holders. Inceptum requires that for any position which is regarded as a controlled function, the Company adopts the Fitness and Propriety criteria as stipulated by the FCA/PRA. Employment will be subject to the individual satisfying these requirements. This process is the Company s standard Fitness and Priority test. Persons regarded as Fit and Proper will be required to provide an annual declaration to the effect that they continue to meet the requirements. They will also be required to advise Compliance of any circumstances that might affect their meeting the requirement. These include: FIT 2.1 Honesty, integrity and reputation FIT 2.2 Competence and capability FIT 2.3 Financial soundness VSML s procedures are aligned with the FCA and PRA FIT requirements at two levels:- (a) At recruitment or appointment stage; and (b) On an ongoing basis. Recruitment / Appointment Fitness and propriety are assessed as part of the recruitment process for new joiners who are likely to perform controlled functions. An external vetting agency is employed to provide Page 21 of 47

22 a report prior to an employment contract being entered into. Similarly, for existing personnel being presented for Approved Person status, a FIT review is an integral element of that process. The exact form of the FIT review is not prescriptive, and will be determined by the nature and role of the controlled function for which an individual is being considered. However, the process may typically involve: Background checks (e.g. relevant registers). Verification of academic / professional qualifications. Take-up of references. Interview by the senior management of the regulated entity Completion of the required regulatory forms and signature of Full Disclosure Declaration by the Candidate. Ongoing Monitoring On an ongoing basis, FIT is monitored via: The appraisal process, in respect of competence and capability. Annual verification / declaration (by which Approved Persons attest that there have been no changes in their circumstances which may impact their fitness and propriety to perform their designated roles). Any ad-hoc notifications or reports of changes of circumstances. Company staff and Board members are held to high performance standards and are annually assessed. Any changes of status are notified to the FCA and PRA by the Company Secretary. B.3 Risk Management System including the Own Risk and Solvency Assessment The Company is subject to regulatory capital requirements imposed by the PRA. Regulatory capital requirements are calculated in accordance with the Solvency II standard formula and an uplift included by management to generate an Own Economic Capital Assessment (OECA). The Board of Directors approves the risk management policies and meets regularly to approve any commercial, regulatory and organisational requirements of such policies and associated strategy and business plans to ensure that they remain aligned. The Company regularly undertakes an Own Risk and Solvency Assessment (ORSA) which is reviewed and approved by the Board. Own Risk Solvency Assessment ( ORSA ) A full ORSA is produced and approved by the Board at least once a year, or more frequently if business changes are identified that require a re-run. The ORSA Policy sets out the process undertaken to support the assessment, generate the ORSA report and the governance around its use and sign off. The responsibility for the update to the ORSA resides with the Head of Risk Management, who will engage the Exco to review and monitor the ORSA. A number of processes which are shown below underpin the effective operation of the ORSA process (further details are set out in the ORSA Policy, Page 22 of 47

23 Governance; Business Strategy; Risk Strategy and Appetite for risk ; Business Planning; Assessment of the Risk Profile: o Risk identification, assessment and management; o Risk Profile versus Risk Appetite Capital assessment; Technical Provisions; SII Balance Sheet; Standard Formula Validation; Assessment of the capital and solvency position; Forward Looking Assessment; and Stress and scenario testing. The ORSA process produces reports to enable the Exco to make informed decisions about the business. B.4 Internal Control System Inceptum s internal control framework consists of the following: A system of governance incorporating the Three lines of defence approach Policies Administrative procedures Accounting procedures Appropriate reporting arrangements A Compliance Function A Risk Function An Internal Audit Function An Actuarial Function Policies have been approved by the Board. These cover the risks to which Inceptum is exposed and key activities of Inceptum. Administrative procedures are detailed in appropriate departmental manuals and other departmental documents. Accounting procedures are the responsibility of the Finance Function. procedures exist for cash management, treasury and investments. Detailed written The internal control policy and the Risk Management Framework together with a number of other associated key Policies and Procedures and the Risk Register also form part of the framework. Reporting arrangements are detailed in each Committee s Terms of Reference and job descriptions. B.4.1 Operation of Compliance Function The description of the compliance function is disclosed in Section B Compliance Officer, Role of the Function above. Page 23 of 47

24 B.5 Internal Audit Function The description of the internal audit function is disclosed in Section B Head of Internal audit, Role of the Function above. B.6 Actuarial Function The description of the Actuarial Function s role is described in Section B B.7 Outsourcing The Company enters into outsourcing arrangements only where there is a sound commercial basis for doing so, and where the risk can be effectively managed. A due diligence process is undertaken prior to any final decision being made as to whether to outsource a material business activity. This addresses all material factors that would impact on the potential service provider s ability to perform the business activity. Inceptum Insurance Company has established an Outsourcing Policy to establish the requirements for identifying, justifying and implementing material outsourcing arrangements. This Policy has been adopted by the Company and sets out the following: Definition of outsourcing and material outsourcing Risk mitigation strategies Board and management responsibility Business Case Due Diligence Business Continuity Management Contractual Agreements Management and control of the Outsourcing Relationship Offshoring Final Approval by Exco The Company s outsourcing arrangements are subject to an annual review and the findings of this report are reviewed by the Board. The table below summarises the material outsourcing arrangements: Company Outsourced Function(s) Jurisdiction Vibe Services Management Re, Actuarial, Claims, UK Limited (a related party) Operations, Finance, HR, IT Alliance Bernstein Investment Management UK Dynamo External actuarial UK Grant Thornton Internal Audit UK B.8 Any Other Information The Company has assessed its corporate governance system and has concluded that it effectively provides for the sound and prudent management of the business, which is proportionate to the nature, scale and complexity of the operations of the Company which is closed to new business. Page 24 of 47

25 C: Risk Profile Risk Management Objectives and Risk Policies The Company s risk management strategy is designed to ensure that policyholders are appropriately protected by ensuring that capital is held at suitable levels. The Company s approach to risk management seeks to identify risks facing the Company, assess their potential impact, manage risk through mitigating actions (where appropriate), and report any failures in risk management to the Board. The Company s approach to managing capital involves managing assets, liabilities and risks in a coordinated way. This is achieved by assessing shortfalls between available and required capital on a regular basis and taking appropriate actions to influence the capital position of the Company in the light of changes in economic conditions and risk characteristics. The Company has a formal risk management process which is an integral part of its governance structure. The principal risks and uncertainties facing the Company are broadly grouped as - risk, market risk, liquidity risk, operational risk, credit risk, group risk and regulatory risk. The process is outlined below. See section E2 for a quantitative analysis of the key risks. C.1 Underwriting risk The principal risk the Company faces under contracts is that the actual claims and benefit payments, or the timing thereof, differ from expectations. This is influenced by the frequency of claims, severity of claims, actual benefits paid and subsequent development of long-term claims. Therefore, the objective of the Company is to ensure that sufficient reserves are available to cover these liabilities. Another risk faced by the Company is material adverse reserve development which could arise in respect of Periodical Payment Orders (PPOs). Some of these are currently potential and may require the Company to make regular and variable payments for many years to come. Indexation will also affect the amount of re recoveries that may be claimed for PPOs as indexation inflates the amount of risk retained by the Company over time. The risk exposure is mitigated by using methods to assess and monitor reserve risk exposures including scenario analysis and stress testing. The Company also has re as part of its risk mitigation programme. Amounts recoverable from reinsurers are estimated in a manner consistent with the outstanding claims provision and are in accordance with the re contracts. Although the Company has re arrangements, it is not relieved of its direct obligations to its policyholders and thus a credit exposure exists with respect to ceded, to the extent that any reinsurer is unable to meet its obligations assumed under such re agreements. Page 25 of 47

26 The table below (UK GAAP) sets out the concentration of outstanding claims liabilities by class: 2016 Gross Re Net Motor 77,081 71,386 5,695 Household Total 77,611 71,511 6,100 ===== ===== ===== Key assumptions The principal assumption underlying the liability estimates is that the future claims development will follow a similar pattern to past claims development experience. This includes assumptions in respect of average claim costs, claim handling costs, claim inflation factors and claim numbers for each accident year. Additional qualitative judgements are used to assess the extent to which past trends may not apply in the future, for example: one off occurrences, changes in market factors such as public attitude to claiming, economic conditions, as well as internal factors such as portfolio mix, policy conditions and claims handling procedures. Judgement is further used to assess the extent to which external factors such as judicial decisions and government legislation affect the estimates. Other key circumstances affecting the reliability of assumptions include variation in interest rates, delays in settlement and changes in foreign currency rates. Sensitivities The claims liabilities are sensitive to key assumptions made and as part of the actuarial review, an assessment is made of the impact of a number of different scenarios on the gross and net reserves. It has not been possible to quantify the sensitivity of certain assumptions such as legislative changes or uncertainty in the estimation process. As part of the ORSA process, stress and scenario testing is carried out on the gross and net reserves and the consequential outcome on capital requirements is assessed. C.2. Market Risk The Company is exposed to market risk through its financial assets and its technical provisions. The categories of market risk to which the company is exposed are: Interest rate risk; being the risk which arises from falls and rises in assets and liabilities associated with fluctuations in interest rates; Credit spread risk; being the risk that arises from the sensitivity of the value of, primarily corporate bonds, to rises in credit spreads over a risk free rate. The following strategy is in place to mitigate the Company s exposure to market risk: The Company shall hold a well-diversified, low risk portfolio of assets, achieving rates of return measured against defined benchmark indices. The Company s asset duration is shorter than its liabilities reflecting that surplus assets are invested in cash and short term investments. Page 26 of 47

27 The Company s investment portfolio is managed by a highly experienced investment manager (Alliance Bernstein) within agreed guidelines. Regular discussions are held between the investment manager and the Company s Investment Committee to review performance and to confirm that the manager is operating within agreed guidelines. Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. There is no currency risk in the Company as all the assets and liabilities are held in sterling. Prudent person principle When making investment decisions the Company considers the risks associated with the investments including the impacts of any market shocks and their liquidity. Assets covering the Minimum Capital Requirement and Solvency Capital Requirement are invested in highly rated and liquid assets. Assets covering the technical provisions are invested in a manner appropriate to the nature and duration of the liabilities. C.3 Credit Risk Credit risk is the risk that one party to a financial instrument will cause a financial loss to the other party by failing to discharge its obligation. Because the Company benefits from extensive re protection, one of the most significant risks to which the Company is exposed is re credit risk. Periodic Payment Orders may require the business to make regular payments for many years to come and there is therefore a potential risk that one or more of the reinsurers currently used may encounter financial problems some years into the future and be unable to meet their obligations. This risk is mitigated through the fact that reinsurers the Company uses are financially strong with the vast majority being rated A or AA by Standard & Poors. Inceptum is also exposed to credit risk from investment counterparties, however, the counterparties are the UK government and UK corporates all of which are highly rated. The following policies and procedures are in place to mitigate the Company s exposure to credit risk: A credit risk policy setting out the assessment and determination of what constitutes credit risk for the Company. Compliance with the policy is monitored and exposures and breaches are reporting to the Company s risk committee. The policy is regularly reviewed for pertinence and for changes in the risk environment. Net exposure limits are set for each counterparty or group of counterparties, geographical and industry segment (i.e. limits are set for investments and cash deposits and minimum credit ratings for investments that may be held). Management and monitoring of re assets so as to minimise the amount of outstanding recoveries, including ensuring there is an appropriate non-payment provision on re recoveries. The table below (UK GAAP) provides information regarding the credit exposure of the Company at 31 December 2016 by classifying assets according to Standard & Poor s credit ratings of the counterparties. AAA is the highest possible rating. Assets that fall outside the Page 27 of 47

28 range of AAA to BBB are classed as speculative grade and have not been rated. Debtors, other than the amounts due from reinsurers, have been excluded from the table as these are not rated. 31 December 2016 Not AAA AA A BBB rated Total Financial investments - debt securities 5,630 11,981 1,993 2,150-21,754 Reinsurers share of claims outstanding 23 45,691 24,542 1, ,511 Debtors arising out of re operations Cash at bank - - 1, , ,653 58,050 28,092 3, ,242 ====== ====== ====== ====== ====== ====== As part of the ORSA process, stress and scenario testing is carried out on credit risk and the consequential outcome on capital requirements is assessed. Prudent person principle Investment counterparties are selected taking into account the credit rating and reputation of each entity. Reinsurer counterparties are monitored utilising their credit rating. C.4 Liquidity Risk Liquidity risk arises from the inability of the Company to generate sufficient cash to meet its obligations as they fall due. Whilst the Company invests in assets that are readily able to be liquated, the most significant liquidity risk arises from timing differences between claim payments and expected re recoveries. The following policies and procedures are in place to mitigate the Company s exposure to liquidity risk: A liquidity risk policy exists that sets out the assessment and determination of what constitutes liquidity risk. Compliance with the policy is monitored and exposures and breaches are reported to the risk and audit committee. The policy is regularly reviewed for pertinence and for changes in the risk environment. Guidelines on asset allocation, portfolio limit structures and maturity profiles of assets are set, in order to ensure that sufficient funding is available to meet and investment contracts obligations. Contingency funding plans are set to meet emergency funding in the event of a large demand on cash. C.5 Operational Risk Operational risk is the risk that errors, caused by people and/or inadequate processes or systems, lead to the Company experiencing losses. The main risk in this regard is a failure in the Company's control framework. The Company's risk register, which details all of the Page 28 of 47

29 current principal risks to the Company, also identifies the key controls in response to these risks and the owners of those controls. The risks and controls are reviewed regularly. C.6 Other Material Risks The Company does not consider there to be any other material risks not covered in C1 to C5 above. Page 29 of 47

30 D: Valuation for solvency purposes D.1 Assets The following table analyses the Company s assets at fair value and Solvency II value at 31 December Assets 000 s UK GAAP Adjustment Solvency Value Value Investments, including accrued interest 21,767-21,767 Re Recoverable 71,511 23,226 94,737 Re Receivable Cash 1,069-1,069 Other assets 5-5 Total Assets 95,260 23, ,486 II The only assets that are valued differently under Solvency II are Re Recoverables. Other than the adjustments noted in the table above the valuation principles applied to these assets are the same as those used in the UK GAAP financial statements, notably: Investments in Government and Corporate Bonds these are quoted instruments in active markets. Market prices as at 31 December 2016 have been applied; Re recoverables Re recoverables on a GAAP basis are discounted in respect of PPOs and potential PPOs using an expected return on assets. Foe Solvency II purposes, recoveries are discounted at the prescribed EIOPA risk free discount rate which is lower than the rate used for GAAP. Re receivables valued at the amount accrued at the period end; and Cash and Cash Equivalents valued at the amount held at the period end, translated using the year-end exchange rate where appropriate. The only assets that are valued differently under Solvency II are Re Recoverables. No deferred tax assets have been recognised on a GAAP or Solvency II basis. Page 30 of 47

31 D.2 Technical Provisions The Solvency II Technical Provisions have been calculated in accordance with the Delegated Regulations (EU2015/35) as adopted by the European Commission on 10 October The Technical Provisions comprise the Best Estimate of the Liabilities ( BEL ) and the Risk Margin. At 31 December 2016, the technical provisions were: GBP 000s Gross UK GAAP Technical Provisions Discounting ENIDS Future Expenses Risk Margin Gross Solvency II Technical Re Net Solvency II Technical Provisions Provisions Direct Motor Other Direct Motor Vehicle Liability Direct Property Fire and AOP Life Annuity ,103 6, ,357 52,772-44,144 8, ,215 15, ,191 52,560-50,256 2,304 Total 77,611 22, ,111 3, ,001-94,737 11,265 Valuation The calculations have been performed on a best estimate basis in accordance with Articles 75 to 86 of the Solvency II Directive. The Technical Provisions are defined as the probability weighted average of future cash flows, discounted to take into account the time value of money. The cash flows projection used in the calculation take in to account all the Solvency II prescribed cash in-flows and out-flows to settle the obligations over their lifetime. They have been calculated at the reserving class level, which is then mapped to Solvency II line of business. There have been no instances where one reserving class maps to more than one Solvency II line of business. The technical provisions are grouped into the gross claims provision, best estimate of provisions relating to earned exposure, and the risk margin, the amount required to transfer the obligations to a third party undertaking. There is no unearned exposure as the company is in run-off and hence a gross premium provision is not required. The gross claims provision starts with the UK GAAP best estimate reserves (with no margin for prudence) and the following adjustments are made: Expenses Page 31 of 47

32 Events Not in Data Re recoveries (less bad debt) Discounting credit Expenses Account must be taken of all expenses that would be incurred in running-off the existing business, including a share of the relevant overhead expenses e.g. professional fees and investment manager s expense. There is no allowance for acquisition expenses or commissions as Inceptum no longer writes new business. Events not in data An allowance is made for ENIDs. ENIDs are allocated to reserving class by applying a percentage load to the gross claims reserves and so this element is allocated in line with the claims reserve allocation. Re recoveries (less bad debt) The Company s re recoverables include amounts from third party reinsurers. Discounting The risk free yield curves provided by EIOPA are used to discount future cashflows of claims provision to the valuation date, to take account of the time-value of money. The cash flows are discounted mid year, which assumes that the average claim is paid mid-year. Best Estimate Liability The best estimate liability has been calculated using standard actuarial projection techniques analysing PPO claims and attritional claims separately. PPO claims have been analysed on an individual claim basis using a cash flow projection based on annual payments for lump sum elements and periodical payments inflated at either ASHE or RPI depending on the type of benefit. Cash flows are probability weighted by the likelihood that the claimant is expected to survive each future year using Actuarial life tables. Attritional claims have been valued using standard actuarial triangulation projections techniques, such as the Chain Ladder and Bornheutter Ferguson methods. Expert judgements are applied on the selection of the method used to estimate the ultimate losses. Risk Margin The Risk Margin is the amount required to transfer the liability obligations to a third party undertaking. The risk margin is calculated as 3,632k and its breakdown is shown in the table below ( 000s). Page 32 of 47

33 Our calculation assumes that the risk margin will run of in proportion to the square root of technical provisions. Transitional Arrangements and adjustments The Company has not applied for and is not applying the matching adjustment (referred to in Article 77b of the Directive), the volatility adjustment (referred to in Article 77d of the Directive), or the transitional risk-free interest rate term structure or the transitional deduction (referred to in Articles 308c and 308d respectively of the Directive) with respect to the calculation of Technical Provisions. Uncertainty associated with the value of the Technical Provisions The ultimate value of the Inceptum s liabilities is subject to uncertainty from a number of sources. These uncertainties include but are not limited to Changes in legislative, political, social and economic conditions The outcome of legislation on individual claims, especially on PPOs and potential PPOs The emergence of medical advancements and changes in medical conditions of claimants, which have not manifested themselves in the data currently available Changes in the claims settlement or reporting process. A key assumption in this work is that historically observed claims patterns will continue into the future The propensity for worse outcomes to occur more frequently than favourable ones Extraordinary changes to the legal, social or economic environment (or to the interpretation of policy language) that might affect the cost, frequency, future reporting or future development of claims. Further to this, as Inceptum ceased to write business from the end of 2009, claim reserves have been reducing since. Now, eight years later, the relatively small size of the claim reserves means scope for variability in outcomes is greater than for larger, more diversified claim portfolios. For example, significant movements in the cost of a single claim could change the reserve estimate materially. There is further uncertainty in the final outcome for reasons more specific to motor accounts in the UK. This principally arises from: The recent sharp rises in third party bodily injury claim costs across the industry, and the estimation of the ultimate value of these claims, particularly given recent changes to the Ogden rate; Increase in bodily injury frequency across the industry over recent years, and the effect on reserve development of this phenomenon. Page 33 of 47