4. Capital resources

4.1 General considerations

L1-48. Qualifying capital resources are determined on a consolidated basis for all financial activities and comprise qualifying financial instruments and capital elements other than financial instruments.
L1-49. Qualifying capital resources are subject to adjustments, exclusions and deductions, as defined in section 4.4. Any item deducted from capital resources is excluded from the calculation of the ICS capital requirement.
L1-50. The ICS identifies two tiers of capital:
- • Tier 1 capital resources comprise financial instruments and capital elements, other than financial instruments, that absorb losses on a going-concern basis and in winding-up; and
- • Tier 2 capital resources comprise financial instruments and capital elements, other than financial instruments, that absorb losses only in winding-up.
L1-51. In determining qualifying capital resources, the ICS differentiates between mutual and non- mutual IAIGs.

4.2 Classification of financial instruments

L1-52. Financial instruments are classified into those two tiers based on consideration of a number of criteria, focused on five key principles:
- • loss absorbing capacity (on a going-concern basis and/or in winding-up);
- • subordination;
- • availability to absorb losses;
- • permanence; and
- • absence of both encumbrances and mandatory servicing costs.
L1-53. Within each tier, financial instruments are allocated into two categories with differing qualifying criteria:
- • Tier 1:
  - o Tier 1 financial instruments for which there is no limit (Tier 1 Unlimited); and
  - o Tier 1 financial instruments for which there is a limit (Tier 1 Limited).
- • Tier 2:
  - o Tier 2 Paid-Up financial instruments (Tier 2 Paid-Up); and
  - o Tier 2 Non-Paid-Up financial instruments (Tier 2 Non-Paid-Up).
L1-54. Table 3 presents the features of Tier 1 Unlimited, Tier 1 Limited and Tier 2 Paid-Up capital with respect to the classification of financial instruments against the five key principles:

Key Principle	Tier 1 Unlimited	Teir 1 Limited	Tier2 Paid-Up
Loss absorbing capacity	Absorbs losses on both a going-concern basis and in winding-up.	Absorbs losses on both a going-concern basis and in winding-up.	Absorbs losses in winding-up.
Level of subordination	Most subordinated (ie is the first to absorb losses);subordinated to policyholders, other non-subordinated creditors, holders of Tier 2 capital instruments, and holders of Tier 1 Limited capital instruments.	Subordinated to policyholders, other non-subordinated creditors and holders of Tier 2 capital instruments.	Subordinated to policyholders and other non-subordinated creditors.
Availability to absorb losses	Fully paid-up	Fully paid-up	Fully paid-up
Permanence	Perpetual	Perpetual For mutuals, this requirement is considered to be met if redemption at maturity (for a dated instrument) can be deferred, subject to supervisory approval or a lock-in feature, subject to a sufficiently long initial maturity. No incentives to redeem permitted. Issuer may redeem after a minimum specified period after issuance or repurchase at any time, subject to prior supervisory approval.	Sufficiently long initial maturity– may have incentives to redeem but first occurrence deemed to be “effective maturity date”.
Absence of both encumbrances and mandatory servicing costs	IAIG has full discretion to cancel distributions (ie distributions are non-cumulative); the instrument is neither undermined nor rendered ineffective by encumbrances.	IAIG has full discretion to cancel distributions (ie distributions are non-cumulative); the instrument is neither undermined nor rendered ineffective by encumbrances.	The instrument is neither undermined nor rendered ineffective by encumbrances.

〈 Table 3: Key Principles for tiering in capital resources 〉

L1-55. With regard to Tier 2 Paid-Up capital, the form of subordination can be either contractual or structural. Structurally subordinated instruments are subject to certain conditions that capture the specificities of structural subordination.
L1-56. The recognition of Tier 2 Non-Paid-Up capital is restricted to mutual IAIGs. It is also required that once these items become paid-up, the resulting capital element will possess the features required of Tier 1 or Tier 2 Paid-Up capital resources.
L1-57. The list of criteria and conditions associated with each tier of capital is specified in the Level 2 text.

4.2.1.Tier 1 Unlimited financial instruments

L2-111. Financial instruments that meet all of the following criteria qualify as Tier 1 Unlimited capital resources:
- a. The instrument is fully paid-up.
- b. The instrument is in the form of issued capital such that it is the first instrument to absorb losses as they occur.
- c. The instrument represents the most subordinated claim in a winding-up of the IAIG where the holder has a claim on the residual assets proportional to its share of the issued share capital after all other claims have been repaid, and which is not subject to a fixed or capped amount.
- d. The instrument is perpetual (ie it does not have a maturity date).
- e. The principal amount of the instrument is not repaid outside winding-up, other than by means of discretionary repurchase permitted under national law.
- f. There is not an expectation created by the IAIG at issuance, through the terms of the instrument or otherwise, that the IAIG will repurchase or cancel the instrument.
- g. There are no circumstances under which a distribution is obligatory (non-payment of a distribution is, therefore, not an event of default).
- h. Distributions are paid out of distributable items, including retained earnings.
- i. The instrument is neither undermined nor rendered ineffective by encumbrances. In particular, the priority of claims is not compromised by guarantees or security arrangements given by either the IAIG or a related entity over which the IAIG exercises control or significant influence, for the benefit of investors.
- j. Neither the IAIG nor a related entity over which the IAIG exercises control or significant influence has purchased the instrument, nor has the IAIG directly or indirectly funded the purchase of the instrument.
- k. The paid-in amount is recognised as equity capital (ie is not recognised as a liability) where a determination that liabilities exceed assets constitutes a test of insolvency.

4.3 Capital elements other than financial instruments

4.3.1.Tier 1 capital elements
4.3.2.Tier 2 capital elements

L1-58. Subject to any exclusion, adjustment or deduction as specified in section 4.4.1, Tier 1 capital elements, other than financial instruments, include the following items:
- a) Retained earnings;
- b) Share premium, resulting from the issuance of instruments included in Tier 1, and other forms of contributed surplus earned from sources other than profits;
- c) Accumulated Other Comprehensive Income (AOCI);
- d) The fair market value of equity-settled employee stock options, provided that a corresponding expense is recorded in the profit and loss account of the IAIG, under applicable accounting standards; and
- e) Other allocated to equity, which includes:
  - i. Minority/Non-controlling interests (NCI); and
  - ii. Adjustments applied to the IAIG’s consolidated balance sheet (as per audited financial statements) to produce the ICS balance sheet.

4.4.1 Deductions from Tier 1 capital resources

L1-62. To the extent that they have not already been excluded through valuation in the ICS balance sheet, the following items are deducted from Tier 1 capital resources:
- a) Goodwill;
- b) Intangible assets, including computer software intangibles;
- c) Each asset recognised on the IAIG’s balance sheet that relates to a defined benefit pension fund;
- d) DTAs on the ICS balance sheet;
- e) Reciprocal cross holdings, arranged either directly or indirectly between financial institutions and that artificially inflate the Tier 1 capital position of the IAIG;
- f) Direct and indirect investments in own Tier 1 capital instruments, not otherwise eliminated;
- g) Reinsurance assets arising from arrangements deemed to constitute non-qualifying reinsurance; and
- h) Encumbered assets in excess of the on-balance sheet liabilities secured by the encumbered assets and incremental ICS capital requirement in respect of those assets and liabilities (see section 4.4.3 for details on the treatment of encumbered assets).
L1-63. Items a) to c) are net of any associated DTL that would be extinguished if the item becomes impaired or derecognised under the valuation approach.

4.4.3 Treatment of encumbered assets

L1-65. When an IAIG holds encumbered assets in excess of the liabilities and associated risks for which those assets have been encumbered, an adjustment to Tier 1 capital resources is made.
L1-66. The details of this adjustment are specified in the Level 2 text.
L2-123. The deduction from Tier 1 capital resources is calculated as the total value of encumbered assets in excess of the sum of the value of the IAIG’s on-balance sheet liabilities secured by the encumbered assets, plus the value of the IAIG’s incremental ICS capital requirement for encumbered assets and secured liabilities.
L2-124. No Tier 1 deduction is required for encumbered assets relating to off-balance sheet securities financing transactions (ie securities lending and borrowing, repos and reverse repos) that do not result in a liability on the balance sheet.
L1-67. The amount of encumbered assets deducted from Tier 1 capital resources is included in Tier 2 capital resources, subject to the limits applicable to Tier 2 (see section 4.5 on capital composition limits).

4.4.4 Limit on non-controlling interests

L1-68. Non-controlling interests (NCI) are subject to a limit calculated at a legal entity level.
L1-69. The calculation of the NCI limit is specified in the Level 2 text.
L2-125. For each legal entity generating NCI at group level, a NCI limit is calculated as:
NIC Limit
$\text{NCI proportion}$ x $\text{Estimated contribution to group ICS}$
• $\text{NCI proportion}$ = $\frac{\text{Equity elements issued to 3rd parties}}{Total equity}$

• $\text{Estimated contribution to group ICS}$ = $\alpha * \text{liabilities}$

• $\alpha = \frac{\text{group ICS capital requirement}}{\text{group GAAP liabilities}}$
L2-126. The amount of NCI generated by that entity and exceeding the limit calculated above is deducted from the amount of Tier 1 capital resources.

4.5 Capital composition limits

L1-70. The Tier 1 Limited and Tier 2 capital resources after adjustments, exclusions and deductions are subject to limits expressed as a percentage of the ICS capital requirement. Those limits, which may differ depending on the IAIG being mutual or non-mutual, are specified in the Level 2 text.
L2-127. For a non-mutual IAIG, the following limits are applicable:
- a. Tier 1 Limited capital resources are limited to 10% of the ICS capital requirement; this limit is increased to 15%, provided that the instruments in excess of the 10% limit possess a Principle Loss Absorbency Mechanism (PLAM);
- b. Tier 2 capital resources are limited to 50% of the ICS capital requirement; and
- c. There is no allowance for Tier 2 Non-Paid Up capital.
L2-128. For the purpose of paragraph L2-127, a PLAM is defined as a mechanism providing for either a write-down of the liability (principal and dividend/coupon) or a conversion of the instrument (into a Tier 1 unlimited financial instrument as defined in section 4.2.1) in contractually predefined going-concern conditions.
L2-129. For a mutual IAIG, the following limits are applicable:
- a. Tier 1 Limited capital resources are limited to 30% of the ICS capital requirement;
- b. Tier 1 Limited + Tier 2 capital resources are limited to 60% of the ICS capital requirement; and
- c. Tier 2 Non-Paid Up capital are limited to 10% of the ICS capital requirement.
L1-71. The GWS, in consultation with the supervisory college, may apply temporary supervisory forbearance on the limit on Tier 1 Limited capital resources for mutual IAIGs, provided that the IAIG submits a plan to restore its capital position.
L1-72. Tier 1 Limited capital resources that are in excess of the associated limit are eligible for inclusion within Tier 2 capital resources, and become subject to the limit applicable to Tier 2 capital resources.