CFM83180 - Old rules: derivative contracts: qualified exclusions: Para 8

Overview of Para 8

This guidance applies to periods of account beginning before 1 January 2005, or beginning after that date and ending before 16 March 2005

Derivative contracts whose underlying subject matter is an excluded matter for the purposes of Sch 26 (now CTA09/PT 7) can be used to replicate a loan paying periodic amounts of interest as well as possibly a return which is dependent on a rise in an index. Particular examples are equities where the company does not hold the derivative contracts for the purposes of a trade.

Many insurance companies have issued policies (often known as guaranteed income bonds) to policyholders allowing the policyholder to obtain an income-like return by making part-surrenders of the policy on a regular basis.

The insurance company needs to find an asset that will produce the cash necessary to pay the policyholder when the bond matures. It also needs an asset, either the same one or another arrangement, to fund the periodic payments.

Most such arrangements have involved derivative contracts, albeit of an unusual type, often with a series of loans from the derivative issuer to fund the annual payments. The contracts used in these arrangements came fully within the derivative contract rules as a result of FA02/SCH26/PARA8.

Paragraph 8 only applied to companies carrying on life assurance business, and full guidance is given in the Life Assurance Manual. It no longer applies in periods of account beginning on or after 1 January 2005 and ending on or after 16 March 2005.