GFSC Guidance Note on The Prudent Person Principle

Version: 2
Publication Date: 28/03/2025 www.gfsc.gi
GFSC Guidance Note
The Prudent Person Principle

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 2
Table of Contents

1. Introduction..................................................................................................................................... 3
2. Investment strategy ........................................................................................................................ 5
3. Investment risk management.......................................................................................................... 6
   Investment Risk Management Policy .............................................................................................. 7
   Counterparty Risk............................................................................................................................ 8
   Risk concentration, risk accumulation and lack of diversification .................................................. 8
4. Outsourcing of investment activities............................................................................................... 9
5. Exposures to non-traded assets.................................................................................................... 10
6. Valuation uncertainty.................................................................................................................... 12
7. Intragroup loans and participations.............................................................................................. 13
8. Outwards reinsurance ................................................................................................................... 14

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 3

1. Introduction
   1.1 This Guidance Note sets out the GFSC’s expectations of firms in accordance with the
   requirements under the Prudent Person Principle (PPP) under Regulation 117 of the Financial Services (Insurance Companies) Regulations 2020 (‘the Insurance Companies Regulations’) regarding:

• their development and maintenance of an investment strategy;
• their management of risks arising from investments and their internal governance within
  the investment function; and
• their investment in assets not admitted to trading on a regulated market (hereafter ‘non￾traded assets’)1 and intragroup loans and participations.
  1.2 This Guidance Note is addressed to Gibraltar insurers, including in the context of provisions
  relating to insurance groups within Part 11 of the Insurance Companies Regulations, (collectively called ‘firms’ in this Guidance Note).
  1.3 The GFSC notes that the PPP sets objective standards for prudent investment.2 These include
  standards in relation to portfolio diversification,3 the use of derivative instruments,4 exposure to nonregulated markets5 and risk concentration,6asset liability matching7 and the security, quality and profitability of the whole investment portfolio.8 Compliance with these standards must be assessed on an objective basis, from the standpoint of the hypothetical prudent person in similar circumstances (taking into account all relevant factors case-by-case), rather than a firm’s subjective view about the prudence of its investment standards. This does not mean that a firm’s own views about the prudence of its investments are irrelevant or would be disregarded. Indeed, firms are required to make their own judgments about the prudence of the way they manage their business for the purposes of the risk management requirements in the Insurance Companies Regulations. Nor does this imply that the same investment policy or the same investment limits ought to apply to different firms with different business strategies and risk profiles.
  1.4 Compliance with the PPP must be considered on a case-by-case basis, as what is prudent for
  one firm, based on its particular business strategy and risk profile, may not be prudent for a different firm. When applied to a particular firm’s circumstances, the PPP’s standards are likely to allow for a range of reasonable investment strategies. In line with the GFSC’s supervisory approach to insurance regulation, the GFSC will exercise its independent judgement, and where it concludes that a firm is not meeting the PPP’s standards it will expect the firm’s senior managers responsible for investment to take action.
  1.5 The Guidance Note should be read in conjunction with the following:
• Part 4 and Chapters 1 and 5 of Part 6 of the Insurance Companies Regulations;
  1 Non-traded assets comprise any investments that are not admitted to trading on a regulated market. 2 Judges have been prepared to rule on what constitutes a prudent investment strategy in other regulatory regimes. For example, see: http://www.bailii.org/ew/cases/EWHC/Ch/2016/1538.html. 3 Regulation 117(4)(c) of the Insurance Companies Regulations 4 Regulation 117(4)(a) of the Insurance Companies Regulations 5 Regulation 117(4)(b) of the Insurance Companies Regulations 6 Regulation 117(4)(d) of the Insurance Companies Regulations 7 Regulation 117(2)(c) of the Insurance Companies Regulations 8 Regulation 117(2)(b) of the Insurance Companies Regulations

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 4

• The Financial Services (Solvency 2)(Technical Standards) 2025 (the ‘Solvency 2 Technical
  Standards’);
  9
• ‘The GFSC’s approach to Insurance Regulation’;10
• The GFSC’s Guidance Note on Liquidity Risk Management for Insurers;11
• The GFSC’s Guidance Note on Financial Management and Planning by Insurers;12
• The GFSC’s Guidance Note on Corporate Governance: Board Responsibilities for Banks and
  Insurers;13
• EIOPA Guidelines on the systems of governance.14
  1.6 In accordance with Regulation 45(9) of the Insurance Companies Regulations, a firm must
  demonstrate that it complies with Chapter 5 of Part 6 (the ‘Investments Part’) of the Insurance Companies Regulations as regards investment risk. Accordingly, this Guidance Note addresses firms’ investment risk management practices and sets out some specific areas where the GFSC would expect firms to pay particular attention in order to comply with the PPP.
  1.7 The GFSC also reminds firms:
• that in accordance with the Insurance Companies Regulations, the GFSC must review and
  evaluate firms’ compliance with matters including the Investments Part of those Regulations, which implement the PPP;
• of the responsibilities resting with Regulated Individuals. Specifically, the Head of Risk
  Management is responsible for managing and reporting to the board on the risk management strategies and processes in place, including those relating to investments;
• that if firms appear to the GFSC to be in breach of the Investments Part, the GFSC would
  consider exercising its relevant supervisory powers under section 70 of the Financial Services Act 2019; and
• that a breach of the PPP may be associated with a failure to meet the requirements set out
  in the Part 4 of the Insurance Companies Regulations (Conditions Governing Business). In particular, the MA eligibility conditions (which firms should comply with at all times) require compliance with the PPP at the level of both the asset and portfolio.15 The GFSC may consider imposing capital add-ons when certain of these requirements are breached. In the case of a breach of MA eligibility conditions that is not rectified for more than two months, the PRA may consider necessary changes to the MA permission (which may be in addition to the reduction to the MA required by Regulation 68D(5) of the Insurance Companies Regulations).
  1.8 The expectations set out in this Guidance Note do not amend the scope of the requirements
  that apply under the Insurance Companies Regulations, the Financial Services Act and under 9 https://www.gibraltarlaws.gov.gi/legislations/financial-services-solvency-2-technical-standards-regulations-2025- 7559 10 https://www.fsc.gi/publications/2019/05/Approach%20to%20Insurance%20Regulation.pdf 11 https://www.fsc.gi/uploads/Guidance%20Notes/GFSC%20Guidance%20Note%20on%20Liquidity%20Risk%20Mana gement%20for%20Insurers.pdf 12 https://www.fsc.gi/uploads/Guidance%20Notes/Guidance%20Note%20- %20Financial%20Management%20and%20Planning%20by%20Insurers%202024.pdf 13 https://www.fsc.gi/uploads/Guidance%20Notes/Guidance%20Note%20- %20Corporate%20Governance%20Board%20Responsibilities2024.pdf 14 https://www.eiopa.europa.eu/content/guidelines-system-governance_en

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 5 retained EU law. In some cases, the relevant requirements will apply at a portfolio level, while in others the requirements are more granular. Accordingly, the level of granularity at which the expectations in this Guidance Note should be applied will depend in each case on (among other things) the scope of all relevant requirements to which the expectation refers or relates and the specific circumstances of each firm case-by-case, taking into account the principle of proportionality.
1.9 In this Guidance note, any reference to any provision of EU legislation is a reference to it as it
forms part of Gibraltar law.
2. Investment strategy
2.1. A The GFSC expects firms to develop and document an investment strategy which describes at
least:

• investment objectives and strategic asset allocation;
• consideration of investment constraints when setting investment objectives and strategic
  asset allocation;
• alignment of the investment strategy with the business model and, where appropriate, how
  the strategy takes into account the nature and duration of a firm’s liabilities and obligations, and the best interests of policyholders;
• alignment of investment strategy with board risk appetite, risk tolerance limits and
  investment risk and return objectives; and
• a complete list of assets and how those assets have been invested in accordance with the
  PPP (in line with the requirements set out in Article 309(2)(e) of the Solvency 2 Technical Standards).
  2.2. Firms should review their investment strategy on an annual basis and additionally, where
  appropriate, following a major external event or material change in the firm’s risk profile.
  2.3. The continuing appropriateness of, or significant changes to, the investment strategy should be
  challenged, approved and controlled by the board or relevant sub-committee of the board. These changes might include, but are not limited to, situations where the firm is planning to invest in a new asset class, make a material, non-routine investment or materially alter the composition of its investment portfolio. Firms wishing to invest in asset classes not already approved by their board should conduct a comprehensive risk assessment to ensure all the necessary expertise, systems and processes are in place to value the asset, and to identify, measure, manage, monitor, control and report associated risks. Firms should also consider whether any changes they wish to make to their investment strategy fall within scope of
  Section 83A of the FSA 2019.16
  2.4. A firm must demonstrate that it complies with the Investments Part (Part 6 Chapter 5) of the
  Insurance Companies Regulations. While the GFSC is not seeking to impose additional reporting requirements, it considers that a firm’s board cannot make effective decisions if it receives information piecemeal. Accordingly, the GFSC expects that firms document compliance in a way that enables the board to effectively engage with, understand and challenge the material. Firms should be able to provide evidence of this compliance to the GFSC on request. 16 https://www.fsc.gi/Materialchange_regulatedfirm_business

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 6
3. Investment risk management
3.1. The GFSC expects investments to be aligned with the firm's risk appetite, risk management
policies, risk tolerance limits and investment strategy alongside the firm’s overall business model (including the profile of their products and policyholders).
3.2. Firms may only invest in assets the risks of which they are able to identify, measure, monitor,
manage, control, report and take into account in their assessment of own solvency needs in the own risk and solvency assessment (ORSA).17 Firms’ risk management frameworks should deliver this. Chapter 4 sets out the GFSC’s expectations for investment risk management where firms have outsourced their investment activities.
3.3. Paragraphs 3.4 to 3.25 of this chapter do not apply to firms investing in assets covering
technical provisions for linked long-term contracts of insurance, except where the assets are held to cover the additional technical provisions in respect of policyholder liabilities, including those for any guarantee of investment performance or other guaranteed benefit provided under those contracts.
3.4. The GFSC expects that when firms invest in asset structures or other investments where the
risk exposure is dependent on the performance of underlying assets (including securitisations, open ended investment companies and derivatives), they should also include the risks of these underlying assets within the scope of their investment risk management framework.
3.5. As part of measuring their risks, the GFSC expects firms to quantify, under a range of scenarios,
the potential impact of investment risks crystallising on their solvency position and their ability to pay policyholders, before and after management actions. Firms are expected to identify scenarios that would cause these risks to crystallise, and to identify and analyse potential risk management actions, in response to stress scenarios.
3.6. Firms’ investment risk monitoring should cover, but not be limited to:

• changes in the value and volatility of their investment portfolios and individual assets and
  the firm’s ongoing ability to monitor these;
• changes in the characteristics of the assets held (e.g. changes in the credit quality);
• changes in the value or characteristics of underlying exposures on which the performance of
  the asset(s) invested in depend;
• changes in the external environment which may affect the security of assets;
• breaches of internal quantitative limits for assets and exposures (see paragraph 3.12 of this
  Guidance Note);
• concentrations of single risks in the investment portfolio (e.g. counterparty, asset class,
  geographical industry or sector); and
• changes to the firm’s risk profile which may lead to asset-liability mismatch.
  3.7. The GFSC expects that, in their monitoring of investment risks, firms should also consider the
  impact of concentrations on the solvency position, including concentrations on the amount of MA benefit claimed. Monitoring of concentrations should include the impact of the crystallisation of single risks (as set out in paragraph 3.6 of this Guidance Note) on the MA benefit. 17 Regulation 46 of the Insurance Companies Regulations

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 7
3.8. The board and any relevant sub-committees of the board should receive appropriate, accurate
and timely management information on the firm’s investment risks. This management information should be provided, at a minimum, whenever the board or relevant committee meets to review the investment strategy, internal investment limits or investment risks. Firms are reminded of the requirement to at least ensure that their investment risk management feeds into their ORSA process and report,18 and the GFSC expects firms to pay particular attention to this where investment risk is assessed to be a key risk currently facing the firm or likely to face the firm in the future.
3.9. Where firms have hedged risks with derivatives and similar commitments, the GFSC expects
firms to be able to monitor the effectiveness of any hedge in mitigating the relevant risk exposure, and take remedial action in the event that it becomes less effective. The GFSC notes that the requirements of Regulation 117(4)(a) of the Insurance Companies Regulations apply to derivative instruments, and as such, firms may only invest in such instruments to the extent that doing so contributes to a reduction of risks to facilitate efficient portfolio management.
3.10. The GFSC expects firms to pay particular attention to the measurement and control of
credit spread and default risk (including credit transition downgrade/upgrade risk). In particular, the GFSC expects firms that outsource credit risk assessments to have sufficient in￾house expertise to appropriately monitor the risks associated with this practice, and reminds firms of their obligations under Regulation 45(11) of the Insurance Companies Regulations. Investment Risk Management Policy
3.11. The risk management system, in accordance with Regulation 45(3) of the Insurance
Companies Regulations, must cover areas including those listed below, and firms must produce policies including for these areas:19

• underwriting and reserving;
• asset-liability management;
• investment, in particular derivatives and similar commitments;
• liquidity and concentration risk management;
• operational risk management; and
• reinsurance and other insurance risk-mitigation techniques.
  3.12. Firms must develop an investment risk management policy that, where appropriate, in
  order to ensure effective risk management, includes internal quantitative investment limits for assets and exposures.20 The GFSC cannot envisage circumstances where it would not be appropriate to set such internal limits and, as such, expects firms to define and operate within these limits. The GFSC expects that such limits would encompass at least asset class, geographic, single-name, sector and off- balance sheet exposures that the firm would expect to hold in reasonably foreseeable market conditions.
  3.13. The GFSC expects quantitative investment limits to be consistent with the board’s risk
  appetite. As such, the GFSC expects firms to document how their limits are determined and how they are consistent with the overall risk appetite and risk management of their firms. The GFSC may review the appropriateness of the limits when assessing compliance with the 18 Regulation 46(8) of the Insurance Companies Regulations 19 Specific requirements are set out in regulation 45B of the Insurance Companies Regulations. 20 Regulation 45B(c)(v) of the Delegated Act

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 8 requirements on the system of governance and investments as part of the supervisory review process.
3.14. The GFSC expects that firms will review their internal quantitative investment limits in
line with reviews of the firm’s investment strategy and investment risk management policy.
3.15. When setting internal quantitative investment limits for asset classes and exposures,
the GFSC expects firms should take into account at least the:

• nature and duration of the firm’s liabilities;
• nature and quantification of the risks associated with each category of asset and with
  individual assets;
• access to investment risk management capabilities proportionate to the complexity of the
  asset class involved (especially for any planned new categories of investment);
• need for proper diversification of assets, as set out in Regulation 117(4)(c) of the Insurance
  Companies Regulations;
• impact of any uncertainty on the valuation of assets, or on the ability of the firm to realise
  an asset’s value in the event of sale, including under stress;
• uncertainty around the timing and the channels through which investment risks may
  materialise and the actions available to mitigate them; and
• material reinsurance cessions and whether these create correlations of counterparty credit
  risk, particularly if collateral arrangements are used, whether, for example, as a result of the counterparty itself, or as a result of collateral arrangements, where utilised. Counterparty Risk
  3.16. Internal quantitative investment limits should be set in order to ensure a properly
  diversified and resilient portfolio of assets (with an acceptable level of volatility) that avoids a material reliance on counterparties (or other common risk factors between the assets).
  3.17. When setting quantitative investment limits, firms should consider an assessment of the
  impact of the failure of the firm’s largest counterparties.
  Risk concentration, risk accumulation and lack of diversification
  3.18. Regulation 117(4)(d) of the Insurance Companies Regulations requires firms to ensure
  that assets issued by the same issuer, or by issuers belonging to the same group, shall not expose the insurance firm to excessive risk concentration. This is an objective standard and must be assessed from the perspective of the hypothetical prudent person in the same situation.
  3.19. Firms are also reminded of their obligations relating to risk concentration reporting
  under Regulation 56D of the Insurance Companies Regulations. The GFSC expects that firms will stress test their portfolios to demonstrate that they are not exposed to excessive risk concentration. The GFSC expects, at the least, that the solvency of a firm would not be threatened by any plausible crystallisation of a risk related to assets issued by the same issuer or by issuers belonging to the same group.
  3.20. Regulation 117(4)(c) of the Insurance Companies Regulations requires assets to be
  properly diversified in such a way as to avoid excessive reliance on any particular asset, issuer or group of undertakings, or geographical area, and excessive accumulation of risk in the portfolio as a whole. This is an objective standard that must be assessed on an objective basis.

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 9 One way the GFSC expects that firms could demonstrate proper diversification is by stress testing their portfolios. More specifically, the GFSC expects that with regard to risks arising from a particular asset, issuer or group of undertakings, or geographical area (e.g. default, change in government policies, deterioration in market or macroeconomic conditions), or other single source of risk:

• the solvency risk appetite of the firm is not threatened in a moderate stress scenario; and
• the solvency of the firm is not threatened in a severe stress scenario and the firm is able to
  recover from a severe shock and restore compliance with all its regulatory requirements.21 In this context, the GFSC considers that what constitutes ‘moderate’ and ‘severe’ stress scenarios depends on the individual circumstances of a firm.
  3.21. The GFSC expects firms to demonstrate how their quantitative investment limits and
  forward-looking investment strategy would prevent solvency from being threatened under a range of stress scenarios. The GFSC expects that firms that appear to it to have excessive levels of concentration risk within their investment portfolio will be subject to greater supervisory scrutiny. This could include increasing the severity of stress scenarios. The GFSC would expect firms to use a combination of simultaneous stresses and be able to identify the set of circumstances that would threaten their solvency risk appetite.
  3.22. The GFSC also expects that the investment risk management policy will articulate how
  the firm has identified and is managing any potential correlation or contagion risks between assets which would lead to excessive concentration of risk and any risks which are common to a material proportion of the firm’s investment portfolio.
  3.23. In determining their quantitative investment limits, firms should have due regard to
  concentration risk and set out the level of concentration exposure that they will not exceed.
  3.24. Firms must ensure that their investments do not expose them to risks that cannot be
  managed effectively in accordance with the requirements in Part 4 (Conditions Governing Business) and Part 6, Chapter 5 (Investments) of the Insurance Companies Regulations. The more complex the risk and the less understood it is (e.g. climate risk), the more difficult it is for firms to manage their exposure to such risks effectively. Therefore, the GFSC expects firms to be able to pay particular attention to such risks in their investment risk management policy and to avoid overexposure to such risks. For example, firms should consider whether there is an excessive accumulation of financial risks from climate change in their investment portfolio, consider appropriate mitigants to those risks. As another example, firms should consider their exposure to political risk, particularly when investing in assets that are ultimately backed by government.
  3.25. In considering the nature and quantification of the risks associated with each category
  of asset and with individual assets (see paragraph 3.14 of this Guidance Note), the GFSC expects a firm to limit its investment appropriately where there is insufficient data to quantify the risks.

4. Outsourcing of investment activities
   21 This is in line with paragraph 2.3 of the Guidance note on Financial Management and Planning by Insurers, in which the GFSC expects that firms set their risk appetites by considering, amongst other factors, ‘recovery options that may be available to the insurer, including consideration of when each option may not be available’.

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 10
4.1. When outsourcing investment-related activities, firms are subject to Regulations 50 and 51 of
the Insurance Companies Regulations, which set out requirements for outsourcing in general. Regulation 50(1) of the Insurance Companies Regulations states that ‘an insurance or reinsurance undertaking remains fully responsible for discharging all of its obligations under these Regulations when it outsources functions or any insurance or reinsurance activities’.
4.2. As such, firms that wholly or partially outsource their investment function themselves remain
subject to the requirements of the PPP. Firms must ensure that any external investment manager only invests their assets in accordance with the PPP. Boards must be aware of any outsourced investment activities and must monitor, regularly review and be satisfied that these align with the firm’s strategy, strategic asset allocation and risk appetite.
4.3. The GFSC expects that firms will undertake appropriate due diligence in relation to outsourced
investment activities. A firm’s risk function should have the ability to understand and manage the specific risks associated with outsourcing its investment function or parts of its investment function. Additionally, firms should be confident that any external party has sufficient risk management expertise to comply with this Guidance Note.
4.4. Article 274 of the Solvency 2 Technical Standards applies for outsourced investment
functions/activities. For the purposes of this article, the GFSC would normally expect ‘investment’ to be regarded as a ‘critical or important operational’ function or activity. Firms should identify a process to determine which functions and activities are critical or important.22The GFSC would expect to challenge firms to explain their reasoning if as a result of this process they determine that investment functions are not ‘critical or important’.
5. Exposures to non-traded assets
5.1. This chapter does not apply to firms’ investments in assets covering technical provisions (“TPs”)
for linked long-term contracts of insurance, except where the assets are held to cover the additional TPs in respect of policyholder liabilities. This includes those for any guarantee of investment performance or other guaranteed benefit provided under those contracts.
5.2. Investments in non-traded assets can be an appropriate match for insurance liabilities,
particularly annuities or Periodic Payment Order liabilities (PPOs), but they can also give rise to additional risks. For example, they can be difficult to value in the absence of regular market pricing and to sell in a timely manner, particularly under stressed market conditions.
5.3. In addition to the factors set out in paragraph 3.15 of this Guidance Note, the GFSC also
expects that, prior to investing in a non-traded asset, when determining any internal investment limit, and as part of ongoing practice, firms will also consider and assess matters including the following:

• the appropriateness and robustness of the valuation methodology under a suitable range of
  operating conditions;
• in the case of internally-rated assets, the robustness, capability and maturity of the internal
  rating framework;
• if using an internal model, the ability to justify and reconcile any material differences
  between how investment risk is assessed for capital purposes and when applying the standards of the PPP; and 22 European Insurance and Occupational Pensions Authority (EIOPA) Guidelines 60 and 63 (System of governance)

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 11

• the materiality of any embedded optionality, how this may change over time and under
  stress, and how any change will affect the risk profile of the asset.
  5.4. Non-traded assets will often be more complex than those traded on a regulated exchange and
  as a result often expose firms to additional risk. The GFSC expects that for the purpose of identifying the risks arising from these investments (in line with Regulation 117(2)(a) of the Insurance Companies Regulations), firms will take particular care to consider both the systemic and idiosyncratic risks arising from the features of each investment.
  5.5. Non-traded assets are often bought and sold less frequently than traded assets or in less deep,
  liquid and transparent markets. Therefore, there is often relatively little credible historical pricing data that can be used to measure the risks they introduce as required under Regulation 117(2)(a) of the Insurance Companies Regulations. Firms with historical records for their own assets are unlikely to have access to historical data relating to the market as a whole. It is therefore important for firms to undertake a fundamental analysis of the underlying risks on their non-traded assets.
  5.6. The GFSC expects that the level of expertise of key persons (including investment managers)
  and the robustness of risk management systems and controls would increase commensurate with any increases in the scale, complexity or concentration of investments in non-traded assets.
  5.7. The GFSC reminds firms of its expectations relating to liquidity risk arising from investment in
  non-traded assets, as set out in the GFSC’s Guidance Note on Liquidity Risk Management for Insurers. 23
  5.8. Regulation 45(9) of the Insurance Companies Regulations requires firms to demonstrate
  compliance with the Investments Part (Chapter 5, Part 6) of those Regulations. Firms investing in non-traded assets should at a minimum be able to demonstrate that:
• key persons have sufficient experience and expertise to be able to understand and manage
  the risks involved in the assets held and challenge decisions;
• the suitability of an investment to match the firm’s liabilities has been assessed in the light
  of suitably severe stress scenarios projected over suitably long horizons. The GFSC would not expect an investment to be suitable if under such stress scenarios it resulted in a material deterioration in the firm’s solvency or liquidity position;
• investments in ‘assets not admitted to trading on a regulated financial market’ are kept at
  ‘prudent levels’ in accordance Regulation 117(4)(b) of the Insurance Companies Regulations on an objective basis from the standpoint of the hypothetical prudent person in similar circumstances; and
• the firm’s internal investment limits (in accordance with the guidance set out in Chapter 3 of
  this Guidance Note) are adequate to ensure that such investments are kept to such prudent levels.
  5.9. The GFSC expects that firms consider the appropriateness of the risk charges applied to any
  non-traded assets within their Solvency Capital Requirement in order to ensure that these are consistent with the potential risks that could arise in a stress scenario. The most significant of these would be a firm’s inability to liquidate its position to meet policyholder liabilities as they 23 https://www.fsc.gi/uploads/Guidance%20Notes/GFSC%20Guidance%20Note%20on%20Liquidity%20Risk%20Mana gement%20for%20Insurers.pdf

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 12 fall due or at a significant reduction in booked value, particularly in cases where there exists no primary market for them.
5.10. Firms with exposures to non-traded assets should also ensure that they have considered
these risks in detail within the Standard Formula Appropriateness section of their Own Risk Solvency Assessment.
5.11. As part of its ongoing supervision, the GFSC will review the investments of a firm against
its peers in the wider market. Where outliers are identified, they may be expected to provide a remediation plan to ensure that firms are not taking unnecessary risks in non-traditional assets classes.
6. Valuation uncertainty
6.1. The GFSC recognises that there is inherent uncertainty in the valuation of any asset. This will be
most material for any asset where there are no quoted market prices in active markets in the same assets, as it is not possible to know for certain what a buyer would pay to a seller for such an asset at a point in time. The less deep, liquid and transparent the market for a particular asset, the greater reliance a firm will have to place on modelled values, and hence the greater the valuation uncertainty. The MA benefit resulting from including a particular asset in the MA portfolio will depend on the modelled values, hence its uncertainty will also be affected by the nature of the market for a particular asset.
6.2. Valuation uncertainty is therefore a key risk for non-traded assets, and is also likely to be a risk
for listed assets that are thinly traded, including cases where an investor holds a material proportion of an issuance. The GFSC expects that firms take into account valuation uncertainty risk for the purposes of complying with the PPP and be able to demonstrate that they comply with the risk management requirements set out in Regulation 45 of the Insurance Companies Regulations in relation to valuation uncertainty risk.
6.3. When assessing whether firms are appropriately managing valuation uncertainty risk, the GFSC
will consider (among other things) the extent to which the firm complies with its requirements under the Delegated Regulation in relation to the valuation of assets. In particular, in relation to the alternative valuation methods referred to in Article 10(3) of the Solvency 2 Technical Standards, which are used to value the non-traded assets, the GFSC will consider whether the firm has credibly justified the alternative valuation approach used. The GFSC will also consider whether the firm has adequately assessed the valuation uncertainty of those assets in accordance with Article 263 of the Solvency 2 Technical Standards.
6.4. When assessing firms’ management of valuation uncertainty risk for the purposes of complying
with the PPP, the GFSC will also consider the extent to which the firm satisfies the requirements under Article 267 of the Solvency 2 Technical Standards relating to the internal control of valuation of assets. The GFSC expects that the more material the firm’s exposure, the greater the skills and expertise that will be required of the persons involved in the valuation of these assets.
6.5. In accordance with Regulation 50(1) of the Insurance Companies Regulations, firms remain fully
responsible for discharging all of their obligations under those Regulations and any other relevant laws, regulations and administrative provisions when they outsource functions or any insurance or reinsurance activities. Accordingly, firms must take the steps necessary to adequately assess and manage valuation uncertainty risk, regardless of whether the valuation function is outsourced. In assessing a firm’s compliance with the requirements of the PPP in the

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 13 context of its investment in non-traded assets, where the firm does outsource the valuation function, the GFSC will consider (among other things) the extent to which the firm complies with the requirements for outsourcing set out in Article 274 of the Solvency 2 Technical Standards.
6.6. The GFSC expects that firms will have effective systems and controls in place to limit and
manage their exposure to valuation uncertainty. This should include a framework for quantifying or grading their exposure to this risk, to enable them to define appropriate internal investment limits (in line with paragraph 3.12 of this Guidance Note) in respect of their investment in assets that expose them to valuation uncertainty. The appropriateness of that framework will depend on all the circumstances in each case, taking into account the principle of proportionality. The GFSC expects that the level of valuation uncertainty and associated risks should be consistent with the defined risk appetite and investment strategy of the firm, including in stress scenarios.
6.7. When undertaking a risk assessment to determine the appropriateness of investment in assets
not yet approved by the board (in line with paragraph 2.3 of this Guidance Note), the GFSC also expects that firms will quantify valuation uncertainty.
6.8. The GFSC notes that valuation uncertainty is distinct from uncertainty about the potential
realisable value of an asset in the future. However, where the value of an asset is uncertain, this will obviously increase uncertainty about the potential realisable value of that asset. Firms should therefore take valuation uncertainty into account when stress testing their portfolios in line with the expectation set in paragraph 3.19 of this Guidance Note.
7. Intragroup loans and participations
7.1. In respect of assets backing TPs, the PPP requires that these must be invested ‘in a manner
appropriate to the nature and duration of the [firm’s] insurance and reinsurance liabilities and in the best interest of all policyholders and beneficiaries, taking into account any disclosed policy objective’.24
7.2. The requirement for assets backing TPs to be invested in policyholders’ best interests has
particular implications for certain intragroup transactions such as intragroup loans and participations or arrangements to that effect (‘intragroup transactions’). Investments in or loans to other group companies may be in the interests of shareholders but they may not necessarily be in the best interests of policyholders. For example, the issuers of loans may be less willing or able to enforce repayment, particularly where loans are upstream. The GFSC expects that it would be a high hurdle for firms to demonstrate that intragroup loans and participations are in the best interests of policyholders and, as such, a high hurdle to demonstrate that they are appropriate for covering TPs.
7.3. The PPP requires that in the case of a conflict of interest, the investment of assets is ‘made in
the best interest of policy holders and beneficiaries’25. This provision applies to all asset classes but is highlighted here as the GFSC considers that investment in intragroup assets is very likely to lead to a conflict of interest (for example, between shareholders and policyholders, between subsidiaries and parent companies, and between policyholders in different subsidiaries). The GFSC therefore expects that a firm’s board should be satisfied that any conflicts of interest have been resolved in the best interest of policyholders before investing in an intragroup asset. 24 Regulation 117(2)(c) of the Insurance Companies Regulations 25 Regulation 117(2)(d) of the Insurance Companies Regulations

Gibraltar Financial Services Commission Guidance Note on the Prudent Person Principle 14 Further to this, the GFSC expects that any conflicts of interest that arise following investment in an intragroup transaction should also be resolved in the best interest of policyholders, which may mean ceasing to invest in that asset.
7.4. Intragroup reinsurance is used to back TPs, but the GFSC generally expects that intragroup
reinsurance arrangements with no element of investment are less likely to present conflicts of interest in the way it observes, for example, that intragroup loans can. Intragroup reinsurance transfers can be, and usually are, different in substance economically from intragroup investments. They usually transfer risk away from the ceding firm in a way designed to ensure that the insurance obligations are closely matched by the reinsurance. As such, in many situations, the GFSC would expect the interests of policyholders and the interests of the ceding firm to be better aligned.
7.5. Nevertheless, the GFSC remains very interested in intragroup reinsurance arrangements
recognising that they carry risks of their own that firms need to be able to measure, monitor, manage, control and mitigate. The GFSC will look to the economic substance of arrangements, and where an intragroup reinsurance arrangement is structured to effectively function as a loan, the GFSC would treat it as such for the purposes of this section.
7.6. As with any investment, intragroup assets are subject to all the other requirements placed on
firms under the PPP. As an example of this, the GFSC expects that intragroup assets are subject to at least the same level of ‘arm’s length’ scrutiny and risk management as other assets, as well as proper governance and documentation with regard to:

• conflicts of interest;
• concentration risk;
• credit risk;
• liquidity risk;
• legal and operational risk;
• wrong-way risk where counterparty default risk is positively correlated with other risks
  borne by the firm (when the crystallisation of a risk could affect the financial condition both of the firm and of other group entities); and
• increased complexity of the group structure leading to dependencies that increase the
  fragility of the group or entity in stress scenarios.

8. Outwards reinsurance
   8.1. The PPP applies to all assets, including reinsurance arrangements. As for any asset, the GFSC
   will take a case-by-case approach to considering whether reinsurance arrangements meet the PPP’s standards (as set out in Chapter 1), and will take into account a particular firm’s circumstances, including the impact of various risk mitigation factors such as the use of collateral.

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