Consultation Paper on Solvency Standard for Life Insurance Business: Financial Reinsurance

Consultation Paper Solvency Standard for Life Insurance Business: Financial Reinsurance consultation on exposure draft The Reserve Bank invites submissions on this Consultation Paper by 6 June 2014. Submissions and enquiries about this consultation should be addressed to: Felicity Barker Adviser Prudential Supervision Department Reserve Bank of New Zealand PO Box 2498 Wellington 6140 Email: felicity.barker@rbnz.govt.nz Please note that a summary of submissions may be published. If you think any part of your submission should properly be withheld on the grounds of commercial sensitivity or for any other reason, you should indicate this clearly. May 2014 Ref #5714100

2 Solvency Standard for Life Insurance Business: Financial Reinsurance Part 1: Introduction

1. The Reserve Bank is consulting on an exposure draft of a proposed amendment to the Solvency Standard for Life Insurance Business (August 2011) (“the standard”) in respect of the requirements for the treatment of certain reinsurance arrangements (colloquially termed financial reinsurance). The proposed amendment affects the treatment of reinsurance in the calculation of the Insurance Risk Capital Charge and the Catastrophe Risk Capital Charge.
2. This consultation paper represents the third public consultation on financial reinsurance. The first consultation was undertaken in December 2012 and the second in October 2013. These previous consultations, which may be accessed on the Reserve Bank website1 , set out the problem definition for the proposed amendment and the options considered.
3. The purpose of this consultation paper is to provide members of the public with an opportunity to comment on the technical workability of the text of the proposed amendment. The Reserve Bank’s view on the problem definition and objectives of the proposed amendment has not changed since the October 2013 consultation and the Reserve Bank has already undertaken consultation on these matters. However, the Reserve Bank has taken into account submissions received on the previous consultation and used this feedback to make drafting changes to the proposed amendments to the standard.
4. This paper provides a summary of the submissions received on the October 2013 consultation document, an overview of the proposed amendment, including the Reserve Bank’s decision on the transition path, and the appendix sets out the proposed amendment. Submissions close on 6 June 2014. Part 2: Summary of submissions
5. Fourteen submissions were received on the October 2013 consultation paper, with a range of views expressed. This section provides a summary of the main themes of the submissions. It does not detail every point raised.
6. There were opposing views on whether an amendment to the standard was needed to address financial reinsurance. A minority of submitters argued that no amendment was needed. Several submitters were supportive of the proposed approach but considered that greater clarity was needed.
7. Most submitters commented on the requirements in paragraph 66 of the October 2013 exposure draft. This paragraph defined the concept of a ‘repayable amount’; 1 http://www.rbnz.govt.nz/regulation_and_supervision/insurers/4295441.html Ref #5714100

3 which is intended to capture elements of a reinsurance agreement that are essentially debt-like in nature. Several submitters considered that this paragraph gave rise to interpretation and implementation issues. Some submitters considered that the requirement was too broad and suggested further exemptions to the requirement. Other submitters raised more technical points, such as how claw-back commissions would be treated and the discount rate to be used to calculate the time value of money. Some submitters suggested that additional guidance on the interpretation of a repayable amount would be useful. 8. The Reserve Bank has taken into account the comments made by submitters. In response the requirements have been restructured such that in the body of the standard there is a requirement that the Insurance Risk Capital Charge (IRCC) include any amount that is a repayable amount. An appendix to the standard has been created to more fully define a repayable amount. The intent is to provide greater clarity and guidance as to when a reinsurance agreement will be considered to contain a repayable amount and how that amount should be valued. The content of this appendix is explained in detail in Part 3. 9. Several submitters considered that the Reserve Bank should implement a regime under which the Reserve Bank formally assesses reinsurance arrangements and issues a determination on whether or not any amount will be considered a repayable amount. While not ruling out such an approach in the future, at this point of time the approach adopted will be one where insurers may submit agreements to the Reserve Bank to seek a Reserve Bank view of the correct treatment under the standard as part of the supervisory process. 10. There were opposing views on whether and how stress testing of reinsurance arrangements should be implemented. Several submitters considered that stress testing should be used to make an assessment of whether a repayable amount exists however others considered that stress testing would lead to unnecessary compliance costs. There were mixed views on whether stress testing should be parameter based or whether reverse stress tests should be mandated and on whether the Reserve Bank should specify the probability outcome to be tested. One submitter considered it should be specified when stress testing will be undertaken. 11. The Reserve Bank considers that stress testing is important to determine when an amount is a repayable amount but also that stress testing is an important risk management tool in relation to reinsurance more generally. The Reserve Bank considers that specifying the probability outcome to be modelled would not always give the correct result because of the diversity of reinsurance arrangements. Insurers should take into account the nature of the risk reinsured when assessing the likelihood of the reinsurer making a loss under the reinsurance agreement. The Reserve Bank continues to hold the view that a reverse stress test is required (that is a specification of the set of parameters that would result in the reinsurer making a loss) however a requirement to test the sensitivity of the solvency reinsurance balance to parameter changes has also been included. Stress testing results are required to be reported to the Reserve Bank. This will provide an important discipline Ref #5714100

4 on stress testing and allow for an assessment of the effectiveness of the policy over time. The amendment sets requirements on when stress testing must be performed. 12. One entity considered insurers that do not have financial reinsurance should not be subject to the disclosure and attestation requirements. We consider all life insurers should be subject to the disclosure requirements as disclosure is the key tool the Reserve Bank will use to improve oversight of reinsurance arrangements. We have, however, removed the separate reinsurance attestation requirement, as we consider this is already sufficiently incorporated within current attestations. 13. One submitter considered that the direction as to when to add a repayable amount onto the IRCC was too prescriptive and suggested the repayable amount could be added onto the CTV minimum. The Reserve Bank has given consideration to the requirements as to when to add the repayable amount onto the IRCC. This is a complex area given a repayable amount may already be recognised in the solvency calculation depending on the outcome of other calculations under the standard. The Reserve Bank has decided to take a more outcomes-based approach, such that the amount added on to the IRCC is the repayable amount less any amount that the licensed insurer can demonstrate has already been recognised in the calculation of the solvency margin (termed the repayable amount adjustment). 14. Some submitters considered that repayable amounts should not always be fully recognised, in particular if the obligation was akin to a contingent obligation. The Reserve Bank disagrees; the essence of a repayable amount is that it is debt-like in nature and repayable at some time (even if the timing is uncertain). This is different from a contingent obligation for which payment is uncertain. 15. Several points of technical detail were made in relation to paragraphs 62-64 of the 2013 exposure draft; these paragraphs set requirements for the recognition of reinsurance. Submissions on these paragraphs included the following points: • The requirements should not apply to the Catastrophe Risk Capital Charge: the Reserve Bank does not agree with this point as there should be a minimum level of certainty that the reinsurance agreement will provide a benefit to the insurer in a range of circumstances for the benefit to be recognised for solvency purposes; • The recognition requirements should only apply where the reinsurance agreement gives rise to a net benefit: the Reserve Bank agrees; • An agreement should be able to be recognised for solvency purposes even if the insurer is required to enter into discussions of termination on the occurrence of an event: the Reserve Bank agrees; the amendment only disallows recognition of an agreement if the agreement can be terminated without the insurer consenting to that termination at the time of termination; • An agreement should still be recognised if the reinsurer is not required to make payment if the insurer is insolvent: the Reserve Bank disagrees as it is important that reinsurers make good their obligation in a range of stress scenarios including insolvency; • Submitters considered paragraph 62(d) (negative experience payments) was too wide: the Reserve Bank agrees and this clause has been removed: Ref #5714100

5 • Submitters considered that a number of other reasons for termination without the consent of the insurer should be permitted: the Reserve Bank has revised the exemptions to allow a wider range of valid termination events; • Submitters considered that future reinsurance inflows that are dependent on mortality/persistency assumptions should be given credit in the solvency liability calculation: the Reserve Bank agrees and considers paragraph 64 of the 2013 exposure draft is unnecessary. 16. The 2013 consultation paper sought views on the transition period. Several parties submitted that the transition period proposed (2 years) was too short. Alternatively, some parties considered a shorter transition could be justified. 17. The Reserve Bank intends that the following transition period will apply to the amendment: • the amendment will apply in respect of new business written, from one year after the date specified as the issue date in the Gazette, • the amendment will apply to all business written prior to the date that is one year following the issue date, from four years from the issue date. 18. Reporting requirements will however apply to the first Financial Condition Report following commencement of the policy. Part 3: Overview of policy 19. The appendix contains the proposed amendment to the standard. The proposed amendment contains three main parts: • restrictions on when reinsurance can be recognised for the purpose of the insurer calculating its solvency capital requirement; • a rule requiring that whenever a reinsurance agreement gives rise to a repayable amount, that amount must be recognised in the insurer’s Solvency Margin. The requirements for identification and valuation of the repayable amount are contained in an appendix to the standard; and • requirements to report to the Reserve Bank. Recognition as an asset/benefit 20. Under the proposed amendment an insurer may not recognise the benefits of reinsurance for the purposes of the calculation of the IRCC or the Catastrophe Risk Capital Charge if the agreement exhibits certain features that may result in the reinsurer not being required to make payments under the agreement. These features are: • the agreement is not legally binding; • the insurer does not have a right to the receipt of monies under the agreement; • the agreement may be terminated in relation to existing reinsured business without the agreement of the insurer at the time of termination; or • the reinsurer may be excused from its obligation to make payments under the agreement, including in the case of insurer insolvency. Ref #5714100

6 21. The proposed amendment contains a number of exceptions to the above rules in paragraph 63, such as if termination is as a result of wrong doing or material default on the part of the insurer. These exceptions have been expanded in light of submissions received. Repayable amounts 22. The amendment requires that an insurer include the ‘repayable amount adjustment’ in the calculation of the IRCC. The repayable amount adjustment is the value of the repayable amount adjusted downwards for any amounts that have already been recognised in the calculation of the insurer’s solvency capital requirements (for example if the solvency liability forms the basis of the calculation of the IRCC and the repayable amount is recognised in the solvency liability). 23. There are three tests to determine if a repayable amount exists: the likelihood test, the specified event test and the embedded obligation test. A repayable amount will exist if any one of these tests is met. Likelihood test 24. The likelihood test assesses whether there is sufficient risk transfer under the agreement as a whole. The test requires that the insurer treat the solvency reinsurance balance (that is the net present value of its contractual obligations under the reinsurance agreement) as a repayable amount if it is highly unlikely that the reinsurer could make a significant loss under the agreement. Only a solvency reinsurance balance that is a net outflow of resources (liability) to the reinsurer is considered a repayable amount. 25. An assessment of the likelihood of the reinsurer making a loss must be performed through stress testing. The insurer must perform a range of scenarios, estimating the reinsurer’s profit under a range of parameters, and at least one reverse scenario, estimating how poor experience would need to be such that the reinsurer would make a loss. Insurers are required to report stress testing information to the Reserve Bank as part of the Financial Condition Report. Specified event test 26. The specified event test is associated with particular contractual terms. The proposed amendment provides that, if under the agreement the insurer will be subject to an obligation to pay an amount to the reinsurer on the occurrence of a specified event, otherwise than out of future profits from the reinsured policies then that amount will be considered to be a repayable amount. As this is a broad requirement a number of exemptions are articulated to the requirement. In order to avoid overlap with the requirements for off balance sheet exposures, the amendment states that no amount treated as a repayable amount under this test will be considered to be an off balance sheet exposure. Ref #5714100

7 Embedded obligations test 27. Even if the insurer assesses that as a whole the reinsurance agreement transfers sufficient risk such that the likelihood test does not apply, the insurer must assess whether a part of the agreement in itself gives rise to a debt-like obligation. In particular the insurer must assess whether reinsurance commissions give rise to a repayable amount. The amendment provides that an amount received from a reinsurer will be considered a repayable amount if the insurer is obligated to repay that amount otherwise than from out of future profits derived from the reinsured portfolio. Valuation 28. The exposure draft specifies how each obligation should be valued. If the likelihood test is met, the repayable amount is the value of the solvency reinsurance balance. If the specified event test is met the value of the obligation is the maximum amount of that obligation. If the embedded obligation test is met the repayable amount is either the value that must be repaid over time or the accumulated value of the obligation, less any amount the insurer expects to receive from third parties in respect of that obligation. An insurer may meet more than one of the above tests. In this case the total repayable amount is the sum of the amounts less a downward adjustment to eliminate any double counting (subject to the minimum being the largest of the three tests). Reporting to the Reserve Bank 29. The final part of the policy is to require insurers to provide a reinsurance statement as part of the Financial Condition Report. The reinsurance statement requires insurers to report to the Reserve Bank certain information on their reinsurance agreements and also their assessment of whether the agreement gives rise to a repayable amount and details of stress tests performed. The reporting requirements are a key mechanism for the Reserve Bank to assess the operation of and compliance with the policy. Ref #5714100

8 Appendix 1: Exposure draft of proposed amendment to the Solvency Standard for Life Business Note that in this exposure draft references to existing paragraphs refer to paragraphs that are currently in the Solvency Standard for Life Insurance Business and references to new paragraphs are new paragraphs proposed to be included in that standard. Add to definitions Repayable amount: has the meaning and value given in paragraph 4 of Appendix C. Solvency reinsurance balance: The present value of the licensed insurer’s net contractual rights and obligations under a reinsurance agreement calculated using the Prescribed Solvency Assumptions set out in Appendix A. The balance should be calculated as the present value of expected payments to the reinsurer minus expected receipts from the reinsurer (hence the balance will be more than 0 where there is an expected net outflow of resources from the insurer to the reinsurer). Add to existing paragraph 60 60. The Insurance Risk Capital Charge requires a calculation of the Solvency Liability. The Solvency Liability is determined using the methods used to determine the Best Estimate Liability, but: (a) allowing for current and future bonuses, subject to the appropriate application of discretions (refer Section 4.2 of this solvency standard); (b) adopting the Prescribed Solvency Assumptions, set out in Appendix A; and (c) is not calculated net of reinsurance if and to the extent that paragraph 62 applies. New paragraphs following existing paragraph 60 New 61. In applying paragraphs 62-65 and Appendix C, attention should be directed to the economic substance of the reinsurance agreement rather than the legal form. The term “reinsurance agreement” is to be interpreted to include any side letters, correspondence or other agreements that alter the obligations of the parties under the reinsurance agreement or that are so inter-connected that in substance they form part of the agreement. New 62. The benefits of a reinsurance agreement must not be netted from the Solvency Liability if: (a) the solvency reinsurance balance in respect of that agreement is less than zero (net inflow); and (b) one or more of the following applies: i. the agreement is not legally binding; or ii. the licensed insurer is not a party that has a right to the receipt (whether directly or indirectly) of reinsurance payments under the agreement; or iii. unless paragraph 63 applies: A. the reinsurance agreement may be terminated or will terminate2 in relation to existing reinsured business without the licensed insurer giving consent or agreeing to that termination at the time of the termination; or B. the reinsurer may, without the consent of the licensed insurer at the time of release, be released from an obligation to pay amounts 2 Including through withdrawal of the portfolio. Ref #5714100

9 otherwise due under the reinsurance agreement, including in the event of insolvency of the licensed insurer. New 63. Paragraph 62(b)(iii) does not apply where the right to termination or release from payment is the result of any of the following events: (a) fraud, misrepresentation or non-payment of monies due, in each case by the licensed insurer; (b) un-remediated material default of a party other than the reinsurer under the agreement, including a failure of the licensed insurer to abide by specified prudent underwriting practices or other policies stipulated in the reinsurance agreement; (c) the agreement or performance of the agreement, or an important part thereof, is rendered illegal, prohibited or is otherwise impossible for reasons for which the reinsurer is not responsible; (d) the reinsurer is prevented at law from making payment; (e) the licensed insurer transfers all or part of the portfolio reinsured without the consent of the reinsurer, including by way of change of ownership of the licensed insurer; (f) war or civil unrest (or a similar event) that affects the licensed insurer or reinsurer; or (g) all the insurance contracts to which the reinsurance relates have expired or been terminated and there is no outstanding insurance liability in respect of those contracts, provided that the licensed insurer confirms that this is the case. New 64. This will be the current paragraph 61 amended in (d) as follows: (d) The Insurance Risk Capital Charge for each Life Fund is the total of the following: i. the amounts determined in (c) above for the Related Product Groups; plus ii. the Other Liabilities within that Life Fund; plus iii. the total of the repayable amount adjustments for the Life Fund determined in accordance with paragraph 65. New 65. The total of the repayable amount adjustments for a Life Fund, is the total value of the repayable amounts for that Life Fund, determined in accordance with Appendix C, less any portion of those amounts that the licensed insurer can demonstrate have otherwise been accounted for in the calculation of the licensed insurer’s Solvency Margin in a manner that achieves a broadly equivalent outcome to that which would have been achieved had those amounts been included in the Other Liability category. The licensed insurer must take account of the principles in paragraph 21 of Appendix C in calculating the repayable amount adjustments. Add to existing paragraph 66 In arriving at the Catastrophe Risk Capital Charge, a licensed insurer can deduct the benefit of any appropriate reinsurance in place, provided the reinsurance agreement(s) represents a true transfer of the risk of loss in respect of the pandemic or other extreme event and provided that none of paragraph 62(b)(i-iii) apply in respect of the agreement. Add to existing paragraph 151 (l) for any Financial Condition Report that is prepared following a licensed insurer’s financial year that ends after [commencement date of amendment]; include a reinsurance statement that includes all of the following information: i. a list of all reinsurance agreements currently in place, including the name of the reinsurer, the starting and termination date of the agreement and the form of the agreement (e.g. quota share, excess of loss, facultative); Ref #5714100

10 ii. the retention of the licensed insurer and cession to reinsurers (min and max if applicable), the capacity provided by each reinsurance agreement, and whether the licensed insurer retains any exposure other than the retention that is not reinsured; iii. the method for calculating reinsurance commissions, selection rebates or selection discounts, and the maximum commission, selection rebate or selection discount payable (if applicable) for the reporting year; iv. an assessment of whether any repayable amount exists under any of the tests in Appendix C, and if so the value of the repayable amount adjustment and an explanation of how that value was calculated; v. if subparagraph (vi) applies, the following information in relation to stress testing of the reinsurance portfolio; A. the combination of parameters that could result in the reinsurer suffering a significant loss under the agreement (or a statement that no such scenario exists); and B. the scenarios performed under paragraph 17(a) of Appendix C and the solvency reinsurance balance under those scenarios; and C. for each of A and B a comment on the likelihood of the scenario occurring, based on quantitative evidence where possible; vi. the information in subparagraph (v) must be provided: A. at the time of providing the Reserve Bank with the first Financial Condition Report that is required to include a reinsurance statement; and B. following inception of a new reinsurance agreement; and C. following any material changes to a reinsurance agreement; and D. annually unless the licensed insurer is able to demonstrate that there has been no material change to the level of risk transferred (aside from that arising from experience) under the agreement since the last stress test was performed. Ref #5714100

11 Appendix C Reinsurance Overview

1. This appendix defines when a repayable amount exists in respect of a reinsurance agreement.

2. The principle to be applied in determining whether a repayable amount exists is that the intended application is to obligations that are in substance in the nature of a liability of the licensed insurer but have been treated as reinsurance for financial reporting purposes. The intent is therefore to provide a treatment that differs from that under financial reporting standards. The objective is to ensure that such obligations have broadly the same impact on the licensed insurer’s Solvency Margin as would be the case had the obligation been included in Other Liabilities.

3. In this appendix any reference to an amount received includes a reference to an amount accounted for as received or receivable and any reference to an amount paid, payable or to pay includes an amount accounted for as paid or payable or to pay. Definition and value of repayable amount

4. The following paragraphs define when a repayable amount exists. Subject to paragraph 5, an amount shall be considered to be a repayable amount if it meets any one of the tests in paragraphs 6, 10, or 14. The value of the repayable amount under each test is the value ascribed in paragraph 6, 12 and 16.

5. Any amount that has been included in Other Liabilities is not a repayable amount. Likelihood test The purpose of the likelihood test is to assess whether there is an effective transfer of risk under the reinsurance agreement as a whole

6. A repayable amount equal in value to the solvency reinsurance balance will exist in relation to a reinsurance agreement if: (a) the value of the solvency reinsurance balance is more than 0; and (b) it is highly unlikely that the reinsurer could realise a significant loss under the agreement, taking into account the time value of money.

7. The licensed insurer must be able to demonstrate that the risk to the reinsurer of loss arises from insurance or lapse risk, rather than from credit risk (i.e. insolvency of the insurer). Significant means more than minor in the opinion of the Appointed Actuary.

8. In order to assess whether it is highly unlikely that the reinsurer could realise a significant loss under the agreement, the licensed insurer must undertake the stress tests required under paragraph 17 and make the assessment required under paragraph 18.

9. The existence of a feature in the reinsurance agreement which may result in payments being made by the reinsurer to the licensed insurer on the basis of experience, including a persistency bonus or profit commission, will not in itself be Ref #5714100

12 sufficient to indicate that a reinsurance agreement contains repayable amounts. However, the licensed insurer must be able to demonstrate through stress testing that premium levels are not set at such a level, or that the operation of these features is not such, that it is highly unlikely that the reinsurer could suffer a significant loss under the agreement. Specified event test The purpose of the specified event test is to ensure that potential obligations on the licensed insurer to pay amounts to the reinsurer are recognised in solvency calculations 10. Subject to paragraph 11, an amount will be a repayable amount if the licensed insurer will, on the occurrence of an event specified in the reinsurance agreement, be under an obligation to pay that amount to the reinsurer otherwise than from out of the future profits arising from the reinsured portfolio. The circumstances of the occurrence of the specified event include but are not limited to the following: (a) financial deterioration, insolvency or administration of the licensed insurer; or (b) poor experience on the underlying portfolio, such as a higher than expected rate of claims or higher than expected lapse rate; or (c) termination of the agreement or withdrawal of the portfolio. 11. The following shall not give rise to a repayable amount under paragraph 10 (for the avoidance of doubt, if one of the following apply a repayable amount may still exist as a result of another specified event in the reinsurance agreement): (a) the amount becomes payable on termination of the agreement or withdrawal of the portfolio as a result of any of the factors listed in paragraph 63 of this solvency standard (subject to 11(e) an amount will be a repayable amount if it becomes payable on termination of the agreement or withdrawal of the portfolio as a result of a factor not listed in paragraph 63); or (b) the amount becomes payable on lapse of an underlying insurance policy and the licensed insurer expects to receive a corresponding amount from a third party in respect of that amount (claw-back commission); or (c) the amount is payable to adjust for an error in calculation; or (d) the licensed insurer may be subject to contractual damages for non￾performance of an obligation or breach of contract; or (e) the specified event is the termination of the reinsurance agreement or withdrawal of the portfolio; and i. both parties must agree to such termination or withdrawal at the point of termination or withdrawal; and ii. the amount that will become payable is to be determined at the point of termination or withdrawal based on the arms length commercial value of the portfolio at that point in time and may not be related to amounts paid in the past by the reinsurer to the insurer. 12. If paragraph 10 applies, the value of the repayable amount shall be the maximum value of the obligation, at the date of the assessment, that the licensed insurer may be subject to on the occurrence of the specified event. 13. Paragraph 10 applies whether or not the obligation on the insurer is subordinated to policy holders and other creditors. If an amount is a repayable amount under paragraph 10, then the licensed insurer is not required to treat that amount as an off balance sheet exposure under paragraph 83 of this solvency standard (whether or not paragraph 20 applies). Ref #5714100

13 Embedded obligations test The purpose of the embedded obligations test is to assess whether there are debt-like obligations embedded within the reinsurance agreement, even if the agreement as a whole transfers sufficient risk 14. The licensed insurer must consider whether any individual cash flows, or group of cash flows, under the reinsurance agreement give rise to a repayable amount under this paragraph. An amount received from the reinsurer will give rise to a repayable amount if the licensed insurer must, under any circumstance, repay that amount otherwise than out of future profits derived by the licensed insurer from the reinsured portfolio. 15. At a minimum the licensed insurer must consider whether amounts received as reinsurance commission give rise to a repayable amount under paragraph 14. Reinsurance commission includes all payments made to the licensed insurer by the reinsurer, of which the purpose or effect is to fund some portion of the licensed insurer’s acquisition costs, including selection rebates, selection discounts or any other similar amounts. 16. Where an amount is assessed as a repayable amount under paragraph 14, the licensed insurer may value that amount as either: (a) the portion of the solvency reinsurance balance attributable to repayment of that amount, less any corresponding amount the licensed insurer expects to receive from third parties in respect of that amount; or (b) the value of the amount received, less any corresponding amount the licensed insurer expects to receive from third parties in respect of that amount and less any amount that has been repaid; provided that no amount less than zero will be a repayable amount. Stress testing 17. In order to make an assessment of whether it is highly unlikely that the reinsurer could realise a significant loss under the reinsurance agreement, the licensed insurer must stress test the reinsurance portfolio. Stress tests must: (a) provide at least three scenarios which test the sensitivity of the solvency reinsurance balance to changes in relevant parameters, such as mortality, morbidity and lapse rates, where those parameters are set at levels where experience is significantly worse than under the Prescribed Solvency Assumptions in Appendix A; and (b) quantify at least one combination of relevant parameters, such as mortality, morbidity and lapse rates, that would result in the reinsurer making a significant loss under the agreement or otherwise state that there is no scenario under which the reinsurer will make a significant loss. 18. If, in relation to paragraph 17(b), the combination of parameters that results in the reinsurer making a significant loss is highly unlikely to occur, or there is no scenario under which the reinsurer makes a significant loss, then the solvency reinsurance balance will be a repayable amount. In making this assessment the licensed insurer should take into account the nature of the risk reinsured. For example, an agreement under which the reinsurer is required to make payment in the event that a low probability but extreme event occurs would be considered to transfer sufficient risk if the reinsurer could make a loss if that event occurred. However, if the agreement is not to cover loss only in low probability events, the licensed insurer should be able to demonstrate that a loss to the reinsurer is Ref #5714100

14 possible under a scenario of greater likelihood. The licensed insurer’s Appointed Actuary must be able to comment upon the likelihood of the scenario under which the reinsurer makes a significant loss occurring, providing quantitative evidence where possible. 19. The Reserve Bank may notify the licensed insurer in writing that the licensed insurer must quantify the solvency reinsurance balance under a particular scenario. Repayable amount calculation and adjustment 20. If a repayable amount exists under more than one of the tests in this Appendix in respect of a reinsurance agreement, the repayable amount in respect of that agreement shall be calculated by: (a) summing all the repayable amounts; and (b) adjusting the sum downwards to ensure that no element is captured more than once, subject to the proviso that the net balance must not be less than the largest repayable amount calculated under any one of the tests. 21. The total of the repayable amount adjustments for a Life Fund is calculated in accordance with paragraph 65 of this solvency standard. In interpreting paragraph 65 the following applies: (a) an amount will not be considered to be accounted for in the calculation of the licensed insurer’s Solvency Margin to the extent that that amount does not increase the Insurance Risk Capital Charge, for example due to the Insurance Risk Capital Charge being based on Current Termination Values (that do not include the repayable amount) for a particular related product group; (b) without limiting how a licensed insurer can demonstrate that an amount has been accounted for in the calculation of the Solvency Margin, the following may be relied on to show that such amount has been so included: i. the basis of the Insurance Risk Capital Charge for a particular related product group is the Solvency Liability and, in respect of that related product group, the Solvency Liability has been increased by the repayable amount attributable to that product group; or ii. the basis of the Insurance Risk Capital Charge for a particular related product group is the Current Termination Values, and the Current Termination Values have been increased by the repayable amount attributable to that related product group.

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