Guidelines on Ceded Reinsurance/Retrocession

Guidelines on ceded reinsurance/retrocession Warsaw, 2014

• 2 - Introduction Taking into account the objectives of supervision over the financial market specified in Article 2 of the Act of 21 July 2006 on supervision over the financial market (consolidated text: Journal of Laws of 2012, item 1149, as amended, hereinafter: the Act), such as ensuring the proper functioning of the market, its stability, safety, and trust in the market, as well as ensuring the protection of the interests of its participants, and the task of the Financial Supervision Authority specified in Article 4(1)(2) of the Act, consisting in taking actions serving the proper functioning of the financial market, the Guidelines on ceded reinsurance/retrocession (hereinafter: the Guidelines) are issued. Ceded reinsurance is an agreement in which an insurance/reinsurance company cedes (transfers) all or part of the insured risk to another insurance/reinsurance company. Reinsurance/retrocession1 is one of the basic tools in the risk management process in an insurance/reinsurance company and plays a significant role in the flow of capital in the insurance market, increasing its insurance capacity, and enabling the insuring of rare risks. The company should ensure that the degree of risk transfer is sufficient given the level of capital buffers and proportional to the type, scale, and complexity of risks inherent in the activities of insurance/reinsurance companies. Regardless of whether an insurance/reinsurance company uses reinsurance, it remains fully responsible for fulfilling all obligations arising from insurance contracts. Furthermore, all material risks in the reinsurance area should be identified and included in the risk management process by the insurance/reinsurance company. The above requires the application of appropriate standards regarding reinsurance. The Guidelines cover standards in the area of:
• general principles,
• risk management system in the reinsurance area,
• obligations of the Management Board, Supervisory Board, and persons involved in reinsurance,
• internal procedures regarding reinsurance,
• reinsurance program,
• ongoing risk management in the reinsurance area,
• financial reinsurance,
• internal control system in the reinsurance area,
• accounting and reporting.

1 reinsurance/retrocession hereinafter referred to as reinsurance

• 3 - The Guidelines constitute a framework for the proper identification, measurement, monitoring, and reporting of risks related to reinsurance, as well as their management. They are a set of recommended actions regarding internal control systems, which indirectly and directly should ensure the implementation of appropriate standards within all processes related to reinsurance. Standards, including those regarding documentation and control mechanisms, may cover reinsurance exclusively or be an element of larger processes. The Guidelines should be applied in a proportional manner, which means differentiating the approach depending on the type, scale, and complexity of risks inherent in the activities of the insurance/reinsurance company, as well as the scale of reinsurance usage. The Financial Supervision Authority expects that the Guidelines will be implemented by 1.01.2015.

• 4 - Glossary of Terms For the purposes of the Guidelines:

1. Risk appetite – the level or character of risk that the Company is willing to take and accept, specified in the risk management strategy.
2. Reinsurance broker – an insurance intermediary participating in the conclusion of reinsurance agreements on behalf and for the account of the Company.
3. Risk tolerance limits – permissible levels of risks accepted by the Management Board.
4. Person supervising the actuarial function – a person in a managerial position responsible for the implementation of the actuarial function.
5. Priority – a specified (in percentage or amount) in a non-proportional reinsurance agreement, value of risk or claims on the Company's share, above which the Reinsurer begins to bear responsibility.
6. Facultative reinsurance – an agreement concluded and negotiated individually for a given insurance contract or specific risk, in which the Company makes a decision each time on the possible cession of the risk, including its amount, and the Reinsurer makes a decision each time on accepting this risk.
7. Financial reinsurance (limited) – a reinsurance agreement whose characteristic feature is a limited transfer of insurance risk. Additionally, characteristic features of financial reinsurance are: a. transfer of risks other than insurance risk (e.g., investment risk, credit risk, interest rate risk) or combination in the agreement of risk transfer and a financing element, b. consideration of the time value of money and investment profits, c. multi-year nature of agreements.
8. Catastrophic reinsurance – an agreement protecting the Company against a sudden increase in the amount of paid indemnities and benefits related to the occurrence of a natural catastrophe (e.g., flood, hurricane, earthquake) or a man-made catastrophe (e.g., transport accident, building collapse) causing large-value damages or accumulation of damages.
9. Non-proportional reinsurance – an agreement in which the portion of the loss covered by the Reinsurer does not remain in the same relation to the total loss as the accepted reinsurance premium, and the Reinsurer, when setting the premium, is guided by the probability and size of the expected loss.
10. Treaty reinsurance (obligatory) – an agreement of a mandatory nature for both the Company and the Reinsurer, in which the Reinsurer is obliged to automatically accept all risks covered by the agreement, and the Company must cede the risks covered by the agreement.
11. Proportional reinsurance – an agreement in which the Company and the Reinsurer participate in a given risk, premium, and losses in the same proportion according to a determined coefficient.

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12. Reinsurer – an insurance company or reinsurance company that accepts risk from the Company.
13. Internal control system – a system including in particular administrative and accounting procedures, organization of internal control, appropriate rules regarding reporting at all levels of the Company's organizational structure, and the compliance function.
14. Internal control system in the reinsurance area – a set of control mechanisms related to reinsurance, constituting part of the Company's internal control system.
15. Management system – a system including at least a transparent organizational structure, in which scopes of responsibility are clearly assigned and appropriately divided, ensuring effective information transfer and decision-making. The management system includes the risk management, compliance, internal audit, and actuarial functions. Within the management system, the internal control system and risk management system operate.
16. Risk management system – a system including the strategy, rules, and procedures necessary to determine, measure, monitor, and report risks to which the Company is or may be exposed, and the interdependencies occurring between these risks, as well as to manage them. The risk management system includes, among others, reinsurance and other risk mitigation techniques.
17. Risk mitigation techniques – mean all techniques that allow the Company to transfer part or all of the risk borne to another entity.
18. Company's own share – the value of losses/risk retained by the Company up to the retention level/priority and the value of losses/risk above the upper reinsurance retention limit retained by the Company.
19. Retention – a specified (in percentage or amount) in a proportional reinsurance agreement value of risk or losses that are retained by the Company.
20. Company – an insurance company of division I or division II that uses ceded reinsurance or a reinsurance company that uses retrocession.

• 6 - Guidelines General Principles Guideline 1. The Company should ensure that the Reinsurer with whom it concludes a reinsurance agreement has the right to conduct reinsurance activities on the territory of the Republic of Poland and possesses appropriate credibility within the meaning of these guidelines. Guideline 2. In concluding a reinsurance agreement, the Company should ensure that the provisions of the agreement clearly and precisely specify the transfer of risk, including at least its character, scale, and scope of the Reinsurer's liability towards the Company. Risk management system in the reinsurance area Guideline 3. The Company should have a risk management system in the reinsurance area allowing for the determination, measurement, monitoring, and reporting of risks to which the Company is or may be exposed, and the interdependencies occurring between these risks, as well as for their management. Obligations of the Management Board, Supervisory Board, and persons involved in reinsurance Guideline 4. The Management Board is responsible for managing risk in the reinsurance area. At least one member of the Management Board should possess knowledge and experience allowing for the assessment of the impact of reinsurance on the Company's activities. Guideline 5. In the course of fulfilling their functions and responsibility for the risk management system, the Supervisory Board should approve and supervise the implementation of the risk management strategy in the reinsurance area.

• 7 - Internal procedures regarding reinsurance Guideline 6. The Company should have established, adopted by the Management Board, and approved by the Supervisory Board risk management strategy in the reinsurance area appropriate to the type, scale, complexity, and business profile of the Company. Guideline 7. The Company should develop rules and procedures regarding risk management in the reinsurance area and implement their provisions so that all actions related to reinsurance are taken in a transparent manner and in accordance with the established risk management strategy in the reinsurance area. Guideline 8. In the event of identifying material credit risk in the reinsurance area, which could significantly affect solvency, the Company should have an emergency plan adopted by the Management Board and approved by the Supervisory Board regarding the realization of the risk of non-performance of obligations by the Reinsurer and contagion risk in the case of reinsurance within a capital group, which would ensure the restoration of the Company's solvency. Reinsurance program Guideline 9. The Company should prepare a reinsurance program. The reinsurance program should be prepared in written form in accordance with the strategy, rules, and procedures regarding risk management. Ongoing risk management in the reinsurance area Guideline 10. The Company should conduct reinsurance activities in accordance with the adopted strategy, rules, and procedures regarding risk management in the reinsurance area. Key decisions regarding reinsurance should be documented. Guideline 11. In the course of its activities, the Company should determine, measure, monitor, and report all material risks to which it is or may be exposed in connection with reinsurance activities, and manage them appropriately.

• 8 - Guideline 12. The Company should have information systems or analytical tools and databases supporting the process of concluding and monitoring reinsurance agreements and measuring the level of risk, and should have appropriate information flow and management procedures to enable the Management Board and persons at the managerial level responsible for reinsurance to make proper decisions. Financial reinsurance Guideline 13. To determine the extent to which the Company uses financial reinsurance, the Company should conduct analyses of all new reinsurance agreements and activities related to reinsurance, especially when the scope of transfer of insurance risk is significantly limited. The method of conducting analyses should be consistent for all reinsurance agreements in the Company and performed each time when concluding reinsurance agreements or making changes to the provisions of reinsurance agreements. Internal control system in the reinsurance area Guideline 14. An effective internal control system in the reinsurance area should be implemented in the Company. Accounting and reporting Guideline 15. The Company should accurately and timely calculate and record in the accounting books and financial statements values related to reinsurance based on adopted principles (accounting policy).

• 9 - General Principles Guideline 1. The Company should ensure that the Reinsurer with whom it concludes a reinsurance agreement has the right to conduct reinsurance activities on the territory of the Republic of Poland and possesses appropriate credibility within the meaning of these guidelines. 1.1. The assessment of the Reinsurer's credibility should take into account the criteria specified in point 9.4. Guideline 2. In concluding a reinsurance agreement, the Company should ensure that the provisions of the agreement clearly and precisely specify the transfer of risk, including at least its character, scale, and scope of the Reinsurer's liability towards the Company. 2.1. In concluding a reinsurance agreement, the Company should limit the level of risk related to future disputes. The reinsurance agreement should: a. be written in a clear manner allowing it to be understood by an independent person familiar with the subject of reinsurance, b. contain definitions understandable to the parties to the agreement (e.g., commonly used in the insurance/reinsurance sector), c. specify at least: i. the parties to the agreement, ii. description of the ceded risk, iii. subject and temporal scope of the Reinsurer's liability, iv. conditions/clauses, including those regarding mutual settlements and the contract termination process, d. clearly specify issues that limit the size of the risk being the subject of transfer or allow for delays in payments by the Reinsurer. 2.2. Agreement conditions (including the scope and parameters of reinsurance coverage), as a rule, should be specified before the start of the reinsurance coverage period, and their confirmation should be documented.

• 10 - Risk management system in the reinsurance area Guideline 3. The Company should have a risk management system in the reinsurance area allowing for the determination, measurement, monitoring, and reporting of risks to which the Company is or may be exposed, and the interdependencies occurring between these risks, as well as for their management. 3.1. The risk management system in the reinsurance area should be effective and well integrated with the Company's organizational structure, decision-making processes, and an efficiently operating internal control system. 3.2. Within the risk management system in the reinsurance area, the Company should have: a. a risk management strategy in the reinsurance area adopted by the Management Board and approved by the Supervisory Board (see Guideline 6), b. written rules and procedures regarding risk management in the reinsurance area (see Guideline 7). 3.3. The risk management system in the reinsurance area, as part of the management system, should be subject to regular reviews with a frequency adapted to the scale and complexity of the Company's activities and the scale of reinsurance usage. Obligations of the Management Board, Supervisory Board, and persons involved in reinsurance Guideline 4. The Management Board is responsible for managing risk in the reinsurance area. At least one member of the Management Board should possess knowledge and experience allowing for the assessment of the impact of reinsurance on the Company's activities. 4.1. The Management Board should be responsible for: a. preparing and implementing the risk management strategy in the reinsurance area (see Guideline 6), b. approving rules for risk management in the reinsurance area (see Guideline 7), c. adopting an emergency plan regarding reinsurance (see Guideline 8).

• 11 - 4.2. Within the Management Board, one person should be designated who is responsible for reinsurance. 4.3. At least one member of the Management Board should possess appropriate knowledge regarding the reinsurance used, at least in the area of: a. factors influencing decisions regarding the transfer of insurance risk, b. the scale of ceded risk (in the context of risk appetite), c. the effectiveness of the reinsurance used, d. risks arising from the use of reinsurance and methods of limiting them, e. scenarios whose realization would cause a significant deterioration of the Company's financial situation. 4.4. The Management Board should ensure that employees performing activities related to reinsurance possess knowledge and experience necessary and appropriate for performing activities in the field of reinsurance. 4.5. The Management Board should indicate in written rules the position or positions at the managerial level responsible for reinsurance. The Company should have succession procedures for persons occupying the aforementioned positions to limit risks associated with their departure or absence. 4.6. Persons at the managerial level responsible for reinsurance should possess appropriate knowledge regarding the reinsurance used by the Company, at least in the area specified in point 4.3, as well as in the area of the reinsurance program. 4.7. Persons and organizational units involved in reinsurance in the Company should have clearly defined scopes of responsibility and scopes of authority for performing activities in the field of reinsurance. Guideline 5. In the course of fulfilling their functions and responsibility for the risk management system, the Supervisory Board should approve and supervise the implementation of the risk management strategy in the reinsurance area. 5.1. The Supervisory Board should be responsible for: a. approving the risk management strategy in the reinsurance area, b. monitoring risk management in the reinsurance area, c. supervising the effectiveness of the Management Board's management of the internal control system in the reinsurance area.

• 12 - 5.2. The Supervisory Board should possess competencies enabling understanding of the main risks to which the Company is or may be exposed in connection with reinsurance activities or their absence. 5.3. The Supervisory Board should receive periodic reports from the Management Board at least once a year containing information regarding the implementation of the risk management strategy in the reinsurance area. 5.4. In the course of monitoring risk management in the reinsurance area, the Supervisory Board should receive periodic reports, with a frequency adapted to the scale and complexity of the Company's activities and the scale of reinsurance usage, regarding at least the impact of reinsurance on the Company's financial results and solvency. Internal procedures regarding reinsurance Guideline 6. The Company should have established, adopted by the Management Board, and approved by the Supervisory Board risk management strategy in the reinsurance area appropriate to the type, scale, complexity, and business profile of the Company. 6.1. The Management Board is responsible for developing and implementing the risk management strategy in the reinsurance area, while the Supervisory Board is responsible for its approval. The risk management strategy in the reinsurance area may constitute a separate document or be part of larger documents. 6.2. The risk management strategy in the reinsurance area should at least: a. define strategic objectives in the field of reinsurance, b. take into account risk appetite, c. take into account the Company's development plans regarding the sale of insurance products, d. take into account the Company's business profile, including in particular the types of insurance/business lines that the Company offers or intends to offer, e. take into account the size of the Company's own funds, including taking into account the size of the surplus of own funds over the capital requirement, f. take into account the Company's financial liquidity, g. take into account forecasts of market and economic trends,

• 13 - h. take into account, if it exists, the seasonality of the sale of the Company's insurance products, i. take into account the geographical concentration of risks, if necessary, j. provide appropriate solutions allowing protection against potential large losses or accumulation of losses. 6.3. The risk management strategy in the reinsurance area should be subject to regular review and assessment, as well as adaptation to new circumstances and significant changes in the Company's activities, and the results of verification should be documented. In the event of new circumstances arising, the Management Board should modify the strategy, obtaining acceptance (approval) from the Supervisory Board. 6.4. The risk management strategy in the reinsurance area should be described in a clear manner so that an independent person familiar with the subject of reinsurance could assess the consistency and adequacy of the risk management strategy in the reinsurance area with the Company's general business strategy and business model. Guideline 7. The Company should develop rules and procedures regarding risk management in the reinsurance area and implement their provisions so that all actions related to reinsurance are taken in a transparent manner and in accordance with the established risk management strategy in the reinsurance area. 7.1. Rules and procedures regarding risk management in the reinsurance area should be prepared in written form in the Polish language, although they may constitute separate documents or be part of larger documents. 7.2. Rules and procedures regarding risk management in the reinsurance area should: a. be adapted to the Company's activities, especially in the case of rules and procedures developed at the capital group level, b. be reviewed regularly and each time in the event of significant changes in the Company's activities, with the results of verification being documented, and the implementation of changes should occur in such a way that persons and organizational units involved in reinsurance are familiarized with them. 7.3. Approval of rules regarding risk management in the reinsurance area and their changes should be made by the Management Board.

• 14 - 7.4. Procedures regarding risk management in the reinsurance area should contain a detailed specification of performed activities. 7.5. Rules regarding risk management in the reinsurance area should specify: a. rules for the selection, assessment, and change of the Reinsurer, b. risk tolerance limits, taking into account the concentration of ceded risk in one entity or one capital group, c. risk tolerance limits for the Company's foreign branches, in the event that the Company has foreign branches, d. risk tolerance limits for catastrophic risk, if it exists, e. rules for managing the risk of non-performance of obligations by the Reinsurer, f. rules regarding reporting to the Management Board and Supervisory Board, g. tasks to be performed and units/positions responsible for their performance. 7.6. Rules or procedures regarding risk management in the reinsurance area should specify, where appropriate: a. rules for the selection, assessment, and change of the Reinsurance broker, b. rules for managing liquidity risk to eliminate mismatch in time between indemnities or benefits paid by the Company and funds obtained from the Reinsurer, c. rules for managing concentration risk in one entity or capital group with respect to reinsurance, d. rules for concluding facultative reinsurance agreements in the event of the need to cover particularly large