Circular NBB_2016_14 on guidelines regarding basic risk when applying risk mitigation techniques in the calculation of the Solvency Capital Requirement under the standard formula

NBB_2016_14 – 25 April 2016 Circular – Page 1/4 boulevard de Berlaimont 14 – BE-1000 Brussels tel. +32 2 221 38 12 – fax + 32 2 221 31 04 company number: 0203.201.340 RPM Brussels www.bnb.be

Circular
Brussels, 25 April 2016
Reference: NBB_2016_14 your contact:
Kajal Vandenput tel. +32 2 221 51 77 – fax +32 2 221 31 04 Kajal.vandenput@nbb.be

Circular regarding the guidelines on basic risk when applying risk mitigation techniques in the calculation of the Solvency Capital Requirement under the standard formula

Scope
Belgian insurance or reinsurance undertakings.
Insurance or reinsurance undertakings that are part of a Belgian group within the meaning of Article 339, 2° of the Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings.
Belgian entities that are part of a Belgian financial conglomerate within the meaning of Article 340, 1° of the aforementioned Law of 13 March 2016.
Branches of third-country entities carrying on insurance [or reinsurance] activities in Belgium.
This circular applies to mutual insurance companies defined in Article 15, 79° of the aforementioned Law of 13 March 2016. For these entities, 'the Bank' should be replaced by 'the Office for the Supervision of Mutual Funds and National Unions of Mutual Funds' as defined in Article 15, 84° of the same Law. This circular does not apply to insurance undertakings referred to in Articles 275, 276 or 294 of the aforementioned Law of 13 March 2016.

Subject
This circular aims to explain the Bank's guidelines on the treatment of risk mitigation techniques in the calculation of the Solvency Capital Requirement under the standard formula.

Legal references
The Law: The Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings.
Regulation 2015/35: Delegated Regulation (EU) 2015/35 of the Commission of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II).

Circular – Page 2/4 NBB_2016_14 – 25 April 2016

Structure
I. Objectives
II. Definitions
III. Additional Information
IV. Entry into Force
V. Guidelines on the application of the 'Life Underwriting Risk' module

Madam, Sir,

I. Objectives
This circular relates to Articles 154 to 160 of the Law.
It aims to provide additional specifications on the treatment of risk mitigation techniques in the calculation of the Solvency Capital Requirement for undertakings of all types and sizes within the framework of Solvency II. It concerns undertakings and professionals responsible for the treatment of risk mitigation techniques in the calculation of the Solvency Capital Requirement using the standard formula.

II. Definitions
In the absence of a definition in this circular, the terms have the meaning defined in the legislative and regulatory acts referenced herein.

III. Additional Information
This circular is part of the harmonized implementation of the principles of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II), as determined by the guidelines of the European Insurance and Occupational Pensions Authority. Undertakings may, for informational purposes, consult these guidelines at the following address: https://eiopa.europa.eu/publications/eiopa-guidelines.

IV. Entry into Force
This circular applies from 23 March 2016.

V. Guidelines on the consideration of basic risk
Guideline 1 – Risk mitigation techniques without significant basic risk Undertakings should consider that a risk mitigation technique does not result in significant basic risk if the following conditions are met:
(a) the exposure covered by the risk mitigation technique is of a nature sufficiently similar to that of the undertaking's risk exposure;

NBB_2016_14 – 25 April 2016 Circular – Page 3/4 (b) the fluctuations in the value of the exposure covered by the risk mitigation technique reflect the fluctuations in the value of the undertaking's risk exposure across a complete series of risk scenarios, including scenarios consistent with the confidence level referred to in Article 151, § 3, of the Law.

Guideline 2 – Financial risk mitigation techniques: criteria for assessing significant basic risk Before taking into account financial risk mitigation techniques in the calculation of the Solvency Capital Requirement using the standard formula, undertakings should assess, among other things:
(a) the relative importance of basic risk compared to the exposure covered by the risk mitigation technique and the undertaking's risk exposure without taking into account other balance sheet items, unless there is a continuous and coherent link between other balance sheet items and the undertaking's risk exposure; (b) the similar nature of the exposures referred to in Guideline 1, taking into account, at a minimum, the type and conditions of the relevant instruments or agreements and the rules governing the markets on which they are listed or which provide the data for their valuation; (c) the fluctuations in the value of the exposures across a complete series of risk scenarios referred to in Guideline 1, including all scenarios taken into account in the relevant modules or sub-modules of the standard formula, taking into account at a minimum:
(i) the degree of symmetry between the two exposures; (ii) all non-linear dependencies according to the scenario; (iii) any relevant asymmetry of behavior in risk sub-modules where both upward and downward stress tests are applied; (iv) the diversification levels of each respective exposure; (v) any relevant risks not explicitly taken into account in the standard formula; (vi) the complete distribution of payments applicable to the risk mitigation technique. The risk mitigation technique should be considered to result in significant basic risk if the aforementioned assessment does not provide sufficient evidence that the changes in the value of the exposure covered by the risk mitigation technique reflect all significant fluctuations in the value of the undertaking's risk exposure. If the conditions of a risk mitigation technique specify a cap on maximum protection against losses as a proportion of the initial exposure, undertakings should apply the assessment only to the proportion covered by the risk mitigation technique when determining whether basic risk is significant.

Guideline 3 – Insurance risk mitigation techniques without significant basic risk Before taking into account an insurance risk mitigation technique in the calculation of the Solvency Capital Requirement using the standard formula, undertakings should establish whether reinsurance contracts and securitization vehicles behave differently from the undertaking's insurance policies across a complete series of risk scenarios due to different conditions. Undertakings should consider that basic risk resulting from currency asymmetry is significant if the exposure covered by the insurance risk mitigation technique is denominated in a currency other than that of the undertaking's risk exposure, unless the currencies in question fluctuate within a sufficiently narrow band or a fixed exchange rate is provided for in the reinsurance contract.

Circular – Page 4/4 NBB_2016_14 – 25 April 2016 If there is significant basic risk arising from currency asymmetry, as indicated in the previous paragraph, undertakings should not take into account the risk mitigation technique in the calculation of the Solvency Capital Requirement, unless the provisions of Article 86 of Regulation 2015/35 are applicable. A copy of this circular is sent to the commissioner(s), approved auditor(s) of your undertaking. We ask you to accept, Madam, Sir, the expression of our distinguished sentiments.

Jan Smets
Governor