Circular NBB_2016_15 on Guidelines for Applying Reinsurance Cession Agreements to the Non-Life Underwriting Risk Sub-module in SCR Calculation under the Standard Formula

NBB_2016_15 – 25 April 2016 Circular – Page 1/11 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_15 your correspondent:
Kajal Vandenput tel. +32 2 221 51 77 – fax +32 2 221 31 04 kajal.vandenput@nbb.be

Circular regarding the guidelines on the application of reinsurance cession agreements to the "non-life underwriting risk" sub-module in the calculation of the Solvency Capital Requirement according to the standard formula

Scope
Belgian insurance or reinsurance undertakings.
Insurance or reinsurance undertakings forming 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 forming part of a Belgian financial conglomerate within the meaning of Article 340, 1° of the aforementioned Law of 13 March 2016. Branches of undertakings from third countries 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 undertakings, "the Bank" should be replaced by "the Office for the Supervision of Mutualities and National Unions of Mutualities" 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 regarding the application of reinsurance cession agreements to the "non-life underwriting risk" sub-module 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 2/11 NBB_2016_15 – 25 April 2016

Structure
I. Objectives
II. Definitions
III. Additional Information
IV. Entry into Force
V. Guidelines on the Application of Reinsurance Cession Agreements to the "Non-Life Underwriting Risk" Sub-module

Madam,
Sir,

I. Objectives
This circular relates to Article 156 of the Law, as well as Articles 119 to 135 and 209 to 214 of Regulation 2015/35.
It aims to provide additional specifications on the application of reinsurance cession agreements to the "non-life underwriting risk" sub-module.

II. Definitions
These guidelines refer to the "non-life underwriting risk chart" representing the various sub-modules composing the "non-life catastrophe risk" sub-module of the Solvency Capital Requirement standard formula, according to Regulation 2015/35. For the purposes of this circular, the following definitions have been developed:
a) "Gross Loss":
i. for risk mitigation applied to a sub-module not dependent on any other sub-module, the loss calculated according to the formula stated in that sub-module;
ii. for risk mitigation applied to a sub-module dependent on one or more other sub-modules, the loss calculated according to the formula stated in that sub-module, but using as input data in the formula the results of each sub-module less the risk mitigation applied (where applicable) in the sub-modules on which this sub-module depends.
b) "Catastrophic Event Accumulating a Large Number of Claims": a catastrophic event accumulating and affecting a group of policies as a whole. The effects on individual policies are not immediately detectable. c) "Catastrophic Event Risk": an event affecting policies that can be specifically identified or a single policy. d) "Gross Event": an event specified with sufficient precision to allow the application of the reinsurance cession program. This is the term applied to the "gross loss" after disaggregation. e) Branches of a "catastrophe" sub-module: branches of one of the four main sub-modules "non-life catastrophe risk" referred to in Article 119 of Regulation 2015/35. f) reinsurance cession/reinsurance cession protections: reinsurance agreements through which an undertaking cedes a risk to a reinsurer. g) "Active Reconstruction Premium": any reconstruction premium potentially due to an undertaking. h) "Clash cover": a liability reinsurance contract for excess risk related to two or more covers or policies, issued by the undertaking involved in a loss, so that the cover can come into play. The attachment point of the reinsurance contract is generally above the limits of each individual policy. i) Catastrophic Event occurring once every 200 years: a catastrophic event corresponding to a Value-at-Risk measure, with a confidence level of 99.5%, as defined in Article 104, § 4 of the Law. j) Component: an autonomous calculation unit of the "non-life catastrophe risk" sub-module for which a Solvency Capital Requirement (SCR) can be determined. The calculation unit can be determined at the sub-module level or at a less detailed level, for example, EEA/non-EEA regions for natural catastrophe risks. In the absence of a definition in this circular, terms have the meaning defined in the legislative and regulatory acts referred to therein.

III. Additional Information
This circular is set within the framework 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 this implementation has been determined by the guidelines of the European Insurance and Occupational Pensions Authority. Undertakings may consult these guidelines for information 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 Application of Reinsurance Cession Agreements to the "Non-Life Underwriting Risk" Sub-module

Section I: Order of Application of Guidelines
Guideline 1 – Order of Application of Guidelines Undertakings should apply the sections of these guidelines successively to assess their reinsurance cessions against catastrophe risk.

Section II: Specification of Events
Guideline 2 – Level of Detail Required to Specify the Catastrophe Event In accordance with Articles 119 to 135 of Regulation 2015/35, undertakings should specify catastrophic events occurring once every 200 years with sufficient detail to allow the application of risk mitigation techniques.

Guideline 3 – Specification of Catastrophes as "Catastrophic Event Accumulating a Large Number of Claims" or as "Catastrophic Event Risk" Undertakings should specify losses defined in the various "catastrophe risk" sub-modules either as "catastrophic event accumulating a large number of claims" or as "catastrophic event risk", in which case undertakings should also specify whether these events affect or do not affect known specific policies. For each "non-life catastrophe risk" sub-module, undertakings should specify the type of event as follows:

Circular – Page 4/11 NBB_2016_15 – 25 April 2016 a) the sub-modules "earthquake risk", "storm risk", "hail risk", "flood risk" and "subsidence risk" are specified as "catastrophic event accumulating a large number of claims"; b) the sub-module "motor third-party liability risk" should be specified as "catastrophic event risk" affecting a single policy; c) the sub-modules "liability risk", "aviation risk", "marine risk" and "fire risk" should be specified as "catastrophic event risk" affecting known policies; d) the sub-module "credit and suretyship risk" should be specified as indicated in Guidelines 13 and 14; e) the sub-module "non-proportional non-life catastrophe reinsurance risk" should be specified as indicated in Guideline 11.

Guideline 4 – Specification of the Number of Events for Natural Catastrophe Risk Sub-modules with Respect to EEA Regions Undertakings should consider the number of events causing gross losses in EEA regions as single or double events affecting one or more regions and should not assume that multiple events occur in each region.

Guideline 5 – Specification of the Number of Events for Natural Catastrophe Risk Sub-modules with Respect to Non-EEA Regions For non-EEA regions where the number of "catastrophic events accumulating a large number of claims" causing the "gross loss" has not been defined, undertakings should adopt an approach similar to that applied under Guideline 4 for each particular sub-module.

Guideline 6 – Selecting the Catastrophic Event If a number of catastrophic events occurring once every 200 years can be defined, undertakings should identify events corresponding to their risk profile and select the event generating the highest catastrophe costs, after application of risk mitigation techniques.

Guideline 7 – Magnitude of Liability Insurance Losses In order to determine the magnitude of individual claims on which the calculation of the basic own funds loss is based in accordance with Article 133 of Regulation 2015/35, undertakings should adopt the procedure described below:
a) within each risk group, the risks with the highest limits should be identified. For this purpose, a "risk" consists of all policies taken out under a program with identical or closely related cover and with the same policyholder (if the insured policyholder is the policyholder of the insurance contract) in force at the same time. b) each of the resulting limits ni should be multiplied by 1.15; c) the values ni calculated in point b) should be aggregated and deducted from the value L(liability, i) and any difference should be allocated proportionally using the actual limits of the values ni; d) the resulting final values ni should be considered as individual claims arising from a single event, each linked to the risk from which it arises. Undertakings should then be able to define for each claim ni the applicable reinsurance cover, according to the nature of the associated risk. Undertakings should be ready to demonstrate to the Bank that their purchase of reinsurance cessions has not been significantly influenced by the possibility that the risk is identified under this procedure.

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Section III: Disaggregating the "Gross Loss"
Guideline 8 – Disaggregating the "Gross Loss" into Individual Countries or Other Components Undertakings should use one of the methods described below to disaggregate the "gross loss" into individual components, if the gross incidence on individual policies has not been defined to allow the application of reinsurance cession protections:
a) Maximum Contribution Method: the "gross loss" is allocated to the component representing the maximum contribution to the "gross loss" before diversification. b) Apportionment Method: the "gross loss" is apportioned across relevant components proportionally to their contribution to the "gross loss" before diversification; where applicable, an approach using correlation matrices may be adopted to share the loss similar to that proposed for allocating the SCR to lines of business. c) Integration Method: this method selects the maximum values (based on the most significant net capital requirement) of the maximum contribution method and the apportionment method mentioned above.

Guideline 9 – Disaggregating the "Gross Loss" for Natural Catastrophe Sub-modules with Respect to EEA Scenarios Undertakings should use the methods defined below to disaggregate the "gross loss" for natural catastrophe sub-modules with respect to EEA scenarios. When disaggregating the "gross loss" into regions, undertakings should use the integration method for storm and flood risk sub-modules and the maximum contribution method for earthquake and hail risk sub-modules. When disaggregating the "gross loss" into operational units, companies and lines of business, undertakings should use the apportionment method. If the undertaking presents a risk profile making the method specified above inappropriate, the undertaking should select a more appropriate approach and justify its choice to the Bank.

Guideline 10 – Disaggregating the "Gross Loss" for Natural Catastrophes for Non-EEA Regions Undertakings should apply to non-EEA regions methods consistent with those applied to EEA risks in Guideline 9 to allocate the "gross loss". If the undertaking presents a risk profile making this approach inappropriate, the undertaking should select a more appropriate approach and justify its choice to the Bank.

Guideline 11 – Disaggregating the "Gross Loss" for Natural Catastrophes for Non-Proportional Non-Life Catastrophe Reinsurance Risk Undertakings should apply the maximum contribution method for the "non-proportional non-life catastrophe reinsurance risk" sub-module to allocate the loss to a region. Undertakings should then estimate the highest risk exposure in that region and the number of specified events, as for "catastrophic events accumulating a large number of claims", applicable to the underlying contracts. If two "catastrophic events accumulating a large number of claims" are defined, this means that both events occur in the same region. If the undertaking presents a risk profile making this approach inappropriate, the undertaking should select a more appropriate approach. The choice of this approach should be justified to the Bank.

Guideline 12 – Specifying the "Gross Loss" for "Man-Made Catastrophe Risk" Sub-modules: Motor Third-Party Liability, Marine, Aviation, Fire and Liability Risks Undertakings should identify specific policies affected by the "gross event" of liability by applying Guidelines 34 to 39. For marine, aviation and fire risk scenarios, undertakings should identify the gross risks affected and thereby define the applicable reinsurance (including excess of loss covers) for the claims. For motor third-party liability risk, the undertaking should assume that the "catastrophic event risk" specified in Regulation 2015/35 arises from a single loss event. The undertaking should assume that the loss occurs in the region and/or operational unit representing the maximum contribution to the "gross loss" before diversification. When applying specific risk covers, the undertaking should be able to satisfactorily demonstrate to the Bank that the purchase of reinsurance cessions has not been significantly influenced by the possibility that the risk is identified as a "gross event" or a contribution to that gross event.

Guideline 13 – Disaggregating the "Gross Loss" for Credit and Suretyship Risk – Important Buyer Scenario When determining the most significant credit risk exposures, undertakings should take into account cumulative exposures vis-à-vis entities within a group.

Guideline 14 – Disaggregating the "Gross Loss" for Credit and Suretyship Risk – Recession Scenario If undertakings must allocate the "gross loss" due to recession to different territories, sectors, product types or, more generally, to the respective scope of the reinsurance agreement to apply their reinsurance protections, they should allocate the "gross loss" pro rata based on gross premium volumes.

Section IV: Application of Reinsurance Cessions
Guideline 15 – Application of Reinsurance Cessions Undertakings should apply each reinsurance cession protection to one of the levels below:
a) different zones within a single region of a branch of a single sub-module; b) different zones within a branch of a single sub-module; c) EEA/non-EEA grouping within a single sub-module; different branches of a "catastrophe" sub-module within a catastrophe sub-module; d) different catastrophe sub-modules, for example in the case of excess of loss cover and global cover for "man-made catastrophe risk" and "natural catastrophe risk" sub-modules. Undertakings may also apply specific line of business and operational unit covers. If a reinsurance cover covers other risks not included in the catastrophe risk sub-module (for example, an excess of loss line of business), the undertaking should take these other risks into account when calculating the benefit of the cover under the "catastrophe risk" module. Undertakings should apply reinsurance cessions in accordance with Articles 209 to 214 of Regulation 2015/35. Undertakings should ensure that there is no double counting of reinsurance recoveries, in accordance with Article 209(1)(e) of Regulation 2015/35. Undertakings should ensure that the total recovery from the risk mitigation methods taken into account in their calculation of net losses does not exceed the total amount authorized under their risk transfer program.

Guideline 16 – "Active Reconstruction Premiums" Undertakings may take into account the receipt of "active reconstruction premiums", if it is possible to demonstrate to the Bank that these premiums will be triggered by the "gross event" specified in the catastrophe sub-module.

NBB_2016_15 – 25 April 2016 Circular – Page 7/11

Undertakings should take into account in their calculations of the "gross loss" additional exposures to secondary or subsequent events resulting from this "active reconstruction premium".

Guideline 17 – Other Impacts on Basic Own Funds Resulting from the Triggering of the Reinsurance Cession Contract Undertakings should take into account reconstruction premiums or other additional cash flows that may result from the triggering of the reinsurance cession protection.

Guideline 18 – Order of Application of Reinsurance Protections Undertakings should apply reinsurance protections in the order defined in their contractual agreements as applicable to the underlying risk.

Guideline 19 – Proportional Reinsurance
For quota share reinsurance, excess of loss reinsurance and facultative proportional reinsurance contracts, undertakings should allocate the "gross event" pro rata to these reinsurance contracts.
If the undertaking's proportional reinsurance contract is subject to an "event limit" or other similar clause, the "gross loss" allocated to this contract cannot exceed this limit and any excess should be added to the "net retained" loss share.

Guideline 20 – Non-Proportional Reinsurance by Risk For excess of loss reinsurance contracts and facultative non-proportional reinsurance contracts, undertakings should only use this non-proportional reinsurance under the standard formula if the "gross event" allows the identification of known policies among the underlying exposed policies. Guideline 3 specifies the sub-modules where this should be the case.

Guideline 21 – Non-Proportional Reinsurance by Event Undertakings should only apply non-proportional reinsurance to defined gross events if the loss can be appropriately divided.
The undertaking should ensure to take into account less common contract features, such as deductibles and partial placements or co-insurance.

Guideline 22 – Non-Indemnity Contracts and Basis Risk Undertakings should only apply non-indemnity contracts under the standard formula if it can be demonstrated that the basis risk level is not material under the scenario definition.

Guideline 23 – Application of Global Cover Contracts and "Clash Cover" Contracts Undertakings should consider at which level they should apply global reinsurance contracts in the calculation of the SCR for non-life catastrophe risk. The choice should take into account the substance of the risk mitigation mechanism and the expected reinsurance recoveries in the event of the occurrence of the gross event. When undertakings estimate reinsurance recoveries from "clash cover" contracts, they should demonstrate to the Bank that the contracts will respond to the catastrophic events defined in the standard formula. Undertakings should ensure that there is no double counting of reinsurance recoveries and should be able to explain and demonstrate the logic of the application to the Bank.

Guideline 24 – Treatment of Shared Reinsurance Covers If there are shared reinsurance covers, the undertaking should apply the principles set out in Guideline 32.

Circular – Page 8/11 NBB_2016_15 – 25 April 2016

Guideline 25 – Treatment of results from lower aggregation levels

Companies should differentiate between reinstatement costs and reinsurance recoveries when aggregating the SCR of the "non-life catastrophe risk" sub-modules. If reinsurance at a given level is not applicable to this combined amount, it will be necessary to share the costs appropriately. In this case, the apportionment method should be used.

Guideline 26 – Treatment of other contracts not specified in these guidelines

Companies should apply the principles set out above in the guidelines to other reinsurance contracts or features not specifically included in these guidelines.

Section V: Reaggregating net losses

Guideline 27 – Reaggregating net losses to define the SCR for the company's catastrophe risk

If companies have allocated a diversified "gross loss" to a more detailed level (namely, the gross event) in order to estimate their reinsurance recoveries, companies should sum the net components to define the SCR.

If companies have SCR results arising from different levels of the calculation, companies should combine the net components to define the SCR for non-life catastrophe risk.

Explanations are provided in Technical Annex I regarding the application of this guideline.

Section VI: Documentation and validation

Guideline 28 – Documentation and validation of selected catastrophic events

For the "Other" sub-module of non-life catastrophe risk, companies should explain to the Bank the catastrophic events selected as part of the regular report to the supervisor, in accordance with Article 309(5)(a) of Regulation 2015/35. The explanation should include details on the main decision points, the review of alternative paths that could have been selected for these main decision points, and the justification for the final selections.

Companies should also include in their documentation details of any difficulties encountered internally regarding the development of appropriate catastrophic events.

Guideline 29 – Documentation of the disaggregation methodology

Companies should document by sub-module the disaggregation mechanism used to apply the reinsurance program. This should include the justification for the selected approach, the review of possible alternative paths, if several reasonable methods are available, and the calculations performed to arrive at the disaggregation.

Guideline 30 – Documentation of net conversion and reaggregation procedures

Companies should document the procedure used to convert the "gross event" to net. This includes the description of:
a) the company's reinsurance program; b) the net conversion calculations; c) details regarding the allocation of recoveries to the relevant insurance sub-modules; d) details on how the reaggregation was performed to obtain the SCRnlCAT.

Companies should also demonstrate in their documentation the absence of double counting of assumed reinsurance recoveries.

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If companies have assumed features of adjustable premiums (e.g., "active and passive reinstatement premiums"), the documentation should provide justification for the methodology and assumptions used to define them.

Section VII: Particular considerations for individual companies that are part of groups

Guideline 31 – Treatment of internal reinsurance agreements

For individual companies, the company should treat reinsurance cession agreements that may exist with other companies in the group ("internal reinsurance") in the same way as agreements with external third parties.

Guideline 32 – Estimating the reinsurance recovery to be paid to an individual company under a group reinsurance contract for "catastrophic event accumulating a large number of claims"

When estimating the reinsurance recovery to be paid on a global reinsurance contract (i.e., a contract offering protection against aggregated cumulative losses of several companies in the group), each individual company should separately follow the steps described below:
a) determine the "gross loss" of a catastrophe occurring once every 200 years for the individual company; b) determine the "gross loss" of a catastrophe occurring once every 200 years for the group; c) estimate the reinsurance recoveries on the group reinsurance contract; d) allocate the reinsurance recoveries according to contractual agreements, where they exist, or estimate the reinsurance recoveries to be paid to the individual company as the ratio of gross losses (a)/(b) multiplied by the amount estimated at point (c).

Guideline 33 – Estimating the reinsurance recovery to be paid to an individual company with respect to a group reinsurance contract for "catastrophic event risk"

When estimating the reinsurance recovery to be paid on a specific risk contract (namely, a contract offering protection against one or more specific risks), individual companies should follow the steps described below:
a) determine if the specific risks triggering the loss occurring once every 200 years for the individual company are the same as those triggering the loss occurring once every 200 years at the group level; b) in the event of overlap, estimate the reinsurance recoveries to be paid to the individual company on the group reinsurance contract.

Section VIII: Allocation of insurance policies to liability risk groups for the "human-origin catastrophe risk" sub-module

Guideline 34 – Liability risk group 1

For the liability risk group 1 referred to in Annex XI of Regulation 2015/35, companies should include professional liability insurance policies offering practitioners coverage against potential liability claims.

Companies should include in this risk group a range of liability insurance products, including:
a) medical professional liability insurance, including for specialist or general practitioners, hospitals and other healthcare providers when they have medical professional liability; b) errors or omissions (E&O) liability insurance or professional liability insurance or other professional liability insurance policies, if there are third parties to whom the insured person owes a duty of care; c) coverage for non-performance and associated financial losses arising from services provided by a company; d) coverage for breach of warranty or intellectual property; e) coverage for any liability for bodily injury or property damage (material or financial) and associated damages and legal defense insurance due to errors or negligence of a professional in the course of their activity.

Circular – Page 10/11 NBB_2016_15 – 25 April 2016

Guideline 35 – Liability risk group 2

For the liability risk group 2 referred to in Annex XI of Regulation 2015/35, companies should include employer liability insurance policies offering coverage for any liability that could be attributed to an employer if an employee suffers bodily injury in the course of their professional activities.

Companies should include in this risk group commitments covering:
a) the provision for treatment or preventive or curative medical care related to occupational accidents, workplace accidents and occupational diseases; b) financial compensation for this treatment; c) financial compensation for occupational accidents, workplace accidents and occupational diseases.

Guideline 36 – Liability risk group 3

For the liability risk group 3 referred to in Annex XI of Regulation 2015/35, companies should include directors and officers liability insurance policies offering coverage for liability and legal defense to directors and officers of companies, or to the entity itself, in the event of loss suffered due to legal action for alleged wrongful acts, acting in their capacity as directors and officers of the entity, including coverage for legal defense costs arising from criminal or regulatory investigations and/or trials.

Companies should include in this risk group policies for management liability and employment practices liability.

Guideline 37 – Liability risk group 4

For the liability risk group 4 referred to in Annex XI of Regulation 2015/35, companies should include insurance policies covering all liabilities arising from acts or omissions due to negligence and causing bodily injury and/or property damage to third parties other than:
a) those included in motor third-party liability and marine, aviation and transport liability; b) those included in liability risk groups 1, 2, 3 and 5 of Annex XI of Regulation 2015/35; c) third-party liability coverage offered to individual occupants of a home, individuals acting in a private capacity (including during hunting) and artisans; d) third-party liability coverage concerning damage or bodily injury caused by domestic animals.

Guideline 38 – Liability risk group 5

For the liability risk group 5 referred to in Annex XI of Regulation 2015/35, companies should include non-proportional reinsurance policies for all risk groups defined in this annex.

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Guideline 39 - Allocation and breakdown

If proportional liability insurance or reinsurance contracts are sold together, including coverages falling under more than one of the aforementioned risk groups, companies should break down and allocate the premiums for each coverage to the most appropriate risk group for that coverage.

Companies should be able to provide supporting evidence and justification for such allocations.

Companies should take proportionality considerations into account when applying the aforementioned guideline regarding breakdown.

Section IX – Particular considerations for group calculation

Guideline 40 – Assumed reinsurance

If intragroup reinsurance benefits any external reinsurance of a company, the participating company should "assume" the internal reinsurance in place for the purpose of calculating the impact of external reinsurance.

A copy of this circular is sent to the commissioner(s), approved auditor(s) of your company.

We ask you to accept, Madam, Sir, the expression of our distinguished sentiments.

Jan Smets
Governor