Circular NBB_2019_16

Boulevard de Berlaimont 14 - BE-1000 Brussels Tel. +32 2 221 35 02 Enterprise number: 0203.201.340 RPM Brussels www.bnb.be National Bank of Belgium Eurosystem

Circular
Brussels, 9 July 2019

Reference:
Your contact:
Nicolas Colpaert
Tel. +32 2 221 35 02 nicolas.colpaert@nbb.be

NBB 2019 16
Circular on the transparency approach 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 undertakings 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 undertakings 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 Control 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.

The purpose of this circular is to explain the Bank's guidelines on the transparency approach 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).

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Structure

I. Objectives
II. Definitions
III. Additional Information
IV. Entry into Force
V. Guidelines on the Transparency Approach

I. Objectives

This circular relates to Articles 154 to 160 of the Law, as well as Articles 84 and 208 to 215 of Regulation 2015/35.

It aims to help undertakings calculate their Solvency Capital Requirement related to market risk under the Law.

Only cases that are not already considered as risk mitigation techniques are taken into account for a possible application of the transparency approach. If insurance or reinsurance undertakings use risk mitigation techniques, it is considered that the underlying risks are understood and that they have already been subject to a transparency approach.

II. Definitions

In the absence of a definition in this circular, the terms have the meaning defined in the legislative and regulatory acts referred to therein.

III. Additional Information

This circular is part of the harmonised 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 (EIOPA).

Undertakings may, for information 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.

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V. Guidelines on the Transparency Approach

Guideline 1 - Money Market Funds

Undertakings should apply the transparency approach to money market funds.

Guideline 2 - Number of Iterations

Undertakings should perform a sufficient number of transparency approach iterations, where applicable (for example, if a fund invests in other funds), in order to take into account any significant risk.

Guideline 3 - Investments in Real Estate Assets

Undertakings should cover the following investments in the "real estate asset risk" sub-module:
a) land, buildings and rights over real estate; b) real estate investments held for use by the undertaking.

For shareholdings in a company whose exclusive activity is the management of facilities, the administration of buildings, the design of real estate projects or similar activities, undertakings should apply the "equity risk" sub-module.

If undertakings invest in real estate assets through collective investment undertakings or other structured investments in the form of funds, they should apply the transparency approach.

Guideline 4 - Data Pooling

With regard to the pools referred to in Article 84, paragraph 3, of Regulation 2015/35, if the assets included in the "margin risk" and "interest rate risk" sub-modules are pooled according to duration bands, undertakings should ensure that the durations assigned to the bands are manifestly prudent.

If pools are used for different credit quality tiers, undertakings should ensure that the credit quality tiers assigned to the groups are manifestly prudent.

Guideline 5 - Data Pooling and Concentration Risk

If, in accordance with Article 84, paragraph 3, of Regulation 2015/35, a pool is applied to single-name exposures of the underlying assets of collective investment funds to calculate the market risk concentration requirement, and if it cannot be demonstrated that the groups into which the fund is split contain none of these single-name exposures, undertakings should consider that all assets for which the effective single-name exposure is not identified belong to the same single-name exposure.

The following paragraph is not applicable if there are limits applicable to risks relating to single-name exposures according to which the fund is managed.

Undertakings should aggregate exposures to the groups referred to in the preceding paragraphs from all collective investment funds in which they invest and verify the consistency of exposures to each group with the exposures of known single names in their asset portfolio.

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Guideline 6 - Indirect Exposure to Catastrophe Risk

When calculating the Solvency Capital Requirement for indirect exposures to catastrophe risks, such as investments in bonds whose repayment depends on the non-occurrence of a given catastrophic event, undertakings should take into account potential credit and catastrophe risks.

Catastrophe risks should be treated in the relevant "catastrophe" sub-modules as if the underlying catastrophe risk were directly held by the undertaking.

Guideline 7 - Catastrophe Bonds Issued by the Undertaking

If an undertaking issues catastrophe bonds that do not meet the requirements of the risk mitigation techniques referred to in Articles 208 to 215 of Regulation 2015/35, their treatment in the standard formula should not result in a reduction of requirements regarding the catastrophe characteristics of these bonds.

Undertakings should treat these catastrophe bonds in the calculation of the Solvency Capital Requirement as if the repayment schedule did not depend on the non-occurrence of a catastrophic event.

Guideline 8 - Longevity-Indexed Bonds

If undertakings purchase longevity-indexed bonds that do not meet the requirements of the risk mitigation techniques referred to in Articles 208 to 215 of Regulation 2015/35, they should calculate the capital requirement regarding mortality risk and margin risk as provided in the following paragraphs.

The capital requirement for the "mortality sub-risk" of the standard formula should be based on a notional portfolio of term insurance contracts:
a) paying the given amount upon death; b) based on a representative sample of the reference population underlying the longevity index; c) where the duration of each term insurance contract is equal to the coupon payment period.

Undertakings should set up the notional portfolio such that, under best estimate assumptions, total benefit payments are equal to the coupon due.

The capital requirement for the "margin risk" sub-module should be based on a bond or loan having the same market value, the same duration, and belonging to the same credit quality tier as the longevity-indexed instrument.

If undertakings sell longevity-indexed bonds, they should calculate the capital requirement regarding the "longevity risk" sub-module as if the notional portfolio consisted of survival insurance contracts, paying the expected amount upon survival to a given age, collectively producing cash flows equivalent to those of the bond.

Undertakings should not consider that the value of longevity-indexed bonds that do not meet the requirements of the risk mitigation techniques referred to in Articles 208 to 215 of Regulation 2015/35 increases when stresses are applied to the "underwriting risk" module.

Guideline 9 - Investment Vehicles with Leverage

In applying the transparency approach, it is important to take into account the entire balance sheet structure of the investment vehicle. Leverage can lead to a significant increase in risk and capital requirements, as illustrated in Annex 1 of this circular.

A copy of this circular is sent to the auditor(s) of your undertaking.

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

Pierre Wunsch
Governor

Annex 1: Transparency Approach Applied to a Leveraged Investment Vehicle - Simplified Example.

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Boulevard de Berlaimont 14 - BE-1000 Brussels Tel. +32 2 221 35 02 Enterprise number: 0203.201.340 RPM Brussels www.bnb.be National Bank of Belgium Eurosystem

Brussels, 9 July 2019

Annex 1 to Circular NBB 2019 16

Annex 1: Transparency Approach Applied to a Leveraged Investment Vehicle - Simplified Example.

Example

• An insurer (hereinafter "IC", "Insurance Company") invests 10 million euros in equity and 25 million euros in leverage (bonds or loans) in a leveraged investment vehicle (hereinafter "LF", "Leveraged Fund"). In doing so, IC holds 10% of the equity and 10% of the debt of LF respectively.
• LF invests exclusively in real estate, amounting to 350 million euros.
• Schematic presentation (in millions of euros):

Insurance Company
Assets:
Equity in LF: 10
Debt in LF: 25
Other assets: 965
Total: 1000

Liabilities:
Own funds: 100
Tech. provisions: 900
Total: 1000

10% of equity = 10% * 100 = 10 and
10% of debt = 10% * 250 = 25

LF (Leveraged Fund)
Assets:
Property: 350
Total: 350

Liabilities:
Equity: 100
Debt: 250
Total: 350

Calculation of Capital Requirements

• For the insurer's leverage (bonds or loans) in the investment vehicle, the "margin risk" sub-module should be applied to the value of the insurer's leverage in the investment vehicle. If the insurer does not hold bonds or loans in the investment vehicle, the "margin risk" sub-module should not be applied. Since leverage is an interest-rate-sensitive asset for the insurer, it should be included in the calculation of the "interest rate risk" sub-module.

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• For the equity investment, the transparency approach should be applied, i.e., concretely:

  1. Analyze the balance sheet structure of the investment vehicle and, consequently, identify the assets and liabilities;
  2. Apply the relevant sub-modules (equity risk, margin risk, real estate asset risk, interest rate risk, etc.) to the balance sheet of the investment vehicle;
  3. Calculate the impact of applying the relevant sub-modules on the value of the investment vehicle's equity and, consequently, on the insurer's equity investment;
  4. Calculate the impact of the change in the value of the equity investment on the insurer's basic own funds. The loss of basic own funds determines the capital requirements.

• Abstracting from other potentially relevant sub-modules (such as interest rate risk), the application of the transparency approach for IC's 10 million euro equity investment in LF implies that the "real estate asset risk" sub-module must be applied to LF's balance sheet.

• Based on the simplified assumptions that:

  • the application of a 25% decrease in property value results in a 25% decrease in the value of the real estate investment, and
  • there are no risk mitigation techniques, which means that the loss in the value of the equity investment translates directly into losses of basic own funds and, consequently, into capital requirements,
    the application of the "real estate asset risk" sub-module generates a capital requirement of 8.75 million euros. In relative terms, this results in a risk weight of 8.75/10 = 87.5%, which is 3.5 times the relative weight applicable to real estate asset risk (3.5 * 25% = 87.5%). This factor of 3.5 is the result found by dividing the value of the investment vehicle's real estate investments by that of its equity (350/100 = 3.5).

BEFORE PROPERTY SHOCK

Insurance Company
Assets:
Equity in LF: 10
Debt in LF: 25
Other assets: 965
Total: 1000

Liabilities:
Own funds: 100
Tech. provisions: 900
Total: 1000

10% of equity = 10% * 100 = 10 and
10% of debt = 10% * 250 = 25

LF (Leveraged Fund)
Assets:
Property: 350
Total: 350

Liabilities:
Equity: 100
Debt: 250
Total: 350

AFTER PROPERTY SHOCK

Insurance Company
Assets:
Equity in LF: 1.25
Debt in LF: 25
Other assets: 965
Total: 991.25

Liabilities:
Own funds: 91.25
Tech. provisions: 900
Total: 991.25

Impact of property shock:
10% of equity = 10% * 12.5 = 1.25 and
10% of debt = 10% * 250 = 25

Property shock: 25% decrease in property value

LF (Leveraged Fund)
Assets:
Property: 262.5
Total: 262.5

Liabilities:
Equity: 12.5
Debt: 250
Total: 262.5

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