Circular NBB_2022_25 / Circular on guidelines for the valuation of technical provisions under Solvency II

boulevard de Berlaimont 14 - BE-1000 Bruxelles tel. +32 2 221 27 31 numero d'entreprise: 0203.201.340 RPM Bruxelles www.bnb.be Banque Nationale de Belgique DE BELGISCHE NATIONAALBANK Eurosystem Circular Brussels, 17 October 2022 Reference:
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Stany Zabinski tel. +32 2 221 34 67 stany.zabinski@nbb.be NBB_2022_25 Circular on guidelines for the valuation of technical provisions under Solvency II 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 Act 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 Act 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 Act of 13 March 2016. For these undertakings, "the Bank" should be replaced by "the Office for the Supervision of Mutualities and National Mutual Unions" as defined in Article 15, 84° of the same Act. This circular does not apply to insurance undertakings referred to in Articles 275, 276 or 294 of the aforementioned Act of 13 March 2016. Objective This circular aims to explain the Bank's guidelines on the valuation of technical provisions under Solvency II. Legal references the Act: the Act of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings; Regulation 2015/35: Commission Delegated Regulation (EU) 2015/35 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). NBB_2022_25 - 17 October 2022 Circular - P. 1/35

Structure
I. Objectives
II. Definitions
Additional information
IV. Entry into force
V. Guidelines on the valuation of technical provisions
VI. Technical annexes
Circular - P. 2/35 NBB_2022_25 - 17 October 2022

Dear Sir,
Dear Madam,
I. Objectives
This circular relates to Articles 124 to 139 of the Act, as well as Articles 17 to 61 of Regulation 2015/35 and replaces Circular NBB_2016_26.
It is recognized that expert judgment is a component of the calculation of technical provisions and should therefore be used to define the assumptions to be retained for valuing the technical provisions of insurance and reinsurance undertakings.
The guidelines will ultimately be applied by actuaries as well as by other professionals who may be appointed to perform the tasks of the actuarial function.
The relevant steps to ensure the reliable calculation of technical provisions should be carried out by the persons responsible for the calculation. The actuarial function should perform the coordination and validation tasks. Undertakings should request the actuarial function - even if it is not explicitly mentioned - to perform its tasks, where applicable taking into account the requirements defined in the guidelines on the valuation of technical provisions and in accordance with the guidelines on the governance system and the requirements referred to in Article 272 of Regulation 2015/35. These guidelines are divided into different sections. Section 1 on data quality examines how to take into account data quality issues when calculating technical provisions and ensure that defects have been duly taken into consideration.
Section 2 on segmentation and decomposition examines how to segment insurance and reinsurance commitments. The objective of segmentation is to achieve an accurate valuation of technical provisions.
Section 3 on assumptions defines the requirements regarding the choice of calculation methods for technical provisions. This relates to the general process of assessing proportionality that undertakings should carry out when selecting the calculation method, as well as to specific methodological aspects of the calculation.
Section 4 on calculation methods for technical provisions contains the relevant guidelines for the calculation of technical provisions as a whole. It also contains a non-exhaustive list of possible approaches for simplifications, given that the methods and techniques for valuing technical provisions are constantly evolving. The usefulness of the proportionality assessment described in these guidelines is not limited to the selection of calculation methods for technical provisions. Its results can also support other steps necessary for the calculation of technical provisions, such as data quality, segmentation, definition of assumptions, and validation.
Given that an exhaustive list would not be consistent with a principles-based proportionality approach and might not provide proportionate calculation methods for all risk profiles, the simplified methods proposed in this document should not be interpreted as an exhaustive list but as possible methods to apply. NBB_2022_25 - 17 October 2022 Circular - P. 3/35

Section 5 on validation focuses on the types and selection of validation approaches and processes, the schedule, the scope and documentation, as well as the re-evaluation of controls that undertakings should perform to validate technical provisions. The objective of these guidelines is to ensure a consistent approach to the validation process of technical provisions in Member States. Some standard validation approaches and processes are presented in the technical annexes accompanied by suggestions regarding the appropriateness of their use.
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 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, for information purposes, consult the final reports of these guidelines at the following address: https://eiopa.europa.eu/publications/eiopa-guidelines.
IV. Entry into force
This circular applies from 1 January 2023.
V. Guidelines on the valuation of technical provisions
Guideline 0 - Proportionality
Insurance and reinsurance undertakings should apply the guidelines on the valuation of technical provisions in a proportionate manner with regard to the nature, scale, and complexity of the risks inherent in their activity. The application of the guidelines should not result in a significant deviation from the value of technical provisions compared to the current amount that insurance and reinsurance undertakings would have to pay if they transferred their insurance and reinsurance commitments to another insurance or reinsurance undertaking immediately.
Section 1: Data Quality
Clarification of the concepts of data completeness and adequacy Guideline 1 - Data completeness Insurance and reinsurance undertakings should ensure that data covering a sufficiently long observation period and characteristic of the measured reality is used in the calculation of technical provisions. To calculate premium reserves for non-life commitments, undertakings should ensure that sufficient and sufficiently detailed historical data is available regarding the total cost of claims and their actual trends. To calculate outstanding claim reserves, undertakings should ensure that sufficient and sufficiently detailed data is available to detect relevant patterns concerning the development of claims and to analyze these patterns within homogeneous risk groups. Circular - P. 4/35 NBB_2022_25 - 17 October 2022

Guideline 2 - Data adequacy
Insurance and reinsurance undertakings should ensure that data relating to different periods is used consistently.
Where appropriate, undertakings should adapt historical data to increase its credibility or improve its quality as input data to establish more reliable estimates of technical provisions and to harmonize it further with the characteristics of the portfolio being valued and the expected future development of risks. Re-examination and validation of data quality Guideline 3 - Data controls Insurance and reinsurance undertakings should ensure that the actuarial function evaluates the completeness and accuracy of data by means of a sufficiently comprehensive set of controls to satisfy the criteria set out in the previous guidelines and to detect any relevant deficiencies. Insurance and reinsurance undertakings should ensure that the actuarial function carries out this evaluation at an appropriate level of detail. Guideline 4 - Taking into account other analyses Insurance and reinsurance undertakings should ensure that the actuarial function takes into account the conclusions of any relevant analysis carried out as part of an external review that verified the quality of the data used to calculate technical provisions. Guideline 5 - Taking into account applicable methods Insurance and reinsurance undertakings should ensure that the actuarial function takes into account the relationship between the conclusions of the data quality analysis and the selection of methods to be applied to value technical provisions. Undertakings should ensure that the actuarial function analyzes the degree of adequacy of the data used to support the assumptions underlying the methods to be applied to value technical provisions. If the data do not adequately support the methods, the undertaking should select an alternative method. When evaluating data completeness, undertakings should ensure that the actuarial function examines the sufficiency and adequacy of the number of observations and the level of detail of the available data to meet the requirements concerning input data for applying the method. Guideline 6 - Source and use of data Insurance and reinsurance undertakings should request the actuarial function to take into account the source and intended use of the data in the data validation process. NBB 2022 25 - 17 October 2022 Circular - P. 5/35

Guideline 7 - Use of expert judgment
Insurance and reinsurance undertakings should ensure that the use of expert judgment to evaluate exact, appropriate, and complete data to be used for calculating technical provisions does not replace the appropriate collection, processing, and analysis of data but complements it, where appropriate. Guideline 8 - Validation and feedback process Insurance and reinsurance undertakings should ensure that the actuarial function also coordinates, as part of the coordination of the calculation of technical provisions, the evaluation and validation of relevant data to be used in the valuation process. This coordination task should include at least the following:
a) Selecting the data to be used for valuation, taking into account the criteria of data accuracy, adequacy, and completeness, in order to choose the most appropriate methods to apply to the calculation. For this purpose, relevant tools should be used to verify any significant differences detected in data from a single year and in other relevant analyses; b) reporting on any recommendations for implementing improvements regarding internal procedures considered important to improve compliance with the criteria set out in point a); c) identifying cases where additional external data is necessary; d) evaluating the quality of external data, as with internal data, focusing on the need for market data or the appropriateness of their use to improve the quality of internal data and on the possibility and manner of strengthening available data; e) evaluating the need to adjust available data, within the framework of current actuarial best practice, to improve the degree of fit and reliability of estimates resulting from actuarial and statistical provisioning methods based on this data; f) recording knowledge acquired as part of the evaluation and validation process that may prove relevant in other steps of the calculation of technical provisions and that relate to the understanding of underlying risks as well as to the knowledge of the quality and limitations of available data. Data limitations Guideline 9 - Determination of the source of significant limitations Insurance and reinsurance undertakings should ensure that the actuarial function evaluates the accuracy, completeness, and adequacy of data to detect any significant data limitations. If significant limitations are detected, the sources of these limitations should also be determined. Guideline 10 - Impact of deficiencies To detect and evaluate the impact of any deficiencies that may affect compliance with data quality requirements, insurance and reinsurance undertakings should ensure that the actuarial function takes into account all relevant available documentation relating to the internal processes and procedures for collecting, storing, and validating data used to value technical provisions and, where appropriate, seeks more specific information by contacting personnel involved in these processes. Circular - P. 6/35 NBB_2022_25 - 17 October 2022

Furthermore, undertakings should ensure that the actuarial function coordinates any relevant tasks that may be carried out to evaluate the impact of detected deficiencies on the available data to be used for calculating technical provisions, in order to determine whether the available data should be used for the intended purpose or whether alternative data should be sought. Guideline 11 - Data adjustment If data contains defects, insurance and reinsurance undertakings should ensure that the actuarial function evaluates the possibility of improving data quality, taking into account its purposes, by adjusting or supplementing it. Insurance and reinsurance undertakings should ensure that appropriate measures are applied to overcome data limitations resulting from information exchange with a business partner. When external data is used, undertakings should ensure that the data remains compliant with the standards set out in these guidelines regarding data quality. Undertakings should decide on the possibility of adjusting data to overcome deficiencies affecting data quality and, where appropriate, on the specific adjustments to be made. Undertakings should ensure that adjustments are limited to those strictly necessary to strengthen compliance with the criteria set out in the previous guidelines and that they do not prevent the detection of trends or other characteristics regarding underlying risks that the data reflects. Guideline 12 - Actuarial function recommendations Insurance and reinsurance undertakings should ensure that the actuarial function issues recommendations to the management body on procedures that could be implemented to improve the quality of available data and to increase its quantity. To carry out this task, the actuarial function should identify the sources of significant limitations and propose possible solutions taking into account their effectiveness and the time required for their implementation. Guideline 13 - Use of expert judgment in case of significant limitations In the case of significant data limitations that are too complex to remedy, insurance and reinsurance undertakings should ensure the use of expert judgment to overcome these limitations and ensure the appropriate calculation of technical provisions. The calculation of technical provisions should not be compromised by inaccurate or incomplete data. Guideline 14 - Documentation of data limitations Insurance and reinsurance undertakings should ensure that the actuarial function documents data limitations, including at least:
a) a description of the deficiencies, including their causes and any references to other documents in which they were identified; b) a brief explanation of the impact of the deficiencies on the calculation of technical provisions, regarding their relative importance and how they affect the process; c) a description of the actions taken by the actuarial function to detect deficiencies, whether in addition to or instead of other sources and documents; NBB 2022 25 - 17 October 2022 Circular - P. 7/35

d) a description of possible short-term solutions to such situations, for the intended purposes, and any relevant recommendations to be implemented to strengthen data quality in the future.
Market data
Guideline 15 - Use of market data
When valuing liabilities that depend directly on financial market behavior or if the calculation of technical provisions requires input data from an external source, insurance and reinsurance undertakings should be able to demonstrate that external data is better suited for the intended purpose than internal data. Undertakings should ensure that external data provided by third parties or market data complements the available internal data. Notwithstanding the degree of dependence of liabilities on market conditions or the level of quality of available internal data, undertakings should take into account relevant external references, where appropriate. External data should be part of the analysis to assess overall compliance with data quality requirements. Guideline 16 - Conditions concerning market data To evaluate the degree of accuracy, adequacy, and completeness of external data, insurance and reinsurance undertakings should ensure that the actuarial function is aware of and takes into account in its analysis the reliability of information sources and the coherence and stability of the information collection and publication process over time. Furthermore, undertakings should ensure that the actuarial function takes into account all realistic assumptions and relevant methods applied to produce data, including any adjustments or simplifications applied to raw data. The actuarial function should be aware of and take into account any changes in external data over time, whether these changes concern associated assumptions or methods or other procedures related to the collection of external data. Furthermore, whenever possible and appropriate, undertakings should ensure that the actuarial function measures data quality as part of the provisioning analysis with regard to available sector or market data considered comparable and, in particular, to the requirements set out in Article 125 of the Act. Any significant deviation should be detected and understood by the actuarial function. This analysis may refer to the specifics of the homogeneous risk group being particularly valued.
Section 2: Segmentation and decomposition
Guideline 17 - Segmentation of insurance or reinsurance commitments arising from health insurance contracts and other non-life insurance contracts Insurance and reinsurance undertakings should ensure that insurance or reinsurance commitments arising from health insurance contracts and other non-life insurance contracts are segmented into life lines of business, if these commitments are exposed to biometric risks (namely, mortality, longevity, disability, or morbidity) and if the common techniques used to evaluate these commitments explicitly take into account the behavior of the variables underlying these risks. Circular - P. 8/35 NBB_2022_25 - 17 October 2022

Orientation 18 - Modification of the segmentation of non-life insurance or reinsurance commitments Insurance and reinsurance undertakings should ensure that insurance or reinsurance commitments initially segmented into non-life business lines and which, following the occurrence of an insured event, become life insurance or reinsurance commitments are evaluated using life techniques that explicitly take into account the behavior of the variables underlying the biometric risks and assigned to the relevant life business lines as soon as there is sufficient information to evaluate these commitments using life techniques.

Orientation 19 - Determining and evaluating the adequacy of a homogeneous risk group Insurance and reinsurance undertakings should calculate technical provisions using homogeneous risk groups in order to establish assumptions.
A homogeneous risk group comprises a set of policies presenting similar risk characteristics. When selecting a homogeneous risk group, undertakings should achieve an appropriate balance between the credibility of the available data, allowing for reliable statistical analyses, and the homogeneity of risk characteristics within the group. Undertakings should define homogeneous risk groups for which it is expected that they will remain reasonably stable over time. Where appropriate, for the purpose of defining risks, undertakings should take into account, among other things, the following elements:
a) underwriting policy; b) claims settlement patterns; c) risk profile of policyholders; d) product characteristics, including guarantees; e) future management decisions.
Undertakings should ensure consistency between the homogeneous risk groups they use to evaluate their technical provisions without deduction of reinsurance and their receivables arising from reinsurance contracts.

Orientation 20 - Calculations at the level of grouped policies In order to calculate technical provisions and perform cash flow projections, insurance and reinsurance undertakings should apply the assumptions established at the level of homogeneous risk groups to individual policies or grouped policies, if the groupings are more detailed than the homogeneous risk groups.

Orientation 21 - Decomposition of insurance and reinsurance contracts covering multiple risks If an insurance or reinsurance contract covers risks on different business lines, it is not necessary to decompose the commitments when only one of the covered risks is significant. In this case, the commitments related to the contract should be segmented according to the most significant risk factor.

NBB_2022_25 - 17 October 2022 Circular - P. 9/35

Orientation 22 - Level of detail of segmentation Insurance and reinsurance undertakings should analyze whether the level of detail of the segmentation of insurance or reinsurance commitments adequately reflects the nature of the risks.
This segmentation should take into account the policyholder's right to participate in profits, the options and embedded guarantees in the contracts, and the relevant risk factors of the commitments.

Orientation 23 - Segmentation with respect to unearned premium reserves and outstanding claims reserves Insurance and reinsurance undertakings should take into account both the nature of the underlying risks assessed together and the quality of the data when selecting homogeneous risk groups to calculate unearned premium reserves and outstanding claims reserves.

Section 3: Assumptions

Orientation 24 - Coherence of assumptions
Insurance and reinsurance undertakings should ensure the coherence of the assumptions used to determine technical provisions, own funds, and the Solvency Capital Requirement.

Orientation 24a - Relative significance in the definition of assumptions Insurance or reinsurance undertakings should define assumptions and use expert judgment taking into account, in particular, the relative significance of the impact of the use of assumptions with regard to the following orientations on the definition of assumptions and expert judgment. Insurance and reinsurance undertakings should evaluate the relative significance taking into account both quantitative and qualitative indicators and taking into consideration binary events, extreme events, and events that are not present in historical data. Insurance and reinsurance undertakings should evaluate the considered indicators globally.

Orientation 24b - Governance of the definition of assumptions Insurance or reinsurance undertakings should ensure that any definition of assumptions and, in particular, the use of expert judgment follows a validated and documented process.
Insurance or reinsurance undertakings should ensure that assumptions are established and used consistently over time and throughout the insurance or reinsurance undertaking and that they are fit for the purpose for which they are intended.
Insurance or reinsurance undertakings should approve assumptions at sufficiently high levels according to their relative significance, ranging from the most important assumptions up to the administrative, management, or supervisory body.

Orientation 24c - Communication and uncertainty in the definition of assumptions Insurance or reinsurance undertakings should ensure that processes concerning assumptions, and in particular the use of expert judgment in the choice of these assumptions, specifically attempt to mitigate the risk of misunderstanding or poor communication between all the different roles related to these assumptions.

Circular - P. 10/35 NBB2022_25 - 17 October 2022

Insurance or reinsurance undertakings should put in place a formal and documented feedback process between providers and users of material expert judgment and the resulting assumptions.
Insurance or reinsurance undertakings should ensure the transparency of the uncertainty of assumptions as well as the variation of final results linked to it.

Orientation 24d - Documentation of the definition of assumptions Insurance or reinsurance undertakings should document the process of defining assumptions and, in particular, the use of expert judgment, so as to ensure the transparency of this process.
Insurance or reinsurance undertakings should include in the documentation the resulting assumptions and their relative significance, the experts who participated in their definition, the intended use, and the validity period.
Insurance or reinsurance undertakings should include the justification of the opinion, including the information base used, with the necessary degree of detail to ensure the transparency of both the assumptions and the processes and decision-making criteria used to select the assumptions and reject other alternatives. Insurance or reinsurance undertakings should ensure that users of important assumptions receive clear and complete written information concerning these assumptions.

Orientation 24e - Validation of the definition of assumptions Insurance or reinsurance undertakings should ensure that the process applied to retain assumptions and use expert judgment is validated.
Insurance or reinsurance undertakings should ensure that the process and tools used to validate assumptions, and in particular the use of Expert Judgment, are documented.
Insurance or reinsurance undertakings should monitor changes to important assumptions in response to new information and analyze and explain these changes as well as deviations of results from important assumptions.
When feasible and appropriate, insurance or reinsurance undertakings should use validation tools, such as stress tests or sensitivity tests.
Insurance or reinsurance undertakings should review the retained assumptions, based on independent internal or external expertise.
Insurance or reinsurance undertakings should detect the occurrence of circumstances in which assumptions would be considered false.

Biometric risk factors

Orientation 25 - Modeling of biometric risk factors Insurance and reinsurance undertakings should consider the proportionality of a deterministic approach or a stochastic approach to model the uncertainty of biometric risk factors.

NBB_2022_25 - 17 October 2022 Circular - P. 11/35

Undertakings should take into account the duration of liabilities when assessing whether a method neglecting expected future changes in biometric risk factors is proportionate, in particular to evaluate the error introduced in the result by the method.
When assessing whether a method assuming that biometric risk factors are independent of any other variable is proportionate, undertakings should ensure to take into account the specifics of the risk factors. For this purpose, the assessment of the level of correlation should be based on historical data and expert judgment.

Orientation 26 - Hedging costs
For insurance and reinsurance undertakings using a hedging program to mitigate risks, the costs of the hedging program should be taken into account to value technical provisions. The expected occurrence of these costs should be integrated into the cash flow inflows and outflows projections necessary to settle insurance and reinsurance commitments.

Orientation 27 - Availability of market data
Insurance and reinsurance undertakings should evaluate the availability of relevant market data on costs taking into account the representativeness of market data with regard to the portfolio of insurance or reinsurance commitments, as well as the credibility and reliability of the data.

Orientation 28 - Costs taken into account according to contractual terms Insurance and reinsurance undertakings should ensure that costs determined by contracts concluded between the undertaking and third parties are taken into account based on the terms of the contract. In particular, commissions arising from insurance contracts are considered to be based on the terms of contracts concluded between the undertakings and sellers, and costs related to reinsurance are taken into account based on contracts between the undertaking and its reinsurers.

Orientation 28a - Investment management costs
Insurance and reinsurance undertakings should include in the best estimate the administration and negotiation costs related to investments necessary for the management of insurance and reinsurance contracts.
In particular, for products whose contract conditions or whose regulation require identifying investments associated with the product (for example, most unit-linked products and index-linked products, products managed in segregated funds, and products to which a smoothing adjustment is applied), insurance and reinsurance undertakings should take into account these investments. For other products, insurance and reinsurance undertakings should base the assessment on the characteristics of the contracts. For the sake of simplification, insurance and reinsurance undertakings may also take into account all investment management costs. Reimbursements of investment management costs paid by the fund manager to the undertaking should be taken into account as other cash inflows. When these

Circular - P. 12/35 NBB_2022_25 - 17 October 2022

reimbursements are shared with policyholders or other third parties, the corresponding cash outflows should also be taken into account.

Allocation of costs

Orientation 29 - Level of detail of cost allocation Insurance and reinsurance undertakings should allocate costs to homogeneous risk groups, at least by business line, according to the segmentation of their commitments used to calculate technical provisions.

Orientation 30 - Cost distribution
Insurance and reinsurance undertakings should allocate and project costs in a realistic and objective manner and should base the distribution of these costs on their long-term commercial strategies, on recent analyses of business operations, on the detection of appropriate cost drivers, and on relevant cost distribution ratios. Without prejudice to the proportionality assessment and the first paragraph of this orientation, insurance and reinsurance undertakings should consider using, to allocate general costs over time, the simplification described in Technical Annex I, provided that the following conditions are met:
a) the undertaking pursues renewable activity every year; b) renewals must be considered as new activities according to the limits of the insurance contract; c) claims occur uniformly during the coverage period.

Orientation 31 - Changing the approach to indirect cost distribution Insurance and reinsurance undertakings should allocate indirect costs to existing and future activities on a consistent basis over time and should only change the allocation base if a new approach is better suited to the current situation.

Cost projection

Orientation 32 - Coherence of costs with other cash flows Insurance and reinsurance undertakings should allocate costs to cash flow projections so that the timing of cost cash flows is coherent with the timing of other cash inflows and outflows necessary to settle insurance and reinsurance commitments.

Orientation 33 - Changes concerning costs
Insurance and reinsurance undertakings should ensure that assumptions regarding the evolution of costs over time, including future costs arising from commitments taken on or before the valuation date, are appropriate and take into account the nature of the costs concerned. Undertakings should take into account inflation that is consistent with the economic assumptions retained and with the dependence of costs on other cash flows of the contract.

Orientation 34 - Simplifications concerning costs When assessing the nature, magnitude, and complexity of the risks underlying the costs taken into account to calculate technical provisions, insurance and reinsurance undertakings should

NBB_2022_25 - 17 October 2022 Circular - P. 13/35

take into account, among other things, the uncertainty of future cost cash flows and any event likely to modify the amount, frequency, and severity of cost cash flows.
Undertakings should also take into account the type of cost and the level of correlation between different types of costs.
When using a simplification to project costs based on a model using information on current and past cost loadings to project future cost loadings including inflation, undertakings should analyze current and historical costs, taking into account, among other things, the location of cost occurrence and factors influencing costs. Undertakings should include in the proportionality assessment an analysis of how costs are linked to the size and nature of insurance portfolios. Undertakings should not apply the simplification if costs have changed considerably or if it is expected that they will not cover the entirety but only part of the costs necessary to cover insurance and reinsurance commitments.

Treatment of financial guarantees and contractual options

Orientation 35 - Charges for embedded options
Insurance and reinsurance undertakings should explicitly take into account amounts charged to policyholders related to embedded options.

Orientation 36 - Adequacy of assumptions
Insurance and reinsurance undertakings should ensure that the assumptions retained to value contractual options and financial guarantees are consistent with current market data, current market practice, policyholder behavior, and management behavior specific to the characteristics of the business and the undertaking. Undertakings should also take into account the impact of adverse market conditions and trends and put in place a regular process to update and ensure that these assumptions remain realistic given all additional information obtained since the last calculation of technical provisions.

Orientation 37 - Assumptions concerning policyholder behavior Insurance and reinsurance undertakings should ensure that assumptions relating to policyholder behavior are based on statistical and empirical evidence, when available. Undertakings should take into account the extent to which policyholders exercise contractual options in a financially rational manner when establishing these assumptions. For this purpose, undertakings should take into account policyholders' knowledge of the value of the policy options and possible reactions of policyholders to changes in the undertaking's financial situation.

Orientation 37a - Dynamic behavior of policyholders Insurance or reinsurance undertakings should base their assumptions concerning the exercise rate of relevant options on:
statistical and empirical evidence, when they are representative of future behavior; and on expert judgment based on sound reasoning and clear documentation.

Circular - P. 14/35 NBB_2022_25 - 17 October 2022

The lack of data concerning extreme scenarios should not be considered a sufficient reason to avoid modeling the dynamic behavior of policyholders and/or interaction with future management decisions.

Orientation 37b - Bidirectional assumptions
When defining assumptions relating to the dynamic behavior of policyholders, insurance and reinsurance undertakings should take into account the fact that the dependence on the triggering event and on the exercise rate of the option is generally bidirectional, i.e., it is appropriate to consider both an increase and a decrease depending on the direction of the triggering event.

Orientation 37c - Option to pay additional or different premiums Insurance and reinsurance undertakings should model all relevant contractual options to project cash flows, including the option to pay additional premiums or to modify the amount of premiums to be paid which fall within the limits of the contracts.

Future management decisions

Orientation 38 - Taking into account future management decisions Insurance and reinsurance undertakings should be able to adequately justify the omission of taking into account future management decisions for reasons of relative significance.

Orientation 39 - Coherence of management decisions with other assumptions Insurance and reinsurance undertakings should take into account the impact of assumed management decisions on other assumptions within a particular valuation scenario. In particular, undertakings should take into account the effects of a certain management decision on policyholder behavior or on related costs. Undertakings should take into account relevant legal or regulatory constraints on management decisions. Furthermore, for a given scenario, undertakings should ensure that assumed future management decisions reflect the balance, consistent with the business plan, between the degree of competitiveness and the risk of dynamic lapse rights.

Orientation 40 - Interrelation with the cedant undertaking Insurance and reinsurance undertakings should consider the future management decisions of the cedant undertaking as policyholder behavior and estimate their technical provisions based on reasonable assumptions regarding the behavior of the cedant undertaking.

Orientation 40a - Complete management plan
Insurance and reinsurance undertakings should ensure that the complete plan of future management decisions approved by the administrative, management, or supervisory body consists of:
either a single document listing all assumptions relating to future management decisions used to calculate the best estimate; either a set of documents, accompanied by an inventory, which clearly provide a complete view of all assumptions relating to future management decisions used in the calculation of the best estimate.

NBB 2022_25 - 17 October 2022 Circular - P. 15/35

Orientation 40b - Taking into account new activities in the definition of future management decisions Insurance and reinsurance undertakings should take into account the effect of new activities in the definition of future management decisions and duly take into account the consequences on other related assumptions. In particular, the fact that the set of cash flows to be projected by application of Article 18 of the Delegated Regulation on contract boundaries is limited should not lead insurance and reinsurance undertakings to consider that the assumptions are based solely on this set of projected cash flows, without any influence from new activities. This is particularly the case for assumptions relating to the allocation of risky assets, the management of the duration gap, or the application of profit-sharing mechanisms.

Future discretionary benefits

Orientation 41 - Taking into account future discretionary benefits Insurance and reinsurance undertakings should take into account expected future discretionary benefits, whether these payments are contractually guaranteed or not. Undertakings should ensure that the valuation of the value of future discretionary benefits takes into account all relevant legal and regulatory restrictions, existing profit-sharing agreements, and any profit distribution plans.

Orientation 42 - Assumptions concerning future discretionary benefits Insurance and reinsurance undertakings should ensure that assumptions concerning the distribution of future discretionary benefits are established in an objective, realistic, and verifiable manner, incorporating the principles and practices adopted by the undertaking to offer insurance contracts with profit-sharing. If the distribution of future discretionary benefits is linked to the financial situation of the undertaking, the assumptions should reflect the interaction between the undertaking's assets and liabilities.

Orientation 43 - Assumptions concerning the modeling of the distribution of future discretionary benefits Insurance and reinsurance undertakings should consider a comprehensive analysis of past experiences, practices, and distribution mechanisms when evaluating the proportionality of a simplified method used to determine future discretionary benefits.

Section 4: Methods for calculating technical provisions
Proportionality assessment

Orientation 44 - General principle of proportionality In order to carry out a global assessment of the risks inherent in their insurance and reinsurance commitments, insurance and reinsurance undertakings should take into account the strong interrelationship between the nature, magnitude, and complexity of these risks. Undertakings should ensure that the actuarial function is able to explain the methods used to calculate technical provisions as well as the reasons that motivated the selection of these methods.

Circular - P. 16/35 NBB_2022_25 - 17 October 2022

Orientation 45 - Assessment of the nature and complexity of risks When assessing the nature and complexity of risks inherent in insurance contracts referred to in Article 56, paragraph 2, point (a) of Regulation 2015/35, insurance and reinsurance undertakings should take into account, at a minimum, the following characteristics, where applicable:
a) the degree of homogeneity of risks; b) the variety of different sub-risks or risk components; c) the interrelationship between these sub-risks; d) the level of uncertainty, namely the extent to which future cash flows can be estimated; e) the nature of the occurrence or crystallization of the risk in terms of frequency and severity; f) the type of evolution of claim payments over time; g) the extent of potential loss, including the tail of the claim distribution; h) the type of activity giving rise to the risks, namely direct operations or reinsurance activities; i) the degree of dependence between different types of risks, including the tail of the risk distribution; j) the risk mitigation instruments applied, where applicable, and their effect on the underlying risk profile.

Orientation 46 - Identification of complex risk structures Insurance and reinsurance undertakings should identify factors indicating the presence of complex risks. This should be the case, at a minimum, when:
a) cash flows are highly path-dependent; b) there are significant non-linear interdependencies between several uncertainty factors; c) cash flows are significantly affected by possible future management decisions; d) risks have a significant asymmetric effect on the value of cash flows, particularly if contracts contain embedded options and guarantees or if there are complex reinsurance contracts; e) the value of options and guarantees is affected by the policyholder's behavior; f) the undertaking uses a complex risk mitigation instrument; g) a variety of covers of different nature are grouped in the contracts; h) contract terms are complex, including, inter alia, deductibles, participations, and inclusion and exclusion criteria for coverage.

Orientation 47 - Assessment of the magnitude of risks Insurance and reinsurance undertakings should define and use the interpretation of magnitude that is best suited to the specific circumstances of the undertaking and the risk profile of its portfolio. Nevertheless, the assessment of "magnitude" should lead to an objective and reliable evaluation. To measure the magnitude of risks, undertakings should define a reference or benchmark specific to the undertaking leading to a relative rather than absolute number. To this end, risks can be taken into account on a scale from low to high relative to the defined reference.

Orientation 48 - Level of detail of the relative importance assessment Insurance and reinsurance undertakings should determine the most appropriate level at which the assessment of relative importance should be carried out for the purpose of calculating technical provisions, which could be that of individual homogeneous risk groups, individual lines of business, or the undertaking's activity as a whole.

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When assessing relative importance, undertakings should take into account the fact that a risk that is not significant relative to the undertaking's activity as a whole may still have significant importance in a smaller segment.
Furthermore, undertakings should not analyze technical provisions in isolation but should take into account in this assessment any effect on equity and therefore on the overall solvency balance sheet as well as on the required Solvency Capital.

Orientation 49 - Consequences of a significant error detected in the proportionality assessment If the insurance and reinsurance undertaking cannot avoid using a method leading to a significant level of error, it should document this fact and consider the consequences for the reliability of the technical provisions calculation and its overall solvency. In particular, the undertaking should evaluate whether the significant level of error is duly taken into account in the determination of the required Solvency Capital and therefore in the definition of the risk margin of technical provisions.

Methods applied to technical provisions calculations during the year

Orientation 50 - Simplified calculation of technical provisions during the year Insurance and reinsurance undertakings may use simplifications, for example the simplification described in Technical Annex VI, subject to proportionality assessment, for quarterly calculations of technical provisions.

Orientation 51 - Calculation of the best estimate for quarterly life and non-life technical provisions For the quarterly calculation of the best estimate of technical provisions, insurance and reinsurance undertakings may perform a projection calculation, taking into account cash flows occurring during the quarter and new commitments created during the quarter. The undertaking should update the assumptions of the projection calculation method when the analysis of actual performance versus forecasted performance indicates that significant changes have occurred during the quarter.

Orientation 52 - Calculation of the best estimate for quarterly life technical provisions For the quarterly projection calculation of the best estimate of life technical provisions for index-linked contracts, unit-linked contracts, contracts providing for profit-sharing, and contracts with financial guarantees, insurance and reinsurance undertakings should use the sensitivity analysis referred to in Article 272, paragraph 5, of Regulation 2015/35 to evaluate the sensitivity of the best estimate to relevant financial parameters. They should document the choice of the set of financial parameters and their continuous adequacy to their asset portfolio, as well as the relevance and accuracy of the sensitivity analysis.

Methods for valuing contractual financial options and guarantees

Orientation 53 - Decision concerning the method Insurance and reinsurance undertakings should ensure that the valuation of contractual financial options and guarantees is based on adequate, applicable, and relevant actuarial and statistical methods, taking into account developments in this field. Undertakings should ensure that, at a minimum, the following aspects are taken into account when making a decision on the method to determine the value of contractual financial options and guarantees:
a) the nature, magnitude, and complexity of inherent risks and their interdependence over the duration of the contracts; b) any information regarding the nature of the options and guarantees and their main factors; c) a thorough examination of the need to add complex calculations; d) the justification of the adequacy of the method.

Orientation 53a - Use of stochastic valuation
Insurance and reinsurance undertakings should use stochastic modeling to value technical provisions for contracts whose cash flows depend on future events and developments, including those involving significant options and guarantees.
When assessing whether stochastic modeling is necessary to correctly apprehend the value of options and guarantees, insurance and reinsurance undertakings should take into account, inter alia, but not exclusively, the following cases:

• any profit-sharing mechanism where future benefits depend on asset performance;
• financial guarantees (e.g., technical rates, even without a profit-sharing mechanism), particularly, but not only, when combined with options (e.g., surrender options) whose dynamic modeling would increase the present value of cash flows in certain scenarios.

Orientation 54 - Methods for valuing contractual financial options and guarantees Insurance and reinsurance undertakings should apply the proportionality assessment referred to in Article 56 of Regulation 2015/35 when considering using a closed-form approach or a stochastic approach to evaluate the options and financial guarantees included in insurance contracts. When neither of the two methods can be applied, undertakings may use as a last resort an approach involving the following steps:
a) analysis of the characteristics of the option or guarantee and how it will affect cash flows; b) analysis of the currently expected amount of the option or guarantee in the money or out of the money; c) determination of the expected variation in the cost of the option or guarantee over time; d) estimation of the probability of increase or decrease in the cost of the option or guarantee in the future.

Economic Scenario Generators (ESG)

Orientation 55 - Documentation of the ESG
Insurance and reinsurance undertakings should be prepared to share the following documents with supervisory authorities, upon request:
a) the mathematical models on which the ESG is based and the reasons for their choice; b) the assessment of data quality; c) the calibration process;

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d) the parameters resulting from the calibration process (in particular those corresponding to the volatility and correlation between market risk factors).

Orientation 56 - General understanding of the ESG When the ESG is outsourced, insurance and reinsurance undertakings should ensure that they have an appropriate understanding of the mathematical models on which the ESG is based, as well as the calibration process, with particular attention to the methods and hypotheses used and its limitations, and they should be kept permanently informed of any significant changes.

Orientation 57 - Calibration process: market data and choice of financial instruments Insurance and reinsurance undertakings should ensure that the calibration process of an ESG used for a valuation consistent with the market is based on data from deep, liquid, and transparent financial markets, as defined in the first article of Regulation 2015/35, and reflecting current market conditions. If this is not possible, undertakings should use other market prices, giving particular importance to possible distortions and ensuring that adjustments to overcome these distortions are made in a thoughtful, objective, and reliable manner. Insurance and reinsurance undertakings should be able to demonstrate that the choice of financial instruments used in the calibration process is relevant given the characteristics of the insurance or reinsurance commitments (e.g., embedded financial options and guarantees).

Orientation 57a - Market risk factors necessary to obtain appropriate results When assessing whether all relevant risk factors are modeled with regard to the provisions of Article 22, paragraph 3, and Article 34, paragraph 5, of the Delegated Regulation, insurance and reinsurance undertakings should be able to demonstrate that their modeling adequately reflects the volatility of their assets and that important sources of volatility are taken into account appropriately (e.g., spreads and default risk). Insurance and reinsurance undertakings should in particular use models capable of modeling negative interest rates.

Orientation 58 - Tests (accuracy, robustness, and consistency with the market) When insurance or reinsurance undertakings use an ESG for the stochastic modeling of technical provisions, they should be able to demonstrate to the competent supervisory authorities the accuracy, robustness, and market consistency qualities of the ESG. A measure of the accuracy of the ESG (at a minimum a Monte-Carlo error analysis) should be evaluated. To demonstrate the robustness of the ESG, insurance and reinsurance undertakings should test the sensitivity of the valuation of certain typical liabilities to the variation of certain parameters of the calibration process. To demonstrate the market consistency qualities of the ESG, at a minimum one of the following tests should be performed on all scenarios generated by the ESG used for valuation:
a) calibration tests: verify that the requirements set out in Article 22, paragraph 3, of Regulation 2015/35 are met;

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b) Martingale tests: verify the Martingale test for asset categories (stocks, bonds, real estate assets, exchange rates, etc.) used in the ESG calibration process and for some portfolio investment strategies; c) correlation tests: compare simulated correlations with historical correlations. Insurance and reinsurance undertakings should ensure that the accuracy, robustness, and market consistency tests of the ESG are performed regularly and at least once a year.

Orientation 59 - Random and pseudo-random number generators Insurance and reinsurance undertakings should ensure that the (pseudo)random number generators used in the ESG have been properly tested.

Orientation 60 - Continuous adequacy of the ESG Insurance and reinsurance undertakings should put in place adequate procedures to ensure that the ESG remains appropriate for calculating technical provisions continuously.

Calculation of the risk margin

Orientation 61 - Methods for calculating the risk margin Insurance and reinsurance undertakings should assess whether a full projection of the entire future required Solvency Capital is necessary to account for the nature, magnitude, and complexity of risks inherent in the reference undertaking's insurance and reinsurance commitments in a proportional manner. In such a case, undertakings should perform these calculations. Otherwise, alternative methods may be used to calculate the risk margin, ensuring that the chosen method is adequate to represent the undertaking's risk profile. If simplified methods are used to calculate the best estimate, undertakings should evaluate the subsequent effect that the use of such methods may have on the available methods for calculating the risk margin, including the use of any simplified methods for projecting future SCRs.

Orientation 62 - Hierarchy of risk margin calculation methods When deciding on the most appropriate level of hierarchy among those described below, insurance and reinsurance undertakings should ensure that the complexity of calculations does not exceed that necessary to reflect the nature, magnitude, and complexity of risks inherent in the reference undertaking's insurance and reinsurance commitments in a proportional manner. Undertakings should apply the hierarchy of methods in a manner consistent with the framework established when defining the principle of proportionality and the need to duly assess risks. Insurance and reinsurance undertakings should use the following hierarchy as a basis for decision-making regarding the methods to be used to project future required Solvency Capital:
Method 1) to approximately estimate individual risks or sub-risks within the total or some of the modules and sub-modules to be used to calculate the future required Solvency Capital as provided for in Article 58, point (a), of Regulation 2015/35.

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Method 2) to approximately estimate the total solvency capital required for each future year, as provided for in Article 58, point a) of Regulation 2015/35, using, among other things, the ratio of the best estimate for this future year given / best estimate at the valuation date. This method is not appropriate when there are negative best estimate values at the valuation date or at later dates. This method takes into account the maturity and the liquidation model of liabilities net of reinsurance. Consequently, it is necessary to take into account how the best estimate of technical provisions net of reinsurance was calculated. It is also necessary to examine whether the hypotheses concerning the company's risk profile can be considered unchanged over time. This includes:
a) for all underwriting risks, examining whether the composition of sub-risks of the underwriting risk is the same; b) for counterparty risk, examining whether the average credit quality of reinsurers and securitization vehicles is the same; c) for market risk, examining whether the significant market risk relative to the net best estimate is the same; d) for operational risk, examining whether the share of reinsurers and securitization vehicles in liabilities is the same; e) for the adjustment, examining whether the loss absorption capacity of technical provisions relative to the net best estimate is the same. If all or some of these hypotheses are not valid, the company should carry out at least a qualitative assessment of the importance of the deviation from the hypothesis. If the effect of the deviation is not significant relative to the total risk margin, this method may be used. Otherwise, the company should adjust the formula appropriately or be encouraged to use a more sophisticated method.

Method 3) to approximately estimate the discounted sum of the total future solvency capital required in a single step, without estimating the solvency capital required for each future year separately, as provided for in Article 58, point b), of Regulation 2015/35, using, among other things, the modified duration of insurance liabilities as a proportionality factor. When deciding on the application of a method based on the modified duration of insurance liabilities, it is necessary to take into account the value of the modified duration to avoid meaningless results for the risk margin. This method takes into account the maturity and the liquidation model of liabilities net of reinsurance. Consequently, it is necessary to take into account how the best estimate of technical provisions net of reinsurance was calculated. It is also necessary to examine whether the hypotheses concerning the company's risk profile can be considered unchanged over time. This includes:
a) for the basic SCR, examining whether the composition and proportions of risks and sub-risks remain unchanged over the years; b) for counterparty risk, examining whether the average credit quality of reinsurers and securitization vehicles remains unchanged over the years; c) for operational risk and counterparty risk, examining whether the modified duration is the same for liabilities with or without reinsurance; d) examining whether the significant market risk relative to the net best estimate is the same over the years; e) for the adjustment, examining whether the loss absorption capacity of technical provisions relative to the net best estimate remains unchanged over the years. A company intending to use this method should examine the extent to which these hypotheses are valid. If all or some of these hypotheses are not valid, the company should carry out at least a qualitative assessment of the importance of the deviation from the hypothesis. If the effect of the deviation is not significant relative to the total risk margin, the simplification may be used. Otherwise, the company should adjust the formula appropriately or be encouraged to use a more sophisticated method.

Method 4) to approximately estimate the risk margin by calculating it as a percentage of the best estimate.
Under this method, the risk margin should be calculated as a percentage of the best estimate of technical provisions net of reinsurance at the valuation date. When deciding on the percentage to use for a given line of business, the company should take into account the fact that this percentage may increase if the modified duration of insurance liabilities - or another measure of the liquidation model of these liabilities - increases. Companies should take into account the very simplistic nature of this approach; it should only be used if it is demonstrated that none of the more sophisticated approaches for calculating the risk margin in the hierarchy above can be applied. When companies rely on this method for calculating the risk margin, they should justify and document the reasoning leading to the percentages used by line of business. The justification and reasoning should take into account any specific characteristics of the portfolios evaluated. Companies should not use this method when there are negative best estimate values. Without prejudice to the proportional revaluation and the provisions of Article 58 of Regulation 2015/35, insurance and reinsurance undertakings may use the simplifications defined in Technical Annex IV when applying the hierarchy of methods.

Guideline 63 - Allocation of the global risk margin If it is too complicated to calculate the contribution of individual lines of business to the global SCR over the entire duration of the total portfolio accurately, insurance and reinsurance undertakings should be able to apply simplified methods to allocate the global risk margin to individual lines of business, which are proportional to the nature, scale, and complexity of the risks concerned. The methods applied should be consistent over time.

Calculation of technical provisions as a whole Guideline 64 - Taking into account uncertainty Insurance and reinsurance undertakings should understand, taking into account uncertainty in order to reliably replicate the cash flows associated with insurance or reinsurance liabilities, that the cash flows of financial instruments must not only provide the same expected amount as the cash flows associated with insurance or reinsurance liabilities but also the same variability patterns.

Guideline 65 - Reliable replication
Insurance and reinsurance undertakings should not consider that the future cash flows associated with insurance or reinsurance liabilities have been reliably replicated if:
a) one or more characteristics of future cash flows, for example, their expected value, their volatility, or any other characteristic, depend on risks whose specific model in the company is not found in actively traded instruments on financial markets; b) current information on trading and prices is not normally immediately available to the public, because one or more characteristics of future cash flows depend to some extent on the evolution of company-specific factors, such as expenses or acquisition costs; or c) one or more characteristics of future cash flows depend on the evolution of external factors for which there are no financial instruments allowing the observation of reliable market values.

Guideline 66 - Short-term disruptions
If an active and transparent market does not temporarily meet one or more of the depth and liquidity conditions and it can be reasonably expected that it will meet the conditions again within the next three months, insurance and reinsurance undertakings should use prices that have been observed during this period for the purposes of these guidelines. Companies should verify that the use of these prices does not produce a significant error in the valuation of technical provisions.

Guideline 67 - Decomposition of liabilities valued as a whole If there are, under the same contract, a number of future cash flows meeting all the conditions to calculate technical provisions as a whole and a number of other future cash flows not meeting some of these conditions, insurance and reinsurance undertakings should decompose the two sets of cash flows. For the first set of cash flows, there is no need to calculate the best estimate and the risk margin separately, but companies should perform a separate calculation for the second set of cash flows. If the proposed decomposition is not possible, particularly when there is significant interdependence between the two sets of cash flows, companies should perform separate calculations of the best estimate and the risk margin for the contract as a whole.

Future premiums
Guideline 68 - Cash flows of future premiums centered on premiums receivable Insurance and reinsurance undertakings should establish the cash flows of future premiums contained within the limits of the contract at the valuation date and include in the calculation of the best estimate of liabilities the cash flows of future premiums maturing after the valuation date. Insurance and reinsurance undertakings should show on the balance sheet premiums maturing up to the valuation date as premiums receivable until the collection of the cash amount.

Calculation of claims provisions
Guideline 69 - Methods for calculating provisions for claims reported but not settled (RBNS) Insurance and reinsurance undertakings should not include the provision for claims incurred but not reported (IBNR) nor the unallocated loss adjustment expenses (ULAE) in the calculation of the provision for claims reported but not settled, representing the component of the claims provision related to events giving rise to the claim and notified to the insurer. Two possible methods to estimate the provision for claims reported but not settled:

• consider the number of claims reported and their average cost;
• estimate on a case-by-case basis.

Guideline 70 - Methods for calculating provisions for claims incurred but not reported If actuarial techniques (e.g., chain ladder techniques) are used to estimate the provision for claims incurred but not reported (IBNR), insurance and reinsurance undertakings should verify the validity of the hypotheses underlying the technique or adjust the development patterns to properly reflect any future evolution.

Guideline 71 - Valuation methods for claims settlement expenses - unallocated loss adjustment expenses (ULAE) When insurance and reinsurance undertakings apply a simplified method for the provision for claims settlement expenses based on an estimate in the form of a percentage of the claims provision, as described in Technical Annex II, this should only be taken into account if the expenses can reasonably be considered proportional to the provisions as a whole, if this proportion is stable over time, and if the expenses are distributed uniformly throughout the duration of the entire claims portfolio.

Calculation of premium provisions
Guideline 72 - Coverage
Insurance and reinsurance undertakings should ensure that premium provisions at the valuation date include the valuation of all liabilities recognized within the limits of insurance or reinsurance contracts, for any exposure to future claim events, if:
a) the coverage has taken effect before the valuation date; b) the coverage has not taken effect before the valuation date, but the insurance or reinsurance company has become a contracting party to the insurance or reinsurance contract offering the coverage.
Without prejudice to the proportional revaluation and the provisions of Article 36, paragraphs 2, of Regulation 2015/35, companies may apply the simplification described in Technical Annex III.

Guideline 73 - Taking into account projections of claim costs Insurance and reinsurance undertakings should ensure that the valuation of claim cash flows included in premium provisions properly takes into account the expected impact and cost of future claims, including the possibility of high-severity claims and infrequent latent claims.

Guideline 74 - Uncertainty regarding policyholder behavior Insurance and reinsurance undertakings should ensure that the valuation of premium provisions takes into account the possibility that policyholders exercise options to extend or renew a contract or to cancel or cease a contract before the end of the expected coverage period.

Guideline 75 - Negative premium provision
Insurance and reinsurance undertakings should ensure that, if the present value of future cash inflows exceeds the present value of future cash outflows, the premium provision, excluding the risk margin, is negative.

Calculation of Expected Profit on Future Premiums (EPFP) Guideline 76 - Separation of insurance liabilities For the purposes of the calculation referred to in Article 260 of Regulation 2015/35, insurance and reinsurance undertakings should divide their insurance liabilities into those attributable to premiums already paid and those attributable to premiums concerning activities in force to be received in the future.

Guideline 77 - Hypotheses used to calculate EPFP For the purpose of calculating technical provisions without risk margin, assuming that premiums relating to existing insurance and reinsurance contracts that should be received in the future are not received, companies should apply the same actuarial method as that used to calculate technical provisions without risk margin in accordance with Articles 126 and 127 of the Law, with the following modifications:
a) policies should be considered as always in force rather than as redeemed; b) regardless of the legal or contractual terms applicable to the contract, the calculation should not include sanctions, reductions, or any other type of adjustment to the theoretical actuarial valuation of technical provisions without risk margin calculated as if the policy were always in force; c) All other hypotheses (e.g., mortality, lapse rates, expenses) should remain unchanged. This means that insurance and reinsurance undertakings should apply the same projection horizon, the same future management decisions, and the same policyholder option exercise rates as those used to calculate the best estimate, without adjusting them to take into account the fact that future premiums will not be received. Even if all expense-related hypotheses remained constant, the level of certain expenses (such as acquisition expenses or investment management expenses, for example) could be indirectly affected.

Guideline 77a - Alternative approach for calculating EPFP Insurance and reinsurance undertakings may identify the expected profit on future premiums as the share of the present value of expected profits on future premiums in the case where the result does not deviate significantly from the value that would have resulted from the valuation described in Guideline 77. This approach can be implemented using a formula.

Methods for calculating amounts recoverable under reinsurance contracts and securitization vehicles Guideline 78 - Scope of taking into account future reinsurance purchases Insurance and reinsurance undertakings should account for future cash flows relating to future reinsurance purchases covering liabilities already recognized on the balance sheet - to the extent that they replace expired reinsurance agreements and it can be demonstrated that the conditions listed below are met:
a) the insurance and reinsurance company has a written policy on the replacement of the reinsurance agreement; b) the reinsurance agreement is not replaced more often than every 3 months; c) the replacement of the reinsurance agreement does not depend on a future event outside the control of the insurance or reinsurance company. If the replacement of the reinsurance agreement depends on a future event that is under the control of the insurance or reinsurance company, the conditions should be clearly documented in the written policy referred to in point a); d) the replacement of the reinsurance agreement should be realistic and consistent with the current commercial practice and business strategy of the insurance or reinsurance company. The insurance or reinsurance company should be able to verify that the replacement is realistic by comparing the hypothetical replacement with replacements previously made by the insurance or reinsurance company; e) the risk that the reinsurance agreement cannot be replaced due to capacity constraints is insignificant; f) an appropriate estimate of future reinsurance premiums to be applied is made, reflecting the risk that the cost of replacing existing reinsurance agreements may increase; g) the replacement of reinsurance agreements is not contrary to the requirements applicable to future management decisions referred to in Article 236 of Regulation 2015/35.

Guideline 79 - Simplified calculation of amounts recoverable under reinsurance contracts and securitization vehicles - premium provisions In order to estimate the amount of amounts recoverable under the reinsurance contract of the premium provision without deduction of reinsurance when a simplified calculation is applied, insurance and reinsurance undertakings should apply a separate gross-to-net coefficient to cash outflows, and companies may eventually apply a different gross-to-net coefficient to cash inflows. Companies should base the gross-to-net coefficient applicable to cash outflows on an examination of past claim events taking into account the future reinsurance program applicable. The gross-to-net coefficient applicable to cash inflows should take into account the relative gross premiums and expected and paid reinsurance premiums. Without prejudice to the provisions of the first paragraph of this guideline and the proportional revaluation, companies may apply the simplifications referred to in Technical Annex V.

Guideline 80 - Simplified calculation of amounts recoverable under reinsurance contracts and securitization vehicles - claims payable provisions Regarding the claims payable provisions for amounts recoverable under reinsurance contracts, insurance and reinsurance undertakings should use separate gross-to-net conversion techniques either for each accident year or for each underwriting year not finally developed for a given line of business or a given homogeneous risk group, where applicable.

Guideline 81 - Simplified calculation of counterparty default adjustment The simplified calculation of the counterparty default adjustment referred to in Article 61 of Regulation 2015/35, based on the assumption that the probability of default remains constant over time, insurance and reinsurance undertakings considering using this simplification should examine whether this hypothesis is realistic, taking into account the credit quality tier of the counterparty and the modified duration of amounts recoverable under reinsurance contracts and securitization vehicles.

General principles underlying technical provisions calculation methods Guideline 82 - The projection period When evaluating whether the projection period and the schedule of cash flows to policyholders during the year are proportional, insurance and reinsurance undertakings should at least take into account the following characteristics:
a) the degree of homogeneity of cash flows;

b) the level of uncertainty, namely the extent to which future cash flows can be estimated; c) the nature of the cash flows.

Section 5: Validation

Orientation 83 - Proportionality of technical provision validation Insurance and reinsurance undertakings should request that the actuarial function ensure that the validation process is proportional, taking into account the significance of the impact, both individually and combined, of assumptions, approximations, and methods on the value of technical provisions.

Orientation 84 - Selection of validation approaches and processes Insurance and reinsurance undertakings should request that the actuarial function identify the most appropriate approaches and processes given the characteristics of the liabilities and the intended use of the approach or process.

Orientation 85 - Qualitative and quantitative approaches Insurance and reinsurance undertakings should request that the actuarial function ensure that the validation process covers both quantitative and qualitative aspects and goes beyond a simple comparison between estimates and results. It should also include qualitative aspects such as the review of controls, documentation, interpretation, and communication of results.

Orientation 86 - Regular and dynamic validation process Insurance and reinsurance undertakings should request that the actuarial function apply a regular and dynamic process in which it periodically refines validation approaches to incorporate experience gained from previous validations and in response to changes in market conditions and operational conditions.

Orientation 87 - Comparison with experience-derived data - deviations Insurance and reinsurance undertakings should ensure that the actuarial function:
a) highlights the total deviation between expected claims and actually observed claims; b) breaks down the total deviation by main sources and analyzes the reasons for the deviation; c) if the deviation does not appear to be a temporary aberration, issues recommendations on changes to be made to the model or assumptions adopted.

Undertakings should ensure that market data and relevant trends are considered as part of the comparison with experience-derived data.

Orientation 88 - Comparison with the market for contracts with options and guarantees Insurance and reinsurance undertakings should examine whether there is a range of market instruments available to approximately replicate contracts with embedded options and guarantees. When available, the price of such portfolios should then be compared with the value of technical provisions, calculated as the sum of the best estimate (calculated using cash flow projections) and the risk margin.

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Technical Annex III - Simplification for premium provisions Simplification aimed at establishing the best estimate of premium provisions based on an estimate of the combined ratio in the relevant line of business:
The following input data are required:
(a) estimate of the combined ratio (CR) for the line of business during the run-off period of the premium provision; (b) present value of future premiums for the underlying commitments (insofar as future premiums are within the limits of the contract); (c) measure of the volume of unearned premiums; it relates to activities that have taken effect on the valuation date and represents the premiums for this activity that have taken effect minus the premiums already earned on these contracts (determined on a pro rata temporis basis).

The best estimate is established from the input data as follows:
BE = CR • VM + (CR - 1) • PVFP + AER • PVFP

Where:
BE = best estimate of the premium provision
CR = estimate of the combined ratio for the line of business on a basis without deduction of acquisition costs, namely CR = (claims + claims-related expenses) / (earned premiums without deduction of acquisition costs) VM = measure of the volume of unearned premiums. It relates to activities that have taken effect on the valuation date and represents the premiums for this activity that have taken effect minus the premiums already earned on these contracts. This measure should be calculated without deduction of acquisition costs. PVFP = present value of future premiums (discounted using the prescribed term structure of risk-free interest rates) without deduction of commissions AER = estimate of the acquisition cost ratio for the line of business

The combined ratio for an accident year (= occurrence year) is defined as the ratio of expenses and claims incurred in a given line of business or given homogeneous group of risks relative to earned premiums. Earned premiums should exclude the adjustment for prior years. Expenses should be those attributed to earned premiums other than claims-related expenses. Incurred claims should exclude the result of settlement, i.e., they should represent the total losses incurred during the year including claims settled (including claims-related expenses) during the year and provisions established at the end of the year.

Alternatively, if this calculation is easier to perform, the combined ratio for an accident year can be considered as the sum of the expense ratio and the claim ratio. The expense ratio is the ratio of expenses (other than claims-related expenses) relative to written premiums, and expenses are those attributable to written premiums. The claim ratio for an accident year in a given line of business or given homogeneous group of risks should be determined as the ratio of the ultimate loss of incurred claims relative to earned premiums.

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Technical Annex IV - Hierarchy of simplifications for the risk margin Regarding level (1) of the hierarchy:
Life underwriting risk
The simplifications taken into account for SCR calculations regarding mortality, longevity, disability, expense, lapse, and catastrophe risks are applicable to risk margin calculations.
Health underwriting risk
The simplifications taken into account for SCR calculations regarding health mortality, health longevity, disability-morbidity in medical expense insurance, disability-morbidity in income protection insurance, health expenses, and health termination SLT are applicable to risk margin calculations. Non-life underwriting risk The calculation of future SCRs relating to premium and reserve risks can be somewhat simplified if renewals and future activities are not taken into account:
If the premium volume in year t is low relative to the reserve volume, the premium volume for year t can be defined as 0. An example could be an activity comprising no contracts over multiple years, where the premium volume can be defined as 0 for all future years t where t ≤ 1. If the premium volume is zero, the capital requirement for non-life underwriting can be calculated approximately using the following formula:
σ(res,mod) • PCONet(t), where σ(res,mod) represents the aggregated standard deviation for reserve risk and PCONet(t) the best estimate of the claim provision to be paid less reinsurance for year t.

The aggregated standard deviation for reserve risk σ(res,mod) could be calculated using the aggregation steps referred to in Article 117 of Regulation 2015/35, assuming that all amounts relating to premium risk are equal to zero.
For further simplification, it is possible to assume that the company-specific estimate of the standard deviation for premium risk and reserve risk remains unchanged over time.
Furthermore, the underwriting risk requirement for catastrophe risk is only taken into account for existing insurance contracts for year t = 0.
Counterparty risk
The requirement for counterparty risk for ceded reinsurance can be calculated directly from the definition for each segment and each year. If the exposure to reinsurer default does not vary considerably over the development years, the risk requirement can be calculated approximately by applying the share of the best estimates of the reinsurers to the observed risk requirement level for year 0. According to the standard formula, counterparty risk for ceded reinsurance is evaluated for the portfolio as a whole rather than for individual segments. If the default risk in a segment is considered similar to the global default risk or if the default risk in a segment is insignificant, the risk requirement can be calculated by applying the share of the best estimates of the reinsurers to the global capital requirement level for reinsurer default for year 0.

Regarding level (2) of the hierarchy:
Using a representative example of a proportional method, the SCR of the reference company for year t could be defined as follows:
SCR_t(Q) = SCR_t(0) • BE_t(Q) / BE_t(0) ^ t = 1, 2, 3, ...

Where:
SCR_ref(0) = SCR as calculated at time t ≤ 0 for the portfolio of insurance (reinsurance) commitments of the reference company; BE_ref(t) = best estimate of technical provisions less reinsurance as evaluated at time t ≥ 0 for the portfolio of insurance (reinsurance) commitments of the company.

The simplification described above can also be applied at a more detailed level, namely for individual modules and/or sub-modules. Note, however, that the number of calculations to be performed will generally be proportional to the number of modules and/or sub-modules to which this simplification is applied. Furthermore, it should be examined whether a calculation at a more detailed level as indicated above will lead to a more accurate estimate of future SCRs to be used for the calculation of the risk margin.

Regarding level (3) of the hierarchy:
Regarding life insurance, the duration approach means that the risk margin CoCM could be calculated according to the following formula:
CoCM = CoC • Du_mod(0) • SCR_ref(0) / (1 + r_t)

Where:
SCR_ref(0) = the SCR as calculated at time t = 0 for the portfolio of insurance (reinsurance) commitments of the reference company; Du_mod(0) = the modified duration of the insurance (reinsurance) commitments of the reference company less reinsurance at time t = 0; CoC = the cost of capital rate.

If SCR_ref(0) includes sub-risks that will not exist over the entire duration of the portfolio (e.g., non-life premium risk for contracts that have matured or significant market risk), the calculation can often be improved by:
excluding these sub-risks from SCR_ref(0) for the aforementioned calculation; calculating separately the contribution of these sub-risks to the risk margin; aggregating the results (if this is easily achievable to allow for diversification).

Regarding level (4) of the hierarchy:
According to this simplification, the risk margin CoCM is calculated as a percentage of the best estimate of technical provisions less reinsurance at time t = 0, i.e., CoCM = σ/ob • BE_net(0)

Where:
BE_net(0) = the best estimate of technical provisions less reinsurance as evaluated at time t = 0 for the portfolio of insurance (reinsurance) commitments of the company within the given line of business; σ/ob = a fixed percentage for the given line of business.

Circular - P. 32/35 NBB_2022_25 - 17 October 2022

Technical Annex V - Simplified calculation of receivables arising from reinsurance contracts and securitization vehicles Regarding premium provisions:
The "gross-to-net" simplifications referred to below regarding claim provisions to be paid, 2), can also be used to calculate receivables arising from premium provisions, namely claim provisions (covered but not incurred) relating to the current accident year (or i = n+1), using the proportional (anticipated) share of reinsurance coverage for that year. This will be a conservative approach for the ceding insurance (reinsurance) undertaking, given that the impact of non-proportional reinsurance for the current accident year (fiscal year) is not taken into account.

Regarding claim provisions to be paid:
1) "Gross-to-net" simplification based on reported but not settled claims (RBNS) (individual case reserves)
This simplification uses the ratio of net provisions to gross provisions of a portfolio A available to estimate the net provisions of another portfolio B (NPB) based on the observable gross provisions of portfolio B (GPB). In other words, the "gross-to-net" (GN) simplification presents itself as follows:
GN_A = NPA / GPA where NPA and GPA represent respectively the net and gross provisions of portfolio A. This simplification is then applied to calculate the net provisions for portfolio B as follows:
NPB = GN_A x GPB

The following criteria should be met to apply this simplification:
the reference portfolio (A) is similar to the portfolio (B) for which the simplification is used, see the principle of substance over form; the ratio (GN) is established using credible and sustainable data. This requires a data set covering at least two years.

Ceded reinsurance varies depending on the size, financial strength, and risk aversion of a company: therefore, caution should be exercised when applying a ratio of net provisions to gross provisions of another reference portfolio. Consequently, such an approach can only be used in cases where it is proven that the reference portfolio is of a very similar nature to that of the company's portfolio. Yet, even in this case, the cession percentage for non-proportional reinsurance will depend heavily on the actual occurrence of significant losses and will therefore be very volatile.

NBB 2022 25 - 17 October 2022 Circular - P. 33/35

2) "Gross-to-net" simplification based on cumulative paid claims (cumulative cash flows)
This simplification allows establishing an estimate of net provisions for unpaid claims using gross provisions for unpaid claims in combination with an estimate of the impact of reinsurance coverage for individual accident years.
Regarding the reasoning for using this simplification, it should be noted that for prior accident years, the reinsurance structure for an individual year is known and (in principle) will not change retroactively. Therefore, it is possible to use a comparison of net cash flows relative to gross cash flows by line of business in the past - differentiated by accident year - to establish an estimate of the impact of proportional and non-proportional reinsurance for the individual accident year (i.e., a "gross-to-net" simplification for the individual accident year).

For each line of business, the "gross-to-net" simplifications for accident years not yet finally developed (GN_i) are presented as follows:
GN_i = A_Net,i,n-i / A_Gross,i,n-i, where A_Gross,i,n-i and A_Net,i,n-i represent respectively the cumulative paid claims without deduction and less reinsurance, and n is the last accident year for which values have been observed for these cash flows.

These simplifications are then used to calculate the net provisions for unpaid claims for individual accident years, namely PCONet,i = GN_i x PCOGross,i where PCOGross,i and PCONet,i represent respectively the gross and net provisions for unpaid claims for accident year i.

To apply this simplification, cumulative gross and net unpaid claims (gross and net cash flows) by accident year should be available for each line of business.
For more recent accident years, and particularly for the last accident year (i=n), the formulated simplification may be somewhat too high because it is possible that IBNR claims represent a significant part of the unpaid claim provisions. Consequently, the formulated simplification could lead to an overestimation of net provisions in these cases.

Circular - P. 34/35 NBB 2022 25 - 17 October 2022

Technical Annex VI - Simplified calculation of the risk margin during the year The risk margin at a given moment during the coming year (i.e., CoCM_net(t)) could be calculated as follows:
CoCM(t) = CoCM(0) • BE_net(t) / BE_net(0), 0 < t < 1

where:
CoCM(0) = risk margin as calculated at time t = 0 for the portfolio of insurance (reinsurance) commitments of the reference company; BE_net(t) = best estimate of technical provisions less reinsurance as evaluated at time t ≥ 0 for the portfolio of insurance (reinsurance) commitments of the reference company.

A copy of this circular is addressed to the commissioner(s), approved auditor(s) of your establishment.
We ask you to accept, Madam, Sir, the expression of our distinguished sentiments.

Pierre Wunsch
Governor
NBB_2022_25 - 17 October 2022 Circular - P. 35/35