Circular on Guidelines Regarding Contract Boundaries

boulevard de Berlalmont 14 - BE-1000 Bruxelles tel. +32 2 221 27 31 numero d'entreprlse: 0203.201.340 RPM Bruxelles www.bnb.be n '»uiH!i!('Nationalei5(inl DE BELCIQUE VAN BELCIE rurosyso'm Circular Brussels, 17 October 2022 Reference:
your correspondent:
Stany Zabinski tel. +32 2 221 34 67 stany.zabinski@nbb.be NBB_2022_24 Circular on Guidelines Regarding Contract Boundaries Scope Belgian insurance or reinsurance undertakings; Insurance or reinsurance undertakings that are part of a Belgian group within the meaning of
Article 339, 2° of the Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings,
Belgian undertakings that are part of a Belgian financial conglomerate within the meaning of
Article 340, 1° of the aforementioned Law of 13 March 2016,
Branches of third-country undertakings carrying on insurance [or reinsurance] activities in Belgium This circular applies to mutual insurance societies defined in Article 15, 79° of the aforementioned Law of 13 March 2016. For these undertakings, "the Bank" should be replaced by "the Office for the Supervision of Mutualities and National Unions of Mutualities" as defined in Article 15, 84° of the same Law. This circular does not apply to insurance undertakings referred to in Articles 275, 276 or 294 of the aforementioned Law of 13 March 2016. Objective This circular aims to explain the Bank's guidelines on contract boundaries. Legal References The Law: The Law of 13 March 2016 on the status and supervision of insurance or reinsurance undertakings Regulation 2015/35: Delegated Regulation (EU) 2015/35 of the Commission of 10 October 2014 supplementing Directive 2009/138/EC of the European Parliament and of the Council on the access to and the exercise of the activities of insurance and reinsurance NBB_2022_24 - 17 October 2022 Circular - P. 1/8

Structure
I.
II.
III.
IV.
V.
Objectives
Definitions
Additional Information
Entry into Force
Guidelines on Contract Boundaries
Circular - P. 2/8 NBB_2022_24 - 17 October 2022

Madam,
Sir,
I. Objectives
This circular relates to Articles 124 and 133 of the Law, as well as Articles 17 and 18 of Regulation 2015/35 and replaces Circular NBB_2016_24.
These guidelines aim to promote the consistent application of contract boundaries for insurance or reinsurance contracts in order to define the limit between existing and future activities. The guidelines allow for the determination of insurance or reinsurance obligations arising in relation to a contract regarding future premiums in accordance with Articles 17 and 18 of Regulation 2015/35.
II. Definitions
For the purposes of these guidelines, the expression "governing bodies" means the internal bodies set up to ensure the governance of an insurance or reinsurance undertaking and which, consequently, must not be considered as third parties when adopting a decision or expressing an opinion on the exercise of the right to terminate a contract, to reject premiums receivable under a contract, or to modify premiums or benefits payable under the contract. In the absence of a definition in this circular, terms have the meaning defined in the legislative and regulatory acts referred to therein.
III. Additional Information
This circular falls within the framework of the harmonised implementation of the principles of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the access to and the exercise of the activities of insurance and reinsurance (Solvency II), as this implementation was 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.
NBB_2022_24 - 17 October 2022 Circular - P. 3/8

V. Guidelines on Contract Boundaries
Guideline 0 - Contract Boundaries
Insurance and reinsurance undertakings should not consider contract boundaries as a precise point in time, but as a limit between premiums and obligations that are part of the contract and those that are not. Cash flows related to premiums and obligations that are part of the contract should be projected based on realistic assumptions, such that the projection of cash flows could go beyond one of the dates referred to in Article 18, paragraph 3, of the delegated regulation. Guideline 1 - Consistent Application of Principles Insurance and reinsurance undertakings must ensure that the principles aimed at defining contract boundaries are applied consistently to all insurance and reinsurance contracts, including long-term ones. Guideline 2 - Unilateral Right Insurance and reinsurance undertakings must consider the right to terminate, reject, or modify premiums or benefits payable under an insurance or reinsurance contract as a unilateral right as long as neither the policyholder nor any third party can impose restrictions on the exercise of this right. For the purposes of this guideline, third parties do not include supervisory authorities and the governing bodies of insurance and reinsurance undertakings. In particular:
a) When, in order to implement the modification of premiums or benefits, the insurance or reinsurance undertaking is required to obtain an external assessment in accordance with the law or the conditions of another agreement outside the insurance or reinsurance contract, the existence of such a requirement should only limit the undertaking's unilateral right if the assessment grants the policyholder or a third party the right to intervene in the use of said right. b) Undertakings should not consider reputational risk or competitive pressures as restrictions on the unilateral right. c) Undertakings should consider that their national laws limit their unilateral right only if these laws limit or grant the policyholder or a third party the right to limit the exercise of said right. d) Undertakings should disregard the right to unilaterally modify premiums or benefits payable under the contract if the premiums or benefits payable depend solely on the decisions of the policyholder or the beneficiary. e) Undertakings should disregard the unilateral right to terminate the contract or to reject premiums receivable under the contract if the exercise of this right, as defined in the contract conditions, is subject to the occurrence of a claim. Guideline 3 - Possibility of Constraint Insurance or reinsurance undertakings should only account for their ability to compel a policyholder to pay a premium if the policyholder's payment is enforceable. Guideline 4 - Premiums Fully Reflecting Risk When determining whether premiums fully reflect the risks covered by a portfolio of insurance or reinsurance obligations, insurance or reinsurance undertakings must assess whether, at the time it is possible to modify either premiums or benefits, the undertaking has, in all circumstances, the right to modify premiums or benefits such that the expected present value of future premiums exceeds the expected present value of future benefits and expenses payable under the portfolio. For the purposes of assessing whether premiums fully reflect the risks covered by a portfolio of insurance or reinsurance obligations in accordance with Article 18, paragraphs 3 and 7, of Regulation 2015/35, insurance and reinsurance undertakings must ensure that this portfolio includes obligations regarding which insurance or reinsurance undertakings can modify premiums or benefits in similar circumstances and with similar consequences. Insurance and reinsurance undertakings must take into account any individual assessment of relevant characteristics of the insured allowing the undertaking to gather sufficient information to duly appreciate the risks associated with the insured. In the case of contracts covering mortality risks or health risks similar to life insurance techniques, the individual risk assessment may be a self-assessment by the insured or may involve a medical examination or medical visit. Guideline 5 - Decomposition of the Contract Insurance and reinsurance undertakings must assess
whether it is possible, at the recognition date, to decompose a contract and examine, at each valuation date, whether a change has occurred that could affect the previous assessment. Insurance and reinsurance undertakings should consider that a contract can be decomposed for the purposes of contract boundaries if and only if two or more parts of the contract are equivalent in terms of risk to two or more contracts that could be sold separately. For the purposes of this guideline, two contracts should be considered equivalent in terms of risk if there are no perceptible differences in the economics of the contracts regarding the insurance risk or financial risk borne by the undertaking. Notwithstanding the preceding point, when all parts of a contract have the same contract boundary, undertakings may consider, within the framework of a simplified approach, not to decompose the contract for the definition of contract boundaries. When an option or guarantee covers more than one part of the contract, insurance and reinsurance undertakings must determine whether it is possible to decompose the contract or if it should be attributed to the corresponding part of the contract. If a contract is considered to be an insurance contract under the Solvency II directive, insurance and reinsurance undertakings must, however, take into account all decomposed parts of the contract giving rise to insurance or reinsurance obligations. If a contract is decomposed for the purposes of assessing contract boundaries, each part should be treated as an independent contract. Guideline 6a - Identification of a Financial Guarantee of Benefits Having a Perceptible Effect on the Economics of a Contract When determining whether a financial guarantee has no perceptible effect on the economics of a contract, insurance and reinsurance undertakings should take into account all potential future cash flows that may arise from the contract. Insurance and reinsurance undertakings should only consider a financial guarantee of benefits to have a perceptible effect on the economics of a contract if the financial guarantee relates to the payment of future premiums and grants the policyholder a perceptible financial advantage. When determining whether a financial guarantee grants a perceptible financial advantage, insurance and reinsurance undertakings should examine to what extent a perceptible change in the overall future cash flows would be expected if the financial guarantee did not exist. Undertakings may carry out this assessment on a qualitative or quantitative basis. For the purposes of this assessment, expected payments related to future discretionary benefits (including, among others, profit participation) whose distribution is entirely voluntary for the undertaking should not be taken into account since they do not represent insurance risk or financial risk for the undertaking. For this purpose, the distribution of future discretionary benefits is considered entirely voluntary
when there is no legal or contractual obligation to specifically allocate profits to an insured or group of insureds or to non-specifically reserve profits for a specific future distribution to insureds. The qualitative assessment should examine whether the configuration (risk, timing, and amount) of the cash flows of the contract with the financial guarantee differs perceptibly from the configuration of the contract without the financial guarantee. The quantitative assessment should be based on whether the relative difference in the value of all future obligations related to the contract with and without the financial guarantee (the "value of the financial guarantee") based on the expected present value is perceptible. When calculating the value of obligations without the financial guarantee, insurance and reinsurance undertakings should assume cash flows equal to the amount that would be paid if the financial guarantee did not exist. For contracts where benefits depend on market returns, undertakings should assume benefits consistent with the relevant risk-free interest rate curve used to calculate the best estimate referred to in Article 77, paragraph 2, of the Solvency II Directive, without volatility adjustment or equalisation reserve adjustment. When calculating the value of obligations with the financial guarantee, insurance and reinsurance undertakings should take into account in the valuation any form of guaranteed benefits arising from the financial guarantee. The adequate consideration of the time value of options and guarantees is relevant for this assessment. Guideline 6b - Identification of Coverage of a Determined Uncertain Event Affecting Negatively the Policyholder with a Perceptible Effect on the Economics of a Contract When determining whether the coverage of a determined uncertain event affecting negatively the policyholder (coverage) has no perceptible effect on the economics of a contract, insurance and reinsurance undertakings should take into account all potential future cash flows that may arise from the contract. Insurance and reinsurance undertakings should only consider coverage to have a perceptible effect on the economics of a contract if it relates to the payment of future premiums and grants the policyholder a perceptible financial advantage. When determining whether coverage grants a perceptible financial advantage, insurance and reinsurance undertakings should examine to what extent a perceptible change in the overall future cash flows would be expected if the coverage did not exist. Insurance and reinsurance undertakings may carry out this assessment on a qualitative or quantitative basis. Circular - P. 6/8 NBB 2022 24 - 17 October 2022

The qualitative assessment should examine whether the configuration (risk, timing, and amount) of the cash flows of the contract with coverage differs perceptibly from the configuration of the contract without coverage.
The quantitative assessment should be based on whether the relative difference in the value of all future obligations related to the contract with and without coverage (the "value of the coverage") based on the expected present value is perceptible. When calculating the value of obligations without coverage, insurance and reinsurance undertakings should assume that the coverage does not exist. When calculating the value of obligations with coverage, insurance and reinsurance undertakings should take into account all obligations. In some cases, the consideration of potential future scenarios is relevant for this assessment. Guideline 6c - Reassessment of the Perceptible Effect of Coverage or a Financial Guarantee In almost all cases, insurance and reinsurance undertakings should maintain contract boundaries constant throughout the duration of the contract. However, it may be necessary to modify contract boundaries following changes in the external environment as defined in Article 29 of the delegated regulation, as well as changes in the terms of the contract. Insurance and reinsurance undertakings are not expected to reassess whether coverage or a financial guarantee has a perceptible effect at each valuation date. However, insurance and reinsurance undertakings should carry out this reassessment if there are indications that it could lead to a different conclusion. In particular, to assess changes in the economic environment, undertakings should compare the current economic environment with the economic environment that existed at the time the assessment used to define the current contract boundaries was carried out, and they should only carry out a reassessment if these changes are extreme. For this purpose, changes in the relevant risk-free interest rate curve used to calculate the best estimate, as provided for in Article 77, paragraph 2, of the Solvency II Directive, which are less extreme than the standard formula shocks on interest rates, should not be considered as extreme. Insurance and reinsurance undertakings should only modify contract boundaries after this reassessment if it results in a conclusion obviously different from the assessment carried out to define the current contract boundaries. When the reassessment of the perceptible effect of coverage or a financial guarantee has led to a change in contract boundaries resulting in a significant impact on the valuation of technical provisions and on the undertaking's solvency, insurance and reinsurance undertakings should immediately report this change to the supervisory authority. Furthermore, insurance and reinsurance undertakings should consider this change as a significant change within the meaning of Article 312, paragraph 3, of the delegated regulation and include it in the annual report mentioned in that article, with a detailed description of the reassessment and its impact on the undertaking's solvency position. Otherwise, the assessment aimed at determining whether coverage
or a financial guarantee has a perceptible effect on the economics of the contract should not change. Insurance and reinsurance undertakings should not reassess contract boundaries for the different scenarios used to calculate the best estimate using simulation methods, nor for the crisis scenarios used to calculate the required solvency capital. NBB_2022_24 - 17 October 2022 Circular - P. 7/8

Guideline 7 - Estimation of Obligations
When insurance or reinsurance undertakings do not have access to the details of a contract or to all the obligations covered by it at the time of its recognition, they must estimate the contract boundaries using all available information in a manner consistent with the principles set out in these guidelines.
Undertakings must revise this forward-looking assessment as soon as more information is available.
Guideline 8 - Reinsurance Contracts
Insurance and reinsurance undertakings must apply the provisions of Article 18 of Regulation 2015/35 to accepted reinsurance contracts regardless of the contract boundaries of the underlying insurance or reinsurance contracts to which they relate.
A copy of this circular is sent 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
Circular - P. 8/8 NBB_2022_24 - 17 October 2022