Compilation of Insurance and Reinsurance Regulations – Capital Requirement for Market and Counterparty Risk

Montevideo, December 30, 2024 Ref: COMPILATION OF INSURANCE AND REINSURANCE REGULATIONS – CAPITAL REQUIREMENT FOR MARKET AND COUNTERPARTY RISK.

The market is hereby informed that, on December 26, 2024, the Superintendency of Financial Services adopted the following resolution:

1. REPLACE in Title I Bis – Minimum Capital, of Book II – Stability and Solvency of the Compilation of Insurance and Reinsurance Regulations, Articles 19, 20 and 21 with the following:

ARTICLE 19 (MINIMUM CAPITAL). The minimum capital for insurance companies shall be the equivalent of the greater value resulting from the comparison between the basic capital requirement and the risk-based capital requirement.

For those companies whose net retained earned premiums at the close of the previous fiscal year are less than the equivalent of UI 180,000,000 (one hundred eighty million indexed units), quoted at the value on the date of said close, only the basic capital requirement shall apply.

ARTICLE 20 (BASIC CAPITAL REQUIREMENT).

1. Group I The basic capital shall be the equivalent in national currency of UI 10,000,000 (ten million indexed units). Insurance companies operating in the surety branch shall be required to have capital of UI 12,000,000 (twelve million indexed units). This additional requirement does not include companies operating exclusively in the rental guarantee sub-branch.

Additionally, companies operating in more than one branch shall be required to have capital of UI 1,700,000 (one million seven hundred thousand indexed units) for each additional branch up to a total of seven branches.

Operating insurance companies that begin to operate in the surety branch must complete the basic capital required for that branch and contribute the capital per branch stipulated in the preceding paragraph. The additional capital per branch will not be required when seven branches have been completed.

2. Group II The basic capital shall be an amount equivalent to the basic capital for one branch, determined in the preceding numeral.

Insurance companies wishing to underwrite collective disability and death insurance contracts and pension annuities for the payment of benefits under the mandatory individual savings regime (Articles 56, 57 and 59 of Law No. 16,713 of September 3, 1995, and amendments) must accredit additional basic capital equivalent in national currency to UI 6,400,000 (six million four hundred thousand indexed units).

The basic capital requirement to operate jointly in the insurance activities of Groups I and II shall be the sum of their basic capitals determined as established above.

The national currency equivalents of the aforementioned amounts in indexed units shall be updated at the end of each calendar quarter.

ARTICLE 21 (RISK-BASED CAPITAL REQUIREMENT). Risk-based capital must be sufficient to face unexpected losses in companies that may arise from the materialization of the main risks to which they are exposed. These risks are:

• Market risk
• Counterparty risk
• Technical insurance risks
• Operational risk

2. INCORPORATE in Title I Bis – Minimum Capital, of Book II – Stability and Solvency of the Compilation of Insurance and Reinsurance Regulations the following articles:

ARTICLE 21.1 (MARKET RISK CAPITAL REQUIREMENT). Market risk is defined as the possibility that companies suffer losses due to adverse movements in market variables such as stock prices, interest rates, exchange rates, readjustment, spread, and real estate values.

The market risk capital requirement (RCRM) shall be determined by the aggregation of the following requirements, recognizing diversification benefits, according to the following formula:

RCRM = sqrt(sum_{i=1 to n} sum_{j=1 to n} (rho_ij * RC_i * RC_j))

Where,

• RCRM = capital requirement for market risk
• (RC_i, RC_j) = correspond to the ordered pairs of capital requirements associated with the different market risks:

Being,

• RC_acciones = capital requirement for equity risk
• RC_tasa_interes = capital requirement for interest rate risk
• RC_tipo_cambio = capital requirement for exchange rate risk
• RC_reajuste = capital requirement for readjustment risk
• RC_spread = capital requirement for spread risk
• RC_bienes_inmuebles = capital requirement for real estate risk

For the application of the above formula, the following correlation matrix must be considered:

Risk	Interest Rate Risk	Equity Risk	Spread Risk	Exchange Rate Risk	Readjustment Risk	Real Estate Risk
Interest Rate Risk	1
Equity Risk	0	1
Spread Risk	0.25	0.25	1
Exchange Rate Risk	0.25			1
Readjustment Risk	0.25				1
Real Estate Risk	0.5	0.75	0.25			1

Insurance companies may apply the “look-through” approach, which implies that for the purposes of calculating market risk requirements, indirect exposures (such as investment fund units or participations in financial trusts) are considered as if they were direct exposures. To do this, they must submit the details of these instruments according to the instructions that will be issued.

If the aforementioned approach is not applied, investments will be subject to the requirement set forth in Article 21.3 for equity risk.

ARTICLE 21.2 (INTEREST RATE RISK CAPITAL REQUIREMENT). Interest rate risk is defined as the possibility that the insurance company experiences losses as a consequence of movements in interest rates.

For the purpose of determining the capital requirement, changes in the net value of asset flows minus liabilities denominated in each currency will be considered in two predefined risk scenarios, which represent a risk of increase or decrease in risk-free interest rates above the base level.

Assets must be valued at market value and will be grouped into assets and liabilities in pesos, indexed units (UI), readjustable units (UR), nominal pesos readjusted by the Average Nominal Wage Index, provisional units (UP) and US dollars, which will be assigned to time bands according to the instructions that will be issued.

The rates to be applied will be obtained according to the following formula:

t_i,t^shock = t_i,t^base + shock_i,t

Where,

• t_i,t^shock = adjusted upward or downward risk-free interest rate, corresponding to currency-i and term-t.
• t_i,t^base = risk-free interest rate corresponding to currency-i and term-t.
• shock_i,t = shock applicable to the interest rate of the base risk-free curve corresponding to currency-i and term-t.

The upward and downward interest rate shock, as well as the risk-free rates, will be communicated in the instructions that will be issued.

In this sense, the capital requirement for interest rate risk for each currency or unit of account will be given, according to the following formula:

RC_tasa_interes = sum_{i} RC_tasa_interes,i

Where,

• RC_tasa_interes = capital requirement for interest rate risk
• RC_tasa_interes,i = Change in the net value of asset flows minus liabilities associated with an increase/decrease in risk-free interest rates corresponding to currency-i.

Specifically,

RC_tasa_interes,i = max(Delta_up,i, Delta_down,i)

Where,

• Delta_up,i = V_i^base - V_i^up = capital requirement associated with an increase in risk-free interest rates, for currency i
• Delta_down,i = V_i^base - V_i^down = capital requirement associated with a decrease in risk-free interest rates, for currency i
• V_i^base = net value of asset flows minus liabilities using the risk-free curve corresponding to currency-i
• V_i^up = net value of asset flows minus liabilities using the upward-adjusted risk-free curve corresponding to currency-i.
• V_i^down = net value of asset flows minus liabilities using the downward-adjusted risk-free curve corresponding to currency-i.

Finally, the capital requirements in pesos, indexed units (UI), US dollars (USD), and the aggregation of readjustable units (UR), nominal pesos adjusted by IMSN and provisional units (UP) must be added:

RC_tasa_interes = RC_tasa_interes,UYU + RC_tasa_interes,UI + RC_tasa_interes,USD + RC_tasa_interes,UR_IMSN_UP

ARTICLE 21.3 (EQUITY RISK CAPITAL REQUIREMENT). Equity risk is defined as the possibility that an insurance company experiences losses as a consequence of changes in the level or volatility of market prices of equity instruments.

The capital requirement for equity risk shall be determined as follows:

RC_acciones = sum_{i} (VM_i * factor_i)

Where,

• RC_acciones = capital requirement for equity risk
• VM_i = market value of instrument-i
• factor_i = capital requirement factor, according to the instructions that will be issued

ARTICLE 21.4 (EXCHANGE RATE RISK CAPITAL REQUIREMENT). Exchange rate risk is defined as the potential loss that an insurance company may experience as a consequence of variations in exchange rates between currencies.

The capital requirement for exchange rate risk shall be determined as follows:

RC_tipo_cambio = sum_{i} (PN_i * factor_i)

Where,

• RC_tipo_cambio = capital requirement for exchange rate risk
• PN_i = net position in currency-i. Corresponds to the absolute value of the difference between assets and liabilities in foreign currency net of positions in derivatives or other currency risk hedging instruments
• factor_i = capital requirement factor, according to the instructions that will be issued

ARTICLE 21.5 (READJUSTMENT RISK CAPITAL REQUIREMENT). Readjustment risk is defined as the risk that losses are generated by movements in the value of national currency units of account.

The capital requirement for readjustment risk shall be determined as follows:

RC_reajuste = min(0, (sum(Activos_UR_UP_IMSN) - sum(Pasivos_UR_UP_IMSN))) * factor

Where,

• RC_reajuste = capital requirement for readjustment risk
• min(0, (sum(Activos_UR_UP_IMSN) - sum(Pasivos_UR_UP_IMSN))) = minimum between 0 and the difference between the sum of assets in readjustable units (UR), provisional units (UP) and nominal pesos adjusted by the Average Nominal Wage Index, and the sum of liabilities in the aforementioned units of account
• factor = capital requirement factor, according to the instructions that will be issued

ARTICLE 21.6 (SPREAD RISK CAPITAL REQUIREMENT). Spread risk refers to the impact on the value of fixed income instruments originating from changes in their credit rating.

Exposures in instruments issued by the Uruguayan government or the Central Bank of Uruguay, regardless of the currency in which they are denominated, should not be included in the calculation.

The capital requirement for spread risk shall be determined as follows:

RC_spread = sum_{i} (VM_i * DM_i * factor_i)

Where,

• VM_i = market value of instrument-i
• DM_i = modified duration of instrument-i
• factor_i = capital requirement factor of value-i, assuming a fall in current credit ratings from the level set in the instructions to be issued.

For the purpose of determining the capital requirement, insurers' assets must be valued at market value and the probabilities of default implicit in the credit ratings set forth in the aforementioned instructions will be used.

The capital requirement factor will be calculated by deducting the probability of default corresponding to the current rating from the probability of default after the fall in the credit rating.

ARTICLE 21.7 (REAL ESTATE RISK CAPITAL REQUIREMENT). Real estate risk is defined as the possibility of experiencing losses as a consequence of a fall in the value of the real estate held. For the purpose of calculating the real estate risk capital requirement, the following must be included:

1. the real estate where the company is located;
2. land, buildings and rights over real estate that have not been designated as the company's location.

The capital requirement for real estate risk shall be determined as follows:

RC_inmuebles = sum_{i} (Valor_inmueble_i * factor_i)

Where,

• RC_inmuebles = capital requirement for real estate risk
• Valor_inmueble_i = value of real estate-i
• factor_i = capital requirement factor, according to the instructions that will be issued

Real estate will be valued as provided in Article 38.

ARTICLE 21.8 (COUNTERPARTY RISK CAPITAL REQUIREMENT). Counterparty risk is defined as the possibility that companies suffer losses due to the inability of counterparties to comply with the originally agreed terms.

It includes exposures to financial instruments – except those considered in the spread risk requirement and those issued by the Uruguayan government or the Central Bank of Uruguay, regardless of the currency in which they are denominated – and to accounts receivable from policyholders, other insurance companies, reinsurers and insurance intermediaries.

For the determination of the capital required for exposures with and without credit rating, the following formula must be considered:

RC_contraparte = RC_contraparte_con_calificacion + RC_contraparte_sin_calificacion

Where,

• RC_contraparte = capital requirement for counterparty risk
• RC_contraparte_con_calificacion = capital requirement for exposures with counterparties with credit rating
• RC_contraparte_sin_calificacion = capital requirement for exposures with counterparties without credit rating

1. Exposures with counterparties with credit rating. For financial instruments and assets with counterparties with credit rating, the requirement shall be determined as follows:

RC_contraparte_con_calificacion = sum_{i} (Exposicion_i * factor_i)

Where,

• RC_contraparte_con_calificacion = capital requirement for counterparty risk in counterparties with credit rating
• Exposicion_i = exposure to counterparty-i valued as provided in Article 38, except in the case of assets with reinsurers, in which case the exposure will be the sum of reserves held by the reinsurer and the current account balance.
• factor_i = capital requirement factor given the implicit probability of default in the current credit rating of asset-i, determined according to the instructions that will be issued.

2. Exposures with counterparties without credit rating The counterparty risk associated with accounts receivable from policyholders and intermediaries without credit rating shall be determined as follows:

RC_contraparte_sin_calificacion = sum_{i=1 to 2} (Exposicion_i * factor_i)

Where,

• RC_contraparte_sin_calificacion = capital requirement for counterparty risk in counterparties without credit rating
• Exposicion_i = exposure to counterparty-i
  • i=1, corresponds to accounts receivable from intermediaries and policyholders with arrears greater than 60 days, net of provisions.
  • i=2, corresponds to the rest of the exposures with arrears greater than 60 days, net of provisions.
• factor_i = capital requirement factor of counterparty-i, determined according to the instructions that will be issued with:
  • i=1 for accounts receivable from intermediaries and policyholders with arrears greater than 60 days, net of provisions.
  • i=2 for the rest of the exposures with arrears greater than 60 days, net of provisions

For the determination of counterparty risk associated with local insurance companies, the factors that depend on the solvency margin of the counterparty insurance company at the end of the previous year will be used, according to the instructions that will be issued.

For the determination of the risk of the remaining counterparties, rating C must be used.

3. EFFECTIVE DATE: The provisions in paragraphs 1) and 2) above shall take effect on January 1, 2028.

CHRISTIAN SALVARREY Manager of Strategic and Operational Management 2024-50-1-02366