Good practices on capital policy for insurers

| DNB UNRESTRICTED | Good practices on capital policy for insurers

1. Introduction The capital policy has a central place in an insurer's risk management. It should contribute to preventing the legal solvency requirements from frequently falling below regulatory requirements. As part of its capital policy, an insurer establishes its internal solvency standard(s). In addition, a capital policy provides guidance as to the composition of own funds and debt. This good practice provides insurers with guidance and examples for drafting an adequate capital policy. Section 2 explains the legal requirements and the place that a capital policy occupies in the broader risk management context, including the Own Risk and Solvency Assessment (ORSA) and the Preparatory Crisis Plan (PCP). Section 3 provides practical guidance and examples on how an insurer can implement the capital policy in practice. These examples apply to all insurers. Sections 4 to 6 are aimed at specific subsectors: section 4 focuses on insurers with long-term liabilities, section 5 on health insurers and section 6 on insurance groups.
2. Legal requirements 2.1 Laws and regulations Pursuant to Article 41 of the Solvency II Directive and Section 26.2 of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels Wft), insurers must have in place an effective system of governance which provides for sound and prudent management of the business.1 Insurers must also have an effective risk management system that covers the risks to be included in the calculation of the Solvency Capital Requirement. EIOPA Guidelines 36 and 37 on system of governance state that insurers should formulate a capital policy and a medium-term capital plan and list the conditions they should meet.2 2.2 Relation between PCP and ORSA The capital policy is related to the PCP and the ORSA. PCP Insurers are also required to draw up a Preparatory Crisis Plan or PCP.3 The PCP ensures that in financially sound times, an insurer defines the measures to be taken in case that its financial position seriously deteriorates. The PCP contains measures with the aim to provide insurers tools for actions to be undertaken in times of crisis. In order to have solutions available for possible crises, the plan addresses the financial, operational and legal feasibility of these solutions. A PCP describes recovery measures, the degree of deployment of the recovery measures and an indication of their financial and operational impact, while also elaborating crisis scenarios appropriate to the risk profile and triggers for the plan’s activation, such as a breach of the SCR and/or MCR. 1 For insurance groups, Article 246 of the Solvency II Directive is relevant, which in a nutshell states that the governance requirements for an insurer apply mutatis mutandis to an insurance group. 2 The EIOPA Guidelines. We apply these guidelines in our supervision. 3 See Sections 3:17(2)(c)(4) and 3:288i(3) of the Financial Supervision Act (Wet op het financieel toezicht – Wft), as well as Sections 26.5 to 26.9 of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels Wft – Bpr).

| DNB UNRESTRICTED | The insights gained from the PCP are used to determine possible internal solvency standards in the capital policy. The PCP analyses the effectiveness and feasibility of recovery measures in a crisis situation. Based on this analysis, an insurer may conclude that certain measures are effective or feasible if the SCR/MCR is breached or the liquidity position has dropped significantly. In particular, the PCP analyses the operational and legal feasibility and financial impact of recovery measures in times of crisis. In addition, an insurer ensures in the PCP that the measures can be implemented without experiencing any substantial obstacles. ORSA Based on insights gained from the PCP, the quality of scenarios included in the ORSA may be improved. The ORSA includes a forward-looking own-risk assessment to provide insight into the level of capital which the insurer requires. This level of capital ensures that the continuity of the insurer or insurance group is not at risk, given the insurer's risk profile, risk tolerances and business strategy. The basic principle is that all material risks must be quantified in a scenario analysis. An insurer appends the capital policy to the ORSA, unless it is already fully integrated in the ORSA. 2.3 Proportionality Small and medium-sized insurers are allowed to apply the proportionality principle when formulating their capital policy. The design of the capital policy is subjected to the nature, size and complexity of the risks involved. This applies in particular to Solvency II Basic-insurers . 3. Practical implementation of the capital policy 3.1. Policy to prevent solvency from falling below regulatory requirements In its capital policy, an insurer defines its own safety margins on top of regulatory solvency requirements. This reduces the likelihood of solvency frequently falling below the regulatory requirement. Due to differences in risks, complexity and size, different insurers can have different safety margins. The safety margin is based on objective and quantified measures defined by the insurer. Good practice An insurer defines one or a few 'internal target standards'. This insurer is able to substantiate this safety margin to all relevant stakeholders because it has based it on objective and quantified measures. In determining its safety margin, the insurer considered several angles, including: • its medium-term risk appetite, taking into account its business plan and prevailing market conditions; • the volatility of its solvency ratio under normal conditions and in stress situations; • any material risks present that are not adequately reflected in the solvency requirement, such as the ultimate forward rate and the appropriateness of the standard formula; • the expectations of shareholders and policyholders, rating agencies and other stakeholders, e.g. with regard to dividend distributions. This insurer also takes into account the range of measures identified in the PCP aimed at recovering and/or making adjustments in a timely manner if necessary.

| DNB UNRESTRICTED | 3.2. Policy on composition of own funds and debt The insurer’s capital policy substantiates the composition of own funds and debt instruments. Own funds Insurers must describe their policy regarding composition of own funds, both with respect to the current situation and any funds to be obtained in the future. In doing so, they take into account their business plan and the corresponding development of solvency needs as well as regulations, for example with regard to tiering. Debt instruments An insurer's capital policy sets out the degree of leverage it wishes to use (if any), as well as its purpose and duration. In addition, the insurer sets a limit for the leverage ratio. If an insurer still uses grandfathered loans, it must explain how it is winding down these loans or replacing them with fully Solvency II￾compliant debt.4 For insurers who do not apply leverage and do not intend to do so in the future it is sufficient to state that they do not apply leverage and do not intend or believe it necessary to do so in the future. Good practice An insurer has included the following information in its policy: • The instruments that could be used to create leverage, and whether these are included in the eligible own funds to cover the capital requirement. For example, the insurer describes the intra-group loans and/or facilities it uses to create leverage, as well as the restrictions and conditions that apply. • The way the leverage is determined and the corresponding range of the leverage ratio; • Leverage ratio limits. In doing so, the insurer considers its risk appetite, the desired external rating as well as other relevant factors. Withdrawals of own funds In its capital policy, the insurer describes situations in which capital withdrawals, such as dividend distributions, redemption of capital instruments, premium refunds and profit distributions, are prudent. The capital policy takes into account guidelines 36 and 37 of EIOPA's Guidelines on system of governance. The insurer describes the form, size, amount and frequency of possible capital withdrawals in its capital policy. In addition, the insurer determines the method for determining the size of the withdrawal, for example as a percentage of profits. The capital policy also describes any regulatory or other restrictions that 4 Transitional measures under SII: Article 308b(9)(b) of the SII Directive (10 years from 01/01/2016).

| DNB UNRESTRICTED | apply to withdrawals, e.g. due to agreements with supervisory authorities or requirements attached to a declaration of no-objection. Good practice An insurer's capital policy sets out the indicators and solvency levels it uses to assess whether a capital withdrawal is prudent. The insurer considers the solvency ratio following withdrawal and analyses how this ratio compares with the insurer's internal target standards and the levels at which capital-strengthening measures are needed. The insurer also takes into account the short-term and long-term expectations it has created among any beneficiaries receiving the withdrawals, such as shareholders, members, etc. Its dividend planning takes into account the insurer's overall (medium-term) strategy, as well as any relevant current events (such as inflation and the ongoing Solvency II review). 3.3. Governance An insurer's capital policy describes the governance applicable to their capital policy, addressing the decision-making process for capital withdrawals. Good practice An insurer’s highest management body approves the capital policy. Its highest supervisory body adopts the capital policy. When adopting the capital policy, the insurer also receives approval from the Annual General Meeting of Shareholders. 3.4. Capital policy review Capital policy is part of the insurer's governance system. Insurers must periodically evaluate their governance system, including their capital policy, and adjust it where necessary. Good practice An insurer reconsiders or reassess its capital policy at least once a year, or earlier if required, for instance if there is an acquisition, change in strategy or change in risk policy. 4. Insurers with long-term liabilities An insurer with long-term liabilities (with maturities of 20 years or more) takes the impact of the economic reality explicitly into account in its capital policy, addressing at least the impact of extrapolation of the yield curve and long-term guarantee (LTG) measures, the development thereof and their consequences on the solvency position. Specifically, an insurer takes this into account when justifying its internal safety margin and dividend policy. Good practice

| DNB UNRESTRICTED | An insurer's capital policy explicitly addresses the sensitivity of the solvency ratio to the extrapolation of the yield curve and LTG measures. In the section on capital management of their Regulatory Supervisory Report (RSR), the insurer includes a detailed description of the difference between their economic solvency position , the extrapolation of the interest rate term structure and any LTG measures, and their solvency position in accordance with the Solvency II framework. 5. Health insurers Health insurers integrate their premium policy in the capital policy. This makes clear how the available capital may be used in setting future premiums. As the level of the capital buffers can in some cases materially impact health insurers' premiums levels, the choice for a particular internal target involves more than just a risk assessment for health insurers. An insurer - given the mandatory nature of basic health insurance - can therefore properly substantiate the level of the safety margin. Good practice In its capital policy, a health insurer describes not only the minimum level of the chosen safety margin, but also the maximum level it considers acceptable. Based on its social role, the health insurer substantiates the maximum level of the safety margin and use of capital when setting premiums. 6. Insurance groups The capital policies of different insurers that are part of a group and the policy of the group as a whole are mutually consistent. Insurance groups substantiate the safety margin at group level, taking into account the safety margins of all entities belonging to the group. The group maintains a sufficient margin of safety for all entities belonging to the group. Good practice An insurance group takes into account the specific risk profiles of the entities and the degree of capital transferability within the group when determining its capital level and safety margin and when considering where capital is held within the group. The diversification benefit that occurs when calculating solvency ratios is also appropriately included in the determination of safety margins. In addition, determining the safety margin at the level of an entity involves determining an appropriate supplementary safety margin at the level of the group.