- Solvency II Law: Articles 190 to 193 (investments - ‘prudent person’ principle), 37, 74, 140 to 189 (own funds and capital requirements) and 123 et seq. (valuation rules)
- Delegated Regulation 2015/35: Articles 262 (overall solvency needs) and 267 (valuation of assets and liabilities)
- Underlying thematic NBB Circular: /
- EIOPA Guidelines: Guidelines 27 to 37 and 52 to 59
6.1. Investment - The ‘prudent person’ principle
The Solvency II Directive and Delegated Regulation 2015/35, as well as Chapter 3 of this Circular explain in detail certain aspects of the ‘prudent person’ principle, such as asset-liability management, investments in derivatives, liquidity risk and concentration risk management. Below, it is primarily the other aspects of the ‘prudent person’ principle that are explained.
6.1.1. Investment risk management
The insurance company shall not depend solely on information from third parties, such as financial institutions, portfolio managers and rating agencies. In particular, the company shall develop its own range of key risk indicators adapted to its policy on investment risk management and its business strategy.
When the company makes investment decisions, it shall take into account the investment-related risks and shall not rely solely on the capital requirements taking sufficient account of the risks, so that they can be appropriately managed.
6.1.2. Assessment of non-routine investment activities
Before carrying out an investment or investment activity of a non-routine nature, the company must assess at least the following:
- its capacity to make the investment or carry out and manage the investment activity;
- the risks specifically related to the investment or investment activity and the effect of the investment or investment activity on the company’s risk profile;
- the alignment of the investment or investment activity with the interests of beneficiaries and policy-holders, including the restrictions set by the company as regards the commitments that may be taken on, and efficient portfolio management;
- the effect of that investment or investment activity on the quality, security, liquidity, return and availability of the portfolio as a whole.
When the investment or investment activity entails a significant risk or leads to a substantial change to the risk profile, the company shall have procedures requiring the company’s risk management function to inform the statutory governing body and management committee of that risk or change in the risk profile.
6.1.3. Investment portfolio security, quality, liquidity, and returns
The company shall regularly assess and regularly supervise the security, quality, liquidity and returns of the portfolio as a whole by at least looking into:
- any restrictions arising from commitments, including from policy-holder guarantees, and any published policies for future discretionary pay-outs and, where applicable, the reasonable expectations of policy-holders;
- the level and nature of risks that the company is prepared to assume;
- the level of diversity of the portfolio as a whole;
- the characteristics of the assets, such as the credit rating of counterparties, the liquidity, the question of whether assets are tangible or intangible, the durability, existence and quality of guarantees or other assets or that cover the assets, gearing or encumbrances;
- events which could change the characteristics of investments, including any guarantees, or which could influence the value of the assets;
- circumstances relating to the location and availability of the assets such as: non-portability; legal problems in other countries; monetary measures; custodian risk; extra collateral and lending.
The company shall set objectives for returns it wishes to gain on its investments, taking into account the need to obtain durable revenue on the asset portfolios to comply with the reasonable expectations of policy-holders.
6.1.5. Conflicts of interest
In its investment policy, the company shall describe how it identifies and handles any potential conflicts of interest in relation to investments, irrespective of whether these conflicts arise within the company or within the entity that manages the asset portfolio. It shall also document the measures taken to manage such conflicts.
6.1.6. Unit-linked insurance and index-linked policies
The company shall ensure that its investments under its unit-linked insurance and index-linked policies are selected in the interest of policy-holders and beneficiaries, taking into account all published policy objectives.
In case of unit-linked insurance activity, the company shall take into account and manage the limitations that unit-linked insurance entails, especially liquidity constraints.
6.1.7. Assets not admitted to trading on a regulated market
For investments that are not admitted to trading on a regulated market, and for complex products that are difficult to mark to market, the company shall implement procedures and manage, supervise and audit these procedures.
Assets admitted to trading on a regulated market but which are not traded or are not traded in the usual way shall be handled by the company in the same way as assets not admitted to trading on a regulated market.
If the company uses derivatives, it shall lay down procedures in line with its policy on investment risk management to exercise supervision on the results of these derivatives.
If the company uses derivatives to promote effective portfolio management, it shall provide evidence of how it improves the quality, security, liquidity or return on the portfolio without this having a significant negative impact on these aspects.
If derivatives are used to reduce the risks or if they are used as a risk-mitigation technique, the company shall document the reasons for the use of derivatives and provides evidence that there is actually an effective risk transfer.
6.1.9. Securitised instruments
If the company invests in securitised instruments, it shall have a good overview of its own interests and the interests of the initiator or sponsor as regards those securitised instruments and shall guarantee that those interests are adequately in line with each other.
6.1.10. Sustainability risks
In implementing the prudent person principle, the Bank also recommends that the company ensure that sustainability risks are taken into account when assessing the security, quality, liquidity and profitability of its portfolio.
 Cf. the definition mentioned above.
6.2. Capital management
The formal aspects of capital management and own funds requirements are covered below.
6.2.1. Capital management policy
The company shall develop a capital management policy that includes a description of the procedures to:
- ensure that own funds items are classified using the aspects listed in Articles 71, 73, 75 and 77 of Delegated Regulation 2015/35, both at the time of pay-out and afterwards;
- supervise separately for each tier the pay-out of own funds items in accordance with the medium-term capital management plan, and supervise before any pay-out of own funds items that the criteria can continuously be met for the right tier.
- ensure that own funds items are not encumbered by any existing agreements or connected transactions or as a result of a group structure, which would undermine their effectiveness as capital;
- guarantee that the measures required or allowed pursuant to contractual, legal or regulatory provisions that apply to an own funds item are initiated and completed on time;
- guarantee that where necessary, supplementary own funds items can be called up on time and that where applicable, they can also effectively be called up;
- identify and document regulations, legal texts or products that lead to segregated funds, and to ensure that appropriate calculations and adjustments are made when establishing the solvency capital requirement and own funds;
- guarantee that the contractual terms and conditions for own funds items are clear and unequivocal as regards the criteria for classification into tiers;
- guarantee that sufficient account is taken with any policy or statement on regular dividends with a view to investigating the capital position and assessing the expected dividends;
- establish and document the cases in which pay-outs based on tier-1 own funds items could be cancelled on a discretionary basis;
- establish, document and enforce the cases in which pay-outs based on an own funds item must be deferred or cancelled in accordance with Article 71(1)(l), and Article 73(1)(g) of Delegated Regulation 2015/35;
- establish the extent to which the company relies on own funds items that fall under transitional measures;
- ensure that the way in which items that belong to the own funds under transitional measures behave during a stress situation and especially the way in which the items compensate for losses, is assessed and where necessary is taken into account in the own risk and solvency assessment.
6.2.2. Medium-term capital management plan
The company shall draw up a medium-term capital management plan, which is supervised by the board of directors and the management committee, taking into account at least the following aspects:
- all planned issues of capital;
- the maturity date of the own funds items, taking into account both the contractual maturity date and any possibilities for early repayment or redemption;
- the result of the projections in the ORSA;
- the way in which an issue, redemption or repayment or any other variation in the valuation of an own funds item influences the application of limitations on tiers;
- the application of the pay-out policy and the effect thereof on the own funds;
- the impact at the end of the transitional period.
6.3. Valuation of assets and liabilities other than technical provisions
The governance aspects relating to the valuation of assets and liabilities are covered below.
6.3.1. Valuation of assets and liabilities other than technical provisions
In its risk policy and procedures for the valuation of assets and liabilities, the insurance company shall at least include the following:
- the method and criteria that must be used for assessing active and inactive markets;
- the requirements to guarantee adequate documentation of the valuation process and of the associated means of control, including those of data quality;
- the requirements relating to the documentation of the valuation approaches used as regards:
- their set-up and the way in which they are implemented;
- the soundness of data, parameters and assumptions;
- the process for independent review and verification of the valuation approaches;
- the requirements for periodic reporting to the board of directors and management committee on matters important for governance in the area of valuation.
6.3.2. Data quality control procedures
The company shall introduce procedures for data quality control to identify deficiencies and to measure, monitor, manage and document the data quality. These procedures shall include the following:
- the completeness of data;
- the adequacy of data, both from internal and external sources;
- independent review and verification of data quality.
The policy and procedures introduced by the company are focused on the need to periodically test market data and inputs against alternative sources and experience.
6.3.3. Documentation when using alternative valuation methods
When alternative valuation methods are used, the company shall document the following:
- a description of the method, objective, main assumptions, limitations and output;
- the circumstances under which the method is not effective;
- a description and analysis of the valuation process, and the means of control coupled with that method;
- an analysis of the valuation uncertainties that the method entails;
- a description of the procedures to test results after the fact and, where possible, a comparison with similar models or other benchmarks, which is carried out when the valuation method is introduced and periodically thereafter;
- a description of the instruments or programmes used.
6.3.4. Independent review and verification of valuation methods
The company shall ensure that an independent review takes place, in accordance with Article 267(4)(b) of Commission Delegated Regulation 2015/35, before the introduction of a new method or an important change, and thereafter at set times.
The company shall establish the frequency of the evaluation in accordance with the importance of the method for the decision-making and risk-management processes.
The company shall apply the same principles to the independent review and verification of both internally developed valuation methods or models, as for valuation methods or models provided by third parties.
The company shall have processes for reporting the results of the independent evaluation and verification as well as the recommendations for corrective measures to the right level of management of the company.
6.3.5. Supervision by the board of directors and the management committee
The members of the management committee and the board of directors should be able to prove that they have enough of an overall insight into the valuation approaches and the uncertainties inherent to the valuation process to be able to duly oversee the risk management process as regards valuation.
6.3.6. Request by the Bank to the company to carry out an independent valuation or verification
The company must be prepared to react promptly to any requests by the Bank to conduct an independent valuation or verification if there is a risk of an incorrect representation in the valuation of asset or liabilities of material importance with potential material consequences for the company’s solvency.
6.3.7. Independence of the external expert
The company should be able to demonstrate to the Bank that the external valuation or verification is carried out by independent experts with the relevant professional skills, appropriate diligence and relevant experience.
6.3.8. Information to be provided to the Bank on the external valuation or verification
The company shall provide the Bank with all relevant information on the external valuation or verification on request. In all cases, the company shall describe the written advice of the experts regarding the valuation of the asset or liability concerned.