Insurance Solvency Standards: guarantees and off-balance sheet exposures

Transcription

1 Consultation Paper: Insurance Solvency Standards: guarantees and off-balance sheet exposures The Reserve Bank invites submissions on this Consultation Paper by 9 August Submissions and enquiries about this consultation should be addressed to: Felicity Barker Adviser Prudential Supervision Department Reserve Bank of New Zealand PO Box 2498 Wellington felicity.barker@rbnz.govt.nz Please note that a summary of submissions may be published. If you think any part of your submission should properly be withheld on the grounds of commercial sensitivity or for any other reason, you should indicate this clearly. June 2013

2 2 Insurance Solvency Standards: Guarantees and off balance sheet exposures Introduction 1. The Reserve Bank is the regulator and supervisor of all insurers carrying on insurance business in New Zealand under the Insurance (Prudential Supervision) Act 2010 (the Act ). The Reserve Bank regulates and supervises to: a. promote the maintenance of a sound and efficient insurance sector; and b. promote public confidence in the insurance sector. 2. Under section 55 of the Act the Reserve Bank may issue solvency standards. These standards may prescribe the methods for determining or calculating the amount of capital that an insurer must maintain (section 56). 3. In light of information obtained through the insurer licensing process, the Reserve Bank has reviewed, and is consulting on, two aspects of the Reserve Bank s Solvency Standards. The first part of this paper proposes changes to the requirements for recognition of third party guarantees of an insurer s assets. The second part of the paper proposes changes to the requirements for off balance sheet exposures. The appendices contain the proposed amended text to be included in the Solvency Standards. 4. The Reserve Bank invites submissions on the proposals by 9 August Guarantees 5. Under the Reserve Bank s Solvency Standards, insurers are required to calculate an Asset Risk Capital Charge. This charge reflects the exposure of the insurer to losses on assets. The charge is intended to reflect both credit risk and asset concentration risk. In calculating the Asset Risk Capital Charge an insurer may take into account the credit risk mitigating effects of guarantees of its assets given by third parties. The same provision is provided in all the Solvency Standards applicable to insurers. 1 This provision provides that: Assets that have been explicitly, unconditionally and irrevocably guaranteed for their remaining term to maturity by a guarantor with a counterparty rating (or for governments, the long-term foreign currency credit rating) in Grades 1, 2 or 3 may be assigned the Asset Risk Capital Factor that would be applicable to the guarantor. Guarantees provided to a licensed insurer by its own parent entity or by any related party are not eligible for this treatment. 6. Guarantees of assets provide an important form of risk mitigation. A guarantee creates a secondary obligation to pay in relation to the asset in the instance that the principal counterparty defaults. For this reason the Solvency Standards allow the insurer to look through to the guarantor in determining the Asset Risk Capital Factor. In this paper this method is termed the substitution approach. The Reserve Bank 1 For example paragraph 77 of the Life Standard and paragraph 82 of the Non-Life Standard.

3 3 continues to support the use of the substitution approach for the treatment of guarantees in the Solvency Standards. 7. However, the extent to which a guarantee mitigates risk will depend upon the terms of the contract. There are a number of provisions that may be included in a contract of guarantee that may limit the risk mitigation effect of a particular guarantee. The current Solvency Standards require that a guarantee be explicit, unconditional and irrevocable in order for the substitution approach to be used in determining Minimum Solvency Capital. Further, the Solvency Standards require that the guarantor be of a certain quality. The Reserve Bank continues to hold the view that these are important requirements to include in the Solvency Standards. 8. Currently, the Solvency Standards require that, for the substitution approach to be used, assets must be guaranteed for their remaining term to maturity. The Reserve Bank has reconsidered this requirement and proposes changes that would allow partial recognition of guarantees of shorter duration than the underlying asset (paragraphs 12-19). 9. The Reserve Bank also proposes to set a limit on the extent to which the Asset Risk Capital Charge may be reduced by way of guarantee (paragraphs 20-21). 10. As well as the two issues we raise above, the Reserve Bank also intends to take this opportunity to provide clarification of the application of the Solvency Standards in relation to guarantees, including the expectations as to legal certainty in relation to guarantees and the treatment of guarantees in the Asset Concentration Risk Charge, the Interest Rate Risk Charge and the Foreign Currency Risk Capital Charge. 11. Below we discuss our detailed proposals. Limited term guarantees 12. Under the current Solvency Standards, guarantees of a shorter term than the underlying asset receive no recognition. However, the Reserve Bank considers that guarantees of a shorter term than the underlying asset still provide some benefit in terms of risk mitigation, and thus it is appropriate that they receive some recognition in the Solvency Standards. However, the level of recognition they receive should take account of the duration of the guarantee relative to the underlying asset, as this better reflects the level of risk mitigation over the life of the underlying asset. 13. The Reserve Bank considers that an approach to the treatment of limited term guarantees similar to that taken in the Banking Capital Adequacy Framework (Standardised Approach) would be appropriate in the Insurance Solvency Standards. Under this approach: a. guarantees of the same or longer duration than the underlying asset receive full recognition; b. guarantees of shorter duration than the underlying asset are recognised subject to a haircut being applied when the term of the guarantee is less than 5 years; c. guarantees of shorter duration than the underlying asset with residual maturity of less than a year receive no recognition. 14. The haircut (b above) is calculated using the following formula, which reduces the amount of the guarantee that may be recognised based on the relative term of the guarantee and the underlying asset:

4 4 min(t,residual maturity guarantee) Guarantee value= guarantee amount * min(5,residual maturity asset) Where T is the value of the denominator, and maturity is expressed as years (or part thereof). 15. To consider the effect of the application of this formula Table 1 shows the amount of the guarantee that may be recognised (for the purposes of the Asset Risk Capital Charge) for an asset held by an insurer of maturity 10 years, where the term of the guarantee is 5 (column 2), 4 (column 3) or 3 (column 4) years. The part of the loan not covered by the guaranteed value will continue to receive the capital factor of the principal counterparty. 2 Year since guarantee issued Table 1 portion of guarantee recognised Proportion recognised (5 year guarantee) Proportion recognised (4 year guarantee) Proportion recognised (3 years guarantee) 16. Under this proposed approach the residual maturity of the underlying asset and guarantee need to be defined. For the guarantee, the maturity date will be defined to include the maturity date, any other date on which the guarantor may terminate the guarantee or any date on which the beneficiary of the guarantee may terminate the guarantee and has an incentive to do so, such as a step-up in the cost of the guarantee. 17. For the underlying asset, the residual maturity will be defined as the longest possible remaining time before the counterparty is scheduled to fulfil its obligations (irrespective of calls). For assets payable on demand that have no contractual maturity date, the residual maturity shall be set at 5 years for the purposes of the above formula (i.e. any guarantee of shorter maturity than 5 years will receive a haircut). This is because the Reserve Bank considers that limited term guarantees of demand loans give rise to some residual risk. If the guarantee expires the insurer may be left with unguaranteed assets resulting in a sudden adverse change of an insurer s solvency position. 18. Where there is a single guarantee, limited in amount, which applies to several separate underlying assets that have different terms, the guarantee must be allocated to the assets with the longest residual maturity first (for example if there is a 2 year guarantee that applies to two debentures, one of term 4 years and one of term 2 years the guarantee must be allocated to the 4 year obligation first). This is to minimise the extent to which default on one exposure affects the capital factor applying to the other. 19. It is proposed that guarantees of shorter duration than the underlying asset with a residual maturity of less than a year would receive no recognition. However, the Reserve Bank considers that an exception is justified to this rule in the case of guarantees with an automatic right of renewal. Non-recognition of these guarantees in the last year of the guarantee could lead to a lumpy capital profile. For this 2 Note there is a slight variation from the formula applied in the Banking Standards in that there is no.25 deduction applied to the numerator and denominator.

5 5 reason the Reserve Bank proposes that automatically renewable guarantees be recognised when the residual maturity is less than 1 year (provided that the insurer has no reason to believe the guarantee will not be renewed). However, we propose that in calculating the portion of the guarantee that can be recognised in accordance with the formula above, the residual maturity of the guarantee must be fixed at 6 months for the entire year prior to the assumed automatic renewal, irrespective of the actual number of months to renewal. For example, this means that a 1 year automatically renewing guarantee of a 2 year loan would receive 25% recognition. Limit on capital mitigation 20. Under the current Solvency Standards there is no limit on the amount of capital mitigation that may be obtained by way of guarantee. The Reserve Bank is aware that the use of guarantees by some insurers has resulted in very large reductions in the Asset Risk Capital Charge that would have applied if the insurer had the same underlying assets but no guarantee. The Reserve Bank considers that all guarantees can give rise to risks, such as legal risk arising from improper contract formation or the risk of a sudden change in Minimum Solvency Capital requirements as a result of non-renewal. 21. For this reason, the Reserve Bank proposes that there be a limit of 15% on the amount that the Asset Risk Capital Charge can be reduced through the use of guarantees. The specification of this limit would be as follows. For the Non-Life Standard, if for the insurer the calculation of the Asset Risk Capital Charge would be such that the sum of the product of the asset values in each Asset Class and the Asset Risk Capital Factor that would be applicable to the principal counterparty would be x, then the substitution of the guarantor for the principal counterparty in determining Asset Risk Capital Factors will not be able to reduce the sum of the product below.85x. For the Life Standard the requirement will apply to the Credit, Equity and Property Risk Capital Charge. Other guarantee issues 22. A guarantee will only be effective in mitigating risk if the guarantee is legally binding. The Reserve Bank considers that the provision of some further requirements in the Solvency Standards as to the requirements for legal certainty would be useful. 23. The Solvency Standards require that a Foreign Currency Risk Charge of 22% be applied to the net open foreign exchange position in each currency other than NZD. The Reserve Bank considers that in the case where an asset is guaranteed the following should apply. Where the underlying asset is denominated in a foreign currency, the underlying asset must be included in the calculation of the net open foreign exchange position rather than the guarantee. Where the asset is denominated in NZD but the guarantee is expressed to be limited to a foreign currency value, the guarantee must be included in the calculation of the net open foreign exchange position if the guarantor has been substituted for the principal counterparty in calculating the Asset Risk Capital Factor. 24. The intended application of the Asset Concentration Risk Charge is that where the guarantor replaces the principal counterparty in determining capital factors, the relevant counterparty for the purposes of the Asset Concentration Risk Charge is the guarantor. The Reserve Bank considers that this should be explicitly stated in the Standards. Further, in relation to the interest rate risk charge, some insurers have questioned the application to guaranteed assets. The Reserve Bank considers that where the insurer retains interest rate risk in relation to a fixed-interest bearing asset,

6 6 that asset must be included in the calculation of interest rate risk despite the existence of a guarantee on that asset. As such, the Reserve Bank intends to provide clarification along these lines. 25. The proposed wording for guarantees is provided in Appendix 1 and for the Asset Concentration, Foreign Currency and Interest Rate Risk Capital Charge Appendix 3. Transition rules for guarantees 26. The Reserve Bank is aware that these proposals relating to guarantees would increase the Minimum Solvency Capital required for some entities. For this reason the Reserve Bank proposes that a two year transition period apply to guarantees. In particular the Asset Capital Factor applicable to the guarantor may continue to be used in relation to a guarantee that was in existence at the time of publication of this consultation document, and qualifies for recognition under the rules in existence prior to the publication of this document (and the guarantee will not count towards the 15% limit or be required to be haircut), until the earlier of: a. the maturity of the guarantee; or b. two years following the passage of the new Solvency Standard on guarantees. Off-balance sheet exposures 27. Contingent liabilities are currently required to be included in the calculation of the Asset Risk Capital Charge. The current Solvency Standards require that a licensed insurer allows for the amount of any off balance sheet exposures that represent contingent liabilities as if they were assets when calculating its Asset Risk Capital Charge. Essentially this requires that an insurer hold capital against a contingent obligation using the Asset Risk Capital Factor applicable to the underlying risk inherent in a comparable asset (or where there is no comparable asset use an Asset Risk Capital Factor of 20%). 28. The Reserve Bank has reviewed the approach to off balance sheet exposures and considers that the current approach is broadly appropriate and is delivering appropriate Minimum Solvency Capital requirements. However, the Reserve Bank has encountered a few instances of insurers having difficulty in interpreting the Standards during the licensing process. Some insurers have been unclear which category various off balance sheet exposures ought to fit into, or what constitutes an off balance sheet exposure. Further, it is intended for both the Life and Non-life Standards that off balance sheet exposures be included in the calculation of the Asset Concentration Risk Charge, the Foreign Currency Risk Capital Charge and the Interest Rate Risk Capital Charge. 29. As such, the Reserve Bank is proposing to revise the text for off balance sheet exposures and the Asset Concentration, Foreign Exchange and Interest Rate Risk Capital Charges. The purpose of the revision is mainly to increase certainty as to the intended application of the Standard and not to effect a change in policy. 30. There is however one area where the requirement to hold capital against off balance sheet exposures has been broadened. This is in explicitly requiring insurers to include an amount that represents the estimated likely payments to be made as a result of disputes in relation to unpaid claims over the next year (where no provisions have been booked for this amount). This is to recognise the risk that an insurer is

7 7 likely to have an outflow of resources as a result of claims disputes, even if that outflow cannot be identified as attaching to a particular dispute. 31. The proposed revisions are provided in the appendices. Amendments will be made to all Solvency Standards, however for simplicity only one set of amendments has been provided. Some adaptations may be required to take account of the differences in the Standards. Questions for response 1. Do you agree that guarantees of shorter duration than the underlying asset should receive some recognition in calculating an insurer s Asset Risk Capital Charge? 2. Do you have any comments on the proposed treatment of limited term guarantees? 3. What are your views on placing a limit on the amount that the Asset Risk Capital Charge can be reduced through the use of guarantees? 4. Do you have any comments on the proposed amendments to the Solvency Standards in the appendices?

8 8 Appendix 1 Guarantees The following amendments (in red italics) are proposed to be made in relation to guarantees. Paragraph 82 of the Non-life Standard and paragraph 77 of the Life Standard (and equivalent provisions of the other Standards) are proposed to be amended to read: Assets that have been guaranteed shall be treated in accordance with paragraphs A-J. Guarantees provided to the licensed insurer by its own parent entity or by any related party are not eligible for this treatment. The following new paragraphs in relation to guarantees are proposed to be added. A. The portion of an asset covered by a guarantee that meets the requirements of paragraph C may be assigned the Asset Risk Capital Factor that would be applicable to the guarantor, subject to paragraphs D-J. The portion of an asset considered to be covered by a guarantee is that portion of the asset equal to the value of the guarantee calculated in accordance with paragraphs D-I. Any unguaranteed portion of the asset must be assigned the Asset Risk Capital Factor applicable to the principal counterparty. B. For the purposes of paragraphs A J the following definitions apply: Beneficiary in respect of a guarantee means the insurer that benefits from the guarantee; Maturity in respect of a guarantee includes: i. a maturity date; and ii. any date on which the guarantor has the capacity to terminate, otherwise end or increase the effective cost of the guarantee; iii. any date on which the beneficiary of the guarantee has the capacity to terminate the guarantee and has an incentive to do so, such as an effective increase in the cost of the guarantee; Maturity in respect of the underlying asset means the longest possible remaining time that the asset may remain an asset of the insurer (irrespective of any potential rights to call); and Principal counterparty means the counterparty to the transaction with the insurer that gave rise to the underlying asset; Residual maturity means the time remaining until maturity. For a demand loan the residual maturity shall be 5 years. C. The guarantee must: be provided by a guarantor with a counterparty rating (or for governments, the long-term foreign currency credit rating) in Grades 1,2, or 3 (refer Table 4); and be legally enforceable, clearly documented in writing and, if exercised, represent a direct claim on the guarantor that may be pursued without legal action being taken against the principal counterparty; and be explicitly referenced to a specific asset or pool of assets; and cover all types of payments the principal counterparty is required to make under the documentation (including interest); and be irrevocable prior to maturity (that is no party may have the right to unilaterally terminate the guarantee prior to any specified date on which the guarantee will mature or may otherwise terminate); and be unconditional (there must be no conditions that need to be fulfilled prior to the guarantor being liable on default of the principal counterparty).

9 9 D. Where an asset, or pool of assets, of an insurer is subject to more than one guarantee, but those guarantees are limited to the extent of common collateral, the guarantees may only be recognised up to the value of that collateral. E. For the purposes of paragraph A, the value of a maturity matched guarantee is the guaranteed amount. A maturity matched guarantee exists when the residual maturity of the guarantee is the same or greater than the residual maturity of the underlying asset. F. For the purposes of paragraph A, the value of a maturity mismatched guarantee must be calculated in accordance with paragraphs G - I. A maturity mismatched guarantee exists if the residual maturity of the guarantee is less than the residual maturity of the underlying asset. G. Except as provided in the next sentence, the value of a maturity mismatched guarantee where the residual maturity of the guarantee is equal to or less than 12 months is 0. Where a maturity mismatched guarantee of residual maturity equal to or less than 12 months provides that it will be renewed automatically unless a notice of termination is given, and the licensed insurer has no reason to believe that the guarantee will not be renewed, the guarantee may be recognised in the 12 months prior to renewal provided that the value of the guarantee is calculated in accordance with the formula in paragraph H and the residual maturity of the guarantee is considered to be 6 months for the entirety of that 12 months for the purposes of that formula. H. If a guarantee is maturity mismatched and the residual maturity of the guarantee exceeds 12 months, the value of the guarantee for the purposes of paragraph A must be adjusted in accordance with the following formula: Value of guarantee = guarantee amount * min(t,residual maturity guarantee) min(5,residual maturity asset) Where maturity is measured in years or part thereof; and T is the lesser of 5 and the residual maturity of the asset expressed in years. I. Where there is a single guarantee, limited in sum, that applies to a pool of assets where the residual maturity of the assets in the pool differ the licensed insurer must assume that the guarantee applies to the asset with the longest residual maturity first for the purposes of paragraph H. J. The licensed insurer must ensure that the assignment of the Asset Risk Capital Factor applicable to the guarantor to any portion of a guaranteed asset, in substitution of the principal counterparty, results in the following condition being met: AV *.85 AVG AV is the sum of the product of: the asset values in each Asset Class multiplied by the Asset Risk Capital Factor from Table 2 applicable to the principal counterparty; and AVG is the sum of the product of: the asset values in each Asset Class multiplied by the Asset Risk Capital Factor from Table 2 applicable to the principal counterparty for assets that are not guaranteed;

10 10 the portion of the asset values in each Asset Class multiplied by the Asset Risk Capital Factor from Table 2 applicable to the principal counterparty for the portion of an asset not covered by a guarantee (see paragraph A), or where recognising that portion as guaranteed would result in the condition being breached; and the portion of the asset values in each Asset Class multiplied by the Asset Risk Capital Factor from Table 2 applicable to the guarantor in relation to the guaranteed portion of the asset (see paragraph A), where the guaranteed portion is reduced to the extent necessary to meet the condition. Where the licensed insurer has guarantees with more than one guarantor, and recognising all of those guarantees would result in the condition not being met, the guarantors with the higher quality counterparty rating must be used in the calculation of AVG before those with a lower quality rating. For example if an insurer could recognise a guarantor of rating grade 1 or a guarantor with rating grade 2, and in either case meet the condition, the insurer must recognise the guarantor with rating grade 1. For example: If an insurer as three assets valued at $100 and based on the rating of the principal counterparty the following Asset Risk Capital Factors would apply 4% (a1), 6% (a2) and 15% (a3) respectively then: AV= (100*.04) + (100*.06) + (100*.15) = 25 Hence AV*.85 = Thus substitution of the guarantor for the principal counterparty must not reduce the sum of the product of the asset values and Asset Risk Capital Factors below Assume a1 is subject to no guarantee, a2 and a3 are guaranteed such that the Asset Risk Capital Factor is reduced to 2%. Further the portion of a3 covered by a guarantee is $50. Allowing all guarantees to be recognised would result in the condition being breached. AVG = (100*.04)+(100*.02)+(50*.15)+(50*.02) = 14.5 The insurer may meet the requirement by not recognising the guarantee on a2 and recognising the guarantee on a portion of the guaranteed portion of a3 ($23). AVG = (100*.04)+(100*.06)+(76*.15)+(24*.02) = 21.8

11 11 Appendix 2 Other off balance sheet exposures It is proposed that the other off balance sheet exposures paragraphs be replaced with the following (where the Non-Life Standard is used as the example). 94. A licenced insurer can be exposed to various investment risks through transactions other than those reflected on its balance sheet, for example by issuing guarantees or letters of credit. For the purposes of this solvency standard other off balance sheet exposures are the sum of contingent liabilities that meet the criteria of paragraph 95 and disputed amounts calculated in accordance with paragraph 96. A licensed insurer must allow for the amount of any such off balance sheet exposures as if they were assets when calculating the Asset Risk Capital Charge, including in the Asset Concentration Risk Charge. 95. At a minimum, a licenced insurer must include the amount of contingent liabilities disclosed within the NZ GAAP financial statements of the licensed insurer within other off balance sheet exposures. Additionally a licensed insurer must include any contingent liabilities that are not disclosed within the NZ GAAP financial statements but which are likely to be disclosed in the next financial statements of the licensed insurer or which are able to be reasonably identified and give rise to a possibility, even if remote, of a net outflow of resources from the licensed insurer over the next 3 years. Without limiting the scope of paragraph 95, the following are examples of contingent liabilities that must be included in the calculation of the Asset Risk Capital Charge: guarantees; letters of credit; undrawn facilities or other financial commitments; agreements that may result in the assumption of financial obligations under prescribed circumstances; agreements, including a call option that would, in the event of exercise of the call, require the licensed insurer to purchase shares or other financial instruments in a related party. A licensed insurer should also consider the following items: tax disputes; other legal disputes; contractual agreements that could give rise to a contingent liability, for example as a result of warranties in a sale and purchase agreement. 96. A licensed insurer must also include an amount for disputed amounts in other off balance sheet exposures. The disputed amount is the amount that the licensed insurer estimates as the likely payments to be made as a result of disputes in relation to unpaid claims over the next year. This should be based on payments in relation to the entire portfolio and should be able to be justified on the basis of historical data and the magnitude of pending disputes. Legal costs should be included. The amount may be reduced by any provisions booked within the licensed insurer s financial statements in relation to disputed claims. 97. For the purpose of this solvency standard, the asset value of a contingent liability is the maximum possible principal or notional principal value or amount of the contingent liability. If a licensed insurer is unable to quantify the value of the contingent liability, the value must be estimated at a prudent amount and noted as such, with the basis of the estimation clearly

12 12 described in the Solvency Returns submitted to the Bank. The asset value must not be net of the value of any collateral, guarantees or other credit support arrangements. 98. The following applies to the determination of the appropriate Asset Risk Capital Factor. Disputed amounts fall within the category Other off balance sheet exposures and are subject to an Asset Risk Capital Factor of 20%. The Asset Risk Capital Factor for a contingent liability will be the Asset Risk Capital Factor that would apply under Table 2 if: the contingent liability were a direct, non-contingent, liability of the licensed insurer; and the counterparty is considered to be the counterparty of the insurer to the contract that creates the contingent liability. Category 10, Other off balance sheet exposures not covered elsewhere, is to be used if there is no other asset category that appropriately reflects the risks inherent in the asset or no other category applies, provided that contingent related party exposures are always classified in row 14: Assets incurring a full capital charge. For example: A guarantee of an AA rated fixed interest debt obligation of maturity greater than 1 year where the counterparty to the guarantee is of grade 1 or 2 would receive an Asset Risk Capital Factor of 2% (row 2). A guarantee of a related party obligation will be considered as an exposure to that related party. It is proposed that Table 2 row 13 (Non-Life) and row 15 (Life) be amended such that the title be Any Other On-balance Sheet Assets (not described elsewhere) to be clearly distinguished from row 10 (Non-Life) and 8 (Life). Further row 10 (Non-Life) and 8 (Life) is proposed to be amended to read, in column 1, Other off balance sheet exposures not covered elsewhere and, in column 2, Other off balance sheet exposures not dealt with elsewhere.

13 13 Appendix 3 The additional text in red italics is proposed for the Asset Concentration Risk Charge, Foreign Currency Risk and Interest Rate Risk Charge (the Non-Life wording is given as the example here). Asset Concentration Risk Charge In order to determine the Asset Concentration Risk Charge, the licensed insurer must first calculate the total value of its assets, including contingent liabilities that meet the criteria in paragraph [95] and derivative positions (the derivative position in regards to a particular entity may be netted where there is a legally binding netting agreement), that represent obligations of one entity (counterparty) or group of related entities, (to the extent that the asset values have not been excluded from, or reduced in, the determination of Actual Solvency Capital in Section 2). Where the Asset Risk Capital Factor applicable to a guarantor has been used in relation to a guaranteed asset, then, to the maximum value of the guarantee, the guaranteed asset shall be considered to represent an obligation of the guarantor, and not the principal counterparty for the purposes of the Asset Concentration Risk Charge. Any unguaranteed portion of the asset must be considered as an obligation of the principal counterparty for the purposes of the Asset Concentration Risk Charge. Where the licensed insurer has looked through an investment vehicle or subsidiary in accordance with paragraph 80, the same look through basis must be used in calculating the Asset Concentration Risk Charge. The Asset Concentration Risk Charge for each counterparty is a separate change in [] the Asset Risk Capital Charge calculated in accordance with paragraph 83, and applies only to the licensed insurer s total asset exposure to each counterparty that exceeds the limits specified in Table 3. Foreign Currency and Interest Rate Risks 96. In applying the solvency standard a licensed insurer must consider the degree of mismatching between assets and liabilities in terms of foreign currency and interest rate risks. Foreign Currency Risk 97. In the case of a currency position, an additional Foreign Currency Risk Capital Charge of 22% must be applied to the net open foreign exchange position in each currency other than NZD, regardless of whether the position is long or short. The net open foreign exchange position is the absolute difference (ignoring any negative sign in the outcome) between any assets and liabilities (taking into account applicable derivative positions and including any contingent liabilities that meet the criteria in paragraph [95]) that are denominated in the relevant currency. Where an asset of a licensed insurer is denominated in a foreign currency and has been guaranteed in either a foreign currency or NZD, the underlying asset is included in the calculation of the net open foreign exchange position and the guarantee is not. Where a NZD asset of a licensed insurer is subject to a guarantee that is limited to a particular foreign currency value, and that asset has been assigned the Asset Risk Capital Factor applicable to the guarantor, the guarantee must be included in the calculation of the net open foreign exchange position (unlimited guarantees denominated in a foreign currency do not need to be included in the net open foreign exchange position).

14 14 98.An Interest Rate Capital Charge is calculated by reference to fixed interest-bearing assets and fixed interest-bearing liabilities. For the purposes of determining the Interest Rate Capital Charge: (a) fixed interest-bearing assets are those assets and derivative position bearing a fixed interest rate for a period of time (re-set period) beyond the balance date at which the solvency calculation is performed. Fixed interest-bearing assets must be included regardless of the existence of any guarantee in relation to such assets. (b) fixed interest-bearing liabilities are insurance liabilities and derivative positions and any other liabilities, including fixed interest-bearing contingent liabilities, where the economic value depends upon discounting actual or expected cash flows; in other words those liabilities where the value depends implicitly or explicitly on interest rate assumptions.