DE NEDERLANDSCHE BANK N.V. Solvency Margin and Technical Provisions (Insurers) Regulation

DE NEDERLANDSCHE BANK N.V. Solvency Margin and Technical Provisions (Insurers) Regulation Regulation of De Nederlandsche Bank N.V. dated 11 December 2006, no. Juza/2006/02455/IH, implementing Article 97, paragraph 2, Article 98, paragraph 3, Article 121, paragraph 2, and Article 124 of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels Wft) (Solvency Margin and Technical Provisions (Insurers) Regulation) De Nederlandsche Bank N.V., After consulting the relevant representative organisations: Having regard to Article 97, paragraph 2, Article 98, paragraph 3, Article 121, paragraph 2, and Article 124 of the Decree on Prudential Rules for Financial Undertakings; ORDERS CHAPTER 1. INTRODUCTORY PROVISIONS Article 1:1 In this regulation the following definitions apply: a) Decree: the Decree on Prudential Rules for Financial Undertakings: b) DNB: De Nederlandsche Bank N.V.; c) Act: the Financial Supervision Act (Wet op het financieel toezicht). CHAPTER 2. SUPPLEMENTARY CONTRIBUTIONS AS COMPONENT OF THE AVAILABLE SOLVENCY MARGIN OF NON-LIFE INSURERS AND FUNERAL EXPENSES AND IN-KIND BENEFITS INSURERS Article 2:1 1. Consent by DNB as referred to in Article 97, paragraph 1, opening words, of the Decree shall be granted if the insurer referred to in that paragraph 1 (b), meets the following conditions: 1

a) the articles of association of the insurer provide that the management board is empowered at all times, without additional conditions, to apportion a negative balance in any financial year among the members of the insurer and that this decision can be implemented forthwith; b) receivables included in the balance sheet on account of the above-mentioned apportionment are deducted from the supplementary contributions included in the available solvency margin; c) the insurer pursues a consistent financial policy revealing in any event how premium income, investment income, costs and, where applicable, claims paid are to be attributed to financial years and groups of policyholders. 2. If DNB has doubts about whether a supplementary contribution presented by an insurer as a component of the available solvency margin can be collected, it may require the insurer to demand and obtain additional security from its members. 3. DNB may retract a consent granted pursuant to paragraph 1 if the data supplied in order to obtain the consent prove to be incorrect or incomplete and knowledge of the correct and complete data would have resulted in a different decision, or if circumstances occur or facts become known that would have resulted in refusal of the consent if they had occurred or become known prior to the date on which the consent was granted. Article 2:2 Funeral expenses and in-kind benefits insurers as referred to in Article 97, paragraph 1 (b) of the Decree, which, subject to part (b), count supplementary contributions on the date of entry into effect of this Regulation as a component of the available solvency margin have consent for this purpose until the day after the date of DNB s written decision on the application referred to in Article 97, paragraph 1, opening words, of the Decree. CHAPTER 3. UNDERWRITING LIABILITIES ADEQUACY TEST FOR INSURERS 3.1. Underwriting liabilities adequacy test for life insurers Article 3:1 1. A life insurer as referred to in Article 114, paragraph 1, of the Decree shall record in writing the method for carrying out the test referred to in Article 121, paragraph 1, of the Decree and shall apply it consistently. 2. In carrying out the test referred to in paragraph 1 a life insurer shall apply prudent criteria and calculation principles 2

3. Without prejudice to paragraph 2, a life insurer shall apply the following criteria and calculation principles in carrying out the test: a) in the case of with profit contracts, explicit account shall be taken of future bonus liabilities for the purposes of the test; b) the test shall take account of the future costs of existing life insurance policies; c) the test shall be calculated using adequate margins for uncertainty. Article 3:2 1. A life insurer shall carry out the test of the adequacy of the balance sheet value of the provision for life insurance, as referred to in Article 121, paragraph 2, of the Decree, on the basis of the term structure of interest rates published by DNB. 2. Notwithstanding paragraph 1, a life insurer may apply a term structure of interest rates which it has itself determined instead of the term structure of interest rates published by DNB. This is conditional upon DNB having approved the method to be applied for the determination of the term structure of interest rates by the life insurer and also the criteria to be applied for the determination of the term structure of interest rates. 3. Paragraph 1 does not apply if and in so far as the provision referred to in paragraph 1 is directly linked to a value referred to in Article 125, paragraphs 1 or 2, of the Decree, and the conditions in these paragraphs relating to the cover for this provision have been fulfilled. 4. Notwithstanding paragraph 1, DNB may, at the request of a life insurer, allow the insurer to carry out the test referred to in paragraph 1 on the basis of a single discount rate published by DNB or a discount rate determined by the life insurer and approved by DNB which is appropriate to the maturity characteristics of the underwriting liabilities, if the life insurer shows: a) that it would not be reasonable to expect compliance with paragraph 1; and b) that the provision is at least equal to the provision on the basis of the term structure of interest rates referred to in paragraph 1. Article 3:3 1. The discount rate referred to in Article 98, paragraph 3, of the Decree shall be a maximum of 3 percent in so far as the provisions are intended to cover liabilities under life insurance contracts concluded on or after 1 August 1999 and a maximum of 4 percent in so far as the provisions are intended to cover liabilities under life insurance contracts concluded before 1 August 1999. 2. Notwithstanding paragraph 1, the discount rate referred to in that paragraph shall be a maximum of 4 percent for life insurance contracts which are concluded on or after 1 August 3

1999 and are intended to insure pension commitments by an employer to his employees or pension commitments contracted out to a pension fund for administration. 3.2. Underwriting liabilities adequacy test for non-life insurers Article 3:4 Article 3:1, paragraphs 1, 2 and 3 (b) and (c), shall apply mutatis mutandis to non-life insurers as referred to in Article 114, paragraph 1, of the Decree. Article 3:5 Article 3.2, paragraphs 1, 2 and 4, shall apply mutatis mutandis to non-life insurers in so far discounting is applied. Article 3:6 The discount rate referred to in Article 98, paragraph 3, of the Decree shall be a maximum of 3 percent in so far as the provisions are intended to cover liabilities under non-life insurance contracts concluded on or after 1 March 2000 and a maximum of 4 percent in so far as the provisions are intended to cover liabilities under non-life insurance contracts concluded before 1 March 2000. 3.3. Underwriting liabilities adequacy test for funeral expenses and in-kind benefits insurers Article 3:7 1. Article 3:1 shall apply mutatis mutandis to funeral expenses and in-kind benefits insurers as referred to in Article 114, paragraph 1, of the Decree. 2. In addition to paragraph 3 of Article 3:1, a funeral expenses and in-kind benefits insurer as referred to in Article 114, paragraph 1, of the Decree shall, in calculating the results of the test, apply as calculation principle that future changes in the package value of existing funeral expenses and in-kind benefits policies should be taken into account in the test. Article 3:8 Article 3:2, paragraphs 1, 2 and 4, shall apply mutatis mutandis to funeral expenses and inkind benefits insurers. 4

Article 3:9 The discount rate referred to in Article 98, paragraph 3, of the Decree shall be a maximum of 3 percent in so far as the provisions are intended to cover liabilities under funeral expenses and in-kind benefits contracts concluded on or after 1 March 2000 and a maximum of 4 percent in so far as the provisions are intended to cover liabilities under funeral expenses and in-kind benefits contracts concluded before 1 March 2000. CHAPTER 4. USE OF UNITS IN COLLECTIVE INVESTMENT SCHEMES TO COVER TECHNICAL PROVISIONS OF LIFE AND NON-LIFE INSURERS Article 4:1 1. A life or non-life insurer as referred to in Article 122, paragraph 1, of the Decree may, with regard to units in collective investment schemes as referred to in Article 124, part (b), which it keeps as an asset to cover the technical provisions, take account of the underlying assets in the possession of the collective investment scheme: a) on condition that the units in the collective investment scheme are or can be directly or indirectly repurchased or redeemed from the assets at the request of the unit-holders; b) if the units in the collective investment scheme are not traded on a regulated market, the insurer has concluded a written contract with the collective investment scheme for the repurchase or redemption of the units at the request of the insurer on the conditions agreed in the contract and within an agreed term. 2. If, for the purposes of Article 124, part (b), of the Decree, the insurer does not take account of the underlying assets in the possession of the collective investment scheme referred to in paragraph 1 or if the collective investment scheme in which the insurer holds units does not comply with the conditions referred to in paragraph 1, the maximum referred to in Article 123, paragraph 3, of the Decree shall apply mutatis mutandis to the unit held by the insurer in the collective investment scheme. CHAPTER 5. FINAL PROVISIONS Article 5:1 This Regulation shall enter into force on the date on which the Decree enters into force. 5

Article 5:2 This Regulation shall be cited as: the Solvency Margin and Technical Provisions (Insurers) Regulation. This Regulation, together with the explanatory notes, shall be published in the Government Gazette. De Nederlandsche Bank N.V., /s/ A. Schilder Executive Director /s/ D.E. Witteveen Executive Director 6

Explanatory Notes General 1. Introduction This regulation is derived from various statutory instruments based on the Insurance Business (Supervision) Act 1993 and the Funeral Expenses and In-kind benefits Insurance Business (Supervision) Act. The instruments concerned are the Technical Provisions (Insurance Business) Decree 1994 (Bulletin of Acts and Decrees 1994, 448), the Technical Provisions (Funeral Expenses and In-kind benefits Insurance Business) Decree 1995 (Bulletin of Acts and Decrees 1995, 556), the further rules governing supplementary contributions as a component of the solvency margin (Government Gazette 2005, no. 34), the regulation on the use of assets that serve as cover for the technical provisions in relation to units in collective investment schemes (Government Gazette 2005, no. 34), the Actuarial Principles Circular of 18 August 1994 (no. 1.332/94-871), the Maximum Interest Rates, Prudential Margins and Technical Provisions Rules (Insurance Business) Regulation 1999 (Government Gazette 1999, no. 134), the Discount Rate and Actuarial Principles Circular of 12 July 1999 (no. 1999/07; WTV 1999/12 and WTN 1999/04) and the Package Valuation (Funeral Expenses and In-kind benefits Insurance Policies) Guideline (1.01/2001-9318).The above-mentioned rules have, in part, been included in the Prudential Rules (Financial Supervision Act) Decree (referred to below as: the Decree) on the basis of the Financial Supervision Act (referred to below as 'the Act'). The technical implementation rules have been included in the present regulation. 2. Administrative burden Chapters 2 and 4 of this Regulation concern a straightforward conversion (without policy changes) of the further rules on supplementary contributions as a component of the solvency margin (Government Gazette 2005, no. 34) and the regulation on the use of assets that serve as cover for the technical provisions in relation to units in collective investment schemes (Government Gazette 2005, no. 34). Neither chapter therefore has any effect on the administrative burden. Chapter 3 elaborates Article 121 of the Decree, which provides that insurers are required to carry out test of the adequacy of the balance sheet valuation of certain provisions annually. The above-mentioned Article 121 modifies the adequacy test for life insurance and introduces such a test for non-life insurers and funeral expenses and in-kind benefits insurers, which does affect the administrative burden. These burdens have already been listed in the explanatory notes to the Decree and have been estimated to increase the burden by 320,000. It is expected that some 70 insurers or insurance groups will be required to carry out the modified adequacy test. 7

The draft of this regulation was submitted to the Dutch Administrative Burden Advisory Board (Actal). The Board has decided not to select the regulation for an Actal test. 3. The Regulation in outline 3.1 Chapter 2. Supplementary contributions as component of the available solvency margin for non-life insurers and funeral expenses and in-kind benefits insurers. Chapter 2 indicates on what conditions De Nederlandsche Bank N.V. (referred to below as DNB) grants consent for supplementary contributions to be reckoned as a component of the solvency margin of mutual insurance associations which carry on the business of non-life insurance or the business of funeral expenses and in-kind benefits insurance (referred to below as the insurers ). This consent is required under Article 97, paragraph 1, of the Decree. Paragraph 2 of this article provides that DNB will introduce further rules governing the conditions on which supplementary contributions can be included in the calculation of the available solvency margin of the insurers concerned. Paragraph 1, opening words and (b), of the article concerned provide that an insurer, in calculating the available solvency margin, may also include the value of the supplementary contributions which a mutual insurance association that carries on the business of funeral expenses and in-kind benefits insurance or the business of non-life insurance may require its members to pay during the financial year under its articles of association, up to a maximum of 50% of the difference between the maximum contributions and the amounts actually claimed. 3.2 Chapter 3. Underwriting liabilities adequacy test for insurers 3.2.1 General Chapter 3 contains rules relating to the underwriting liabilities adequacy test for insurers (referred to below as adequacy test) and the prudential filters necessary in this connection for determining the available and required solvency margin. The basis for the Regulation is provided by Article 121, paragraph 2, of the Decree. This sets out that, without prejudice to the provisions of Articles 114, 116, 117 and 119 of the Decree and subject to the international accounting standards, DNB will introduce rules governing the criteria and calculation principles to be used in the adequacy test regarding the discount rate, mortality and disability. The basic aims of this Regulation and the resulting 8

reporting obligations are to promote a clear view of the management and financial position of the insurer and application of the system of single-track annual accounting aimed at restricting administrative burden. In so far as applicable the Regulation should comply with the rules laid down in the European directives for insurance in the field covered by the Regulation. These explanatory notes also deal with the application of the prudential filters under Article 98 of the Decree. It should be noted in principle that an insurer is required to take account of taxation in the context of prudential filters. 3.2.2 Different provisions non-life insurers In the case of non-life insurers, the Decree differentiates between the provision for unearned premiums and unexpired risks, including any catastrophe provision which may have been made (Article 115, paragraph 1), and the provision for claims outstanding or benefits to be paid outstanding (Article 117, paragraph 1). The provision for unearned premiums and unexpired risks The provision for unearned premiums and unexpired risks includes amongst others: - a provision for premiums received in the financial year for risks relating to the subsequent financial year or financial years; this provision also includes the premiums received in previous financial years and relating to the subsequent financial year or financial years (as in the case of certain multi-year non-life insurance contracts). - a provision for claims and costs under existing policies which may occur after the end of the financial year and which cannot be covered by the provision relating to the unearned premiums together with the premiums yet to be received in the subsequent financial year or financial years; and - a catastrophe provision. The provision for claims and costs from existing policies is intended first to cover financing systems with fixed premiums for risks and costs that increase over time and, second, to cover the difference between the requisite risk premiums and overhead charges and the available risk premiums and overhead charges in the agreed premiums. A catastrophe provision is deemed to mean a provision for certain events which need not necessarily occur each year. This provision is formed by application of predetermined rules on transfers to and from these provisions. 9

Provision for claims outstanding or benefits to be paid outstanding The provision for claims outstanding or benefits to be paid outstanding is the provision for claims that have been occurred, whether or not reported to the company. This provision consists of: - a provision for claims incurred before the balance sheet date or liabilities for benefits that have been reported but not yet dealt with; - a provision for claims incurred before the balance sheet date or liabilities on which not enough information has been received (Incurred But Not Enough Reported, IBNER); - a provision for claims incurred before the balance sheet date or liabilities for payment that have not yet been reported (Incurred But Not Reported, IBNR); and - a provision for the costs connected with handling claims and benefits. Pursuant to Article 117, paragraph 1 (c), of the Decree, the benefits expected from subrogation and acquisition of the ownership of the insured property in connection with claims or benefits shall be taken into account in these provisions. The IBNER provision is the provision to cover changes in the estimates of claims or liabilities to pay benefits for which provision cannot yet be made at individual claim level but for which an aggregate amount can be forecast. This includes the provision for claims to be reopened. The IBNR provision is the provision for claims or liabilities to pay benefits that have not yet been reported. The provision for the costs incurred in dealing with claims and benefits (future claim handling and payment costs) should be determined separately. 3.2.3 Method, criteria, calculation principles, adequate margins for uncertainty and prudential filters 3.2.3.1 Method Under Article 121 of the Decree, insurers are obliged to test the adequacy of the balance sheet value of the technical provisions. For non-life insurers this may involve both a calculation and a qualitative test, and for life insurers and funeral expenses and in-kind benefits insurers this should only be a calculation. Article 121, paragraph 2, of the Decree provides that if discounting is used, DNB will introduce rules, subject to the international accounting standards, governing the criteria and calculation principles to be used in regarding the discount rate, mortality and disability. This will ensure that insurers who apply these accounting standards are not confronted by two sets of accounting 10

rules. As indicated in the explanatory notes to the Decree, the calculation principles and the criteria for the adequacy test are an elaboration of the possibilities which IFRS 4 provides as part of the international accounting standards. On the basis of the (international) accounting standards and the provisions of the Act and the Decree, insurers may select criteria and calculation methods for determining the value of technical provisions in the balance sheet. In addition to the prevailing criteria (such as the maximum discount rates of 3% and 4%), IFRS 4 also allows for the possibility of discounting cash flows by a risk-free term structure of interest rates. All insurers may apply this criterion. In so far as discounting is used, the Decree explicitly establishes a relationship between the result of the test and the value of the technical provision in the balance sheet. Article 121, paragraph 4, of the Decree provides that the value of the technical provision in the balance sheet should at least be equal to the value resulting from the test referred to in paragraph 2 of this article. In addition, paragraph 3 of this article provides that if the assets which serve to cover the technical provisions are not valued at their current value the insurer may include in the adequacy test the difference between the current value and the balance sheet value of these assets. This means that if the said assets are valued at a lower value than the current value, the difference may be deducted from the result of the test. It also follows from this that the capital adequacy test should always be carried out before the profit or loss is determined. In determining the available solvency margin, the insurer may have to calculate a prudential filter in connection with the maximum discount rate to be applied. Calculations which have already been made in the course of the adequacy test are carried out once again at the maximum discount rate of 3% or 4%. For each homogenous risk group, a prospective provision should be determined for the underwriting liabilities as the sum of the expected value of the cash flows resulting from these liabilities and an adequate uncertainty margin. A homogenous risk group means a group of insurances having similar risk characteristics which are generally administered separately from other insurances. The expected value of the cash flows resulting from the liabilities must be based on insurance technical criteria that are regarded as realistic. The sum of the expected value and the related uncertainty margin then constitute the provision calculated on the basis of prudent criteria. It follows from the application of a suitable uncertainty margin that this should not result in criteria that are excessively prudent or unduly cautious. 11

When carrying out the test a non-life insurer should take into account, in accordance with Article 117, paragraph 1 (c), of the Decree, the benefits from subrogation and the acquisition of the ownership of the insured property expected in connection with claims or benefits. No quantitative rules apply to the criteria and calculation principles to be applied in setting mortality and disability rates. The insurer is therefore free, within the limits set by law, to choose the criteria to be applied in respect of mortality and disability. What criteria the insurer applies is explained in its report on the adequacy tests it has performed. The criteria should be supported by means of observations and statistics of the insurer itself, possibly amplified with suitable data from other sources. Account should be taken in this connection of the extent to which the risk characteristics of a homogenous risk group differ (or are expected to differ) from the population used for the observations, and also whether or not historic trends are expected, on the basis of sufficiently reliable proof, to continue in the future. Article 121, paragraph 1, of the Decree does not contain any more detailed rules for testing the adequacy of the provision for unearned premiums and unexpired risks. If statistical or mathematical methods are used in determining the provision for unearned premiums and unexpired risks, the methods and criteria applied should be explained and assessed in terms of their adequacy. In practice, this will apply in particular to the provision for unexpired risks. To test the adequacy of the provisions for claims outstanding or of non-periodic benefits outstanding the provision will be assessed on the balance sheet date by evaluating the run-off of claims and the non-periodic benefits, while taking account of trends. This test can be carried out on a quantitative basis (for example, by the use by non-life insurers of claims settlement triangles) or on a qualitative basis. It is up to the insurer itself to choose between a qualitative or quantitative test, although it must give reasons for its decision. In testing the adequacy of the provision for periodic benefits outstanding, the non-life insurer should use the same method of calculation as life insurers and funeral expenses and in-kind benefits insurers. The insurer should take account of future costs in testing the adequacy of the above-mentioned provisions. If an insurer has created an equalisation provision (other than the mandatory equalisation provision for credit insurances) or a catastrophe provision on the balance sheet, this may be included in the assessment of the adequacy of the provisions on the balance sheet. 12

3.2.3.2 The discount rate The main change made in the present scheme is that the underwriting liabilities are discounted in the adequacy test on the basis of a nominal, risk-free term structure of interest rates. The basic assumption is that DNB may in this way get a better view of the insurer s financial position. This is why the present value of the underwriting liabilities is determined in the adequacy test by discounting the expected cash flows by reference to a term structure of interest rates based on the current value of capital market instruments which will certainly result in receipt of the benefits to be paid (the nominal, risk-free term structure of interest rates). The expected value is therefore not influenced by the characteristics of the investments that cover the liabilities. The creditworthiness of the insurer also has no influence of the valuation of the liabilities. For non-life insurers these rules apply to liabilities whose expected future cash flows are discounted in the valuation for balance sheet purposes. Article 60 (1) (g) of Directive 91/674/EEC (OJ 374), the directive on the annual accounts of insurance undertakings, sets out the conditions on which discounting may be applied These conditions are implemented in Article 117, paragraph 3, of the Decree. Basically the effect of the conditions is that discounting is permitted only if there is an obligation to pay an annuity or claims whose settlement will last at least a further four years or the insurance concerns the accident and health classes. For discounting underwriting liabilities denominated in euros, DNB publishes a nominal term structure of interest rates that can be used to determine the present value. With the approval of DNB, an insurer itself can also determine and apply a term structure of interest rates for use in the adequacy test. Insurers who are not reasonably able to comply with the requirement that the present value of the underwriting liabilities be determined by reference to a term structure of interest rates may, with the approval of DNB, apply a method of approach that is based on the most suitable uniform interest rate possible and is geared to the maturity characteristics of the insurance portfolio on the reporting date. If non-life insurers do not discount expected future cash flows, this may be regarded as an implicit method of allowing a sufficiently adequate margin for uncertainty for particular bases of the expected value. If they nonetheless subsequently proceed to discount, the underlying criteria will have to be stated explicitly (e.g. assumptions about inflation). In either case, it must be plausibly demonstrated that the method concerned produces an adequate margin for uncertainty. 13

3.2.3.3 Adequate margins for uncertainty In accordance with Article 121, paragraph 1, first sentence, of the Decree insurers should apply expected future payment obligations and adequate margins for uncertainty when carrying out the adequacy test. There are no quantitative regulations for this. Nonetheless, application of the criteria and calculation principles referred to in Article 3:1, paragraph 3, of this Regulation means that an explicit distinction must be made between the value expected on the basis of realistic criteria on the one hand and the appropriate margins for uncertainty on the other. To ensure that the margins for uncertainty applied by the insurer are reasonable, DNB considers it desirable that the industry and professional organisations should themselves take steps to develop reference material. Books of tables containing margins for uncertainty could be drawn up for this purpose in order to simplify application for certain insurers and limit the administrative burden, although their use would not be mandatory. 3.2.3.4 Provisions for guaranteed benefits and surrender value Article 116, paragraph 1 (a), of the Decree states that when the provision for life insurance (like the provision for funeral expenses and in-kind benefits insurance) is calculated by a life insurer (and by a funeral expenses and in-kind benefits insurer) it should include all guaranteed benefits and guaranteed surrender values. The adequacy test accordingly takes account of all guaranteed benefits and guaranteed surrender values. If the calculation of the provision for life insurance produces a negative result, it will be fixed at nil and any capitalised initial costs, with the exception of receivables from intermediaries for commission to be refunded in the case of lapses and early surrenders, will be netted with the provision. This rule on fixing at nil does not apply in full to funeral expenses and in-kind benefits insurers. If a funeral expenses and in-kind benefits insurer makes applies prudent surrender frequencies, this may produce a result in which part of the provision for funeral expenses and in-kind benefits insurance is not fixed at nil. A funeral expenses and in-kind benefits insurer must plausibly show that the surrender criteria do produce an adequate margin. 3.2.3.5 Provisions for bonuses and options Since life insurers and funeral expenses and in-kind benefits insurers, are required to include, when carrying out the adequacy test, the bonuses to which the policyholder, insured or benefit claimant is collectively or individually entitled, including all options which the policyholder, insured or benefit claimant possesses under the life insurance conditions, it follows that (taking into account the accounting standards) interest and bonus guarantees and other embedded options should be valued in accordance with an 14

explicit method. In applying an explicit method, account should be taken of uncertain income intended for bonuses when determining future income and liabilities. An estimate should be made of the bonuses to be paid. This amount should be, included in the determination of the future expenses. The implicit method is no longer permitted. 3.2.3.6 Provisions for costs Costs and commission are included by life insurers and funeral expenses and in-kind benefits insurers when carrying out the adequacy test which implies that the provisions will be determined including adequate provisions for future costs out of existing insurances. The basis for determining the future costs is the insurer s current level of costs, taking account of future developments such as inflation and foreseeable extra costs. 3.2.3.7 Valuation of package of services of funeral expenses and in-kind benefits insurers In the case of package insurances, the liability of funeral expenses and in-kind benefits insurers consists in particular of the package of services specified in the policy. This package may be supplied by the funeral expenses and in-kind benefits insurer itself or be purchased from third parties. In determining the technical provisions resulting from the liabilities under these package insurances, the funeral expenses and in-kind benefits insurer should take account of the following: the funeral expenses and in-kind benefits insurer should make an adequate estimate of the current value of the package on the basis of the benefits paid by it in the year immediately preceding the date of the balance sheet, to which a 1-year trend estimate is then applied. It is assumed for this purpose that the insurance portfolio remains the same. In estimating the future development of the value of the package, the funeral expenses and in-kind benefits insurer should take account of past trend data. Structural changes that are already known or can reasonably be expected should be taken into account. An existing example of this is the application of stricter environmental standards in the case of cremations. An example of a future change is an increase that has already been announced in the burial charges by municipalities in an area where a local funeral expenses and in-kind benefits insurer operates. Funeral expenses and in-kind benefits insurers that arrange funerals themselves or outsource this work within the group of which they form part must ensure adequate internal cost allocation. This applies in particular if and in so far as assets are held 15

with a view to carrying out funerals (such as a crematorium or chapel) and these assets serve as cover for technical provisions. The investment returns of these assets are often wholly or partly dependent on the internal cost allocation. The allocated internal costs should be included in the valuation of the package. Funeral expenses and in-kind benefits insurers that arrange funerals themselves or outsource this work within the group of which they form part should be alert to capacity variances as a consequence of fluctuations in annual turnover. In a peak year it seems as though the fixed costs are lower because they can be apportioned among a larger number of funerals. This must be corrected by taking account of the number of funerals performed over a series of years. If a funeral expenses and in-kind benefits insurance is being offered as package insurance, the insurer will be obliged to provide the package of services specified in the policy. A situation may occur in this connection where not all parts of the insured package are taken in the arrangement of the funeral. Some insurers stipulate in the policy that the value of the not taken parts of the package is forfeited to them. Other insurers provide in the policy that not taking parts of the package confers entitlement to alternative services of equal value. If the not taken parts of the package are forfeited to the insurer an adequate level of taking services may be assumed for the purpose of determining the technical provisions. Account should be taken of relevant future developments when determining this level. If there is entitlement to alternative services, the level of taking services is assumed to be 100%. It is also important to note that many funeral expenses and in-kind benefits insurers have in their policies provided for the option to adjust the premiums or alter the package. In determining future income and expenditure, a funeral expenses and in-kind benefits insurer should estimate the extent to which it can and will make use of this provision. For this purpose each funeral expenses and in-kind benefits insurer should define the extent to which the provision of adjusting the premiums or package will be used. The funeral expenses and in-kind benefits insurer may itself determine the extent of the target adjustment. However, the target adjustment used in determining the technical provision should be calculated in accordance with commercial statements, for example in brochures, and with the contractual entitlement in the policy conditions. The target adjustment must also be in keeping with a consistent practice, having regard to the extent to which the funeral expenses and in-kind benefits insurer has made use of this provision in the past. The target adjustment should evolve in a stable manner from year to year. 16

In accordance with what has been noted above in relation to bonuses and options and subject to the accounting standards, the possibility of adjusting premiums or altering the package is in principle valued in an explicit manner, taking account of the target adjustments determined by the funeral expenses and in-kind benefits insurer. By way of exception, an implicit valuation method may also be applied here. In such a case the funeral expenses and in-kind benefits insurer should determine the package value for the entire future on the estimate for the year after the date of the balance sheet. The funeral expenses and in-kind benefits insurer then should make such correction to the discount rate referred to above as allows the expenses that accompanies the estimated change in the costs of the package to be financed from the difference between the discount rate on the basis of the normal term structure of interest rates and the corrected discount rate. 3.2.3.8 Other corrections It is not always possible to fully reconcile the accounting rules with the prudential reporting rules. European directives on prudential supervision contain explicit departures from the accounting rules. An example concerns the equalisations provisions for insurers. The international accounting standards exclude the possibility of an equalisation provision. This is why Article 114, paragraph 2, of the Decree contains a special arrangement for insurers who apply the international accounting standards. Instead of an equalisation provision these insurers must keep an equalisation reserve. Unlike an equalisation provision, an equalisation reserve is part of the equity capital. Article 120 of the Decree also applies to this equalisation reserve. There is also a prudential filter which provides that the equalisation reserve which an IAS/IFRS insurer operating in the credit sector is obliged to keep under Article 95, paragraph 1 (1), of the Decree does not form part of the available solvency margin. 3.2.3.9 The prudential filters belonging with the adequacy test for life insurers and funeral expenses and in-kind benefits insurers Since the application of a nominal risk-free term structure of interest rates does not in all cases produce a valuation of the technical provision that is in keeping with the requisite prudence, it is necessary to apply the prudential filter referred to in Article 98, paragraph 3, of the Decree to maintain the existing level of prudence that is related to the discouting criteria. The extent of the result of the prudential filter is dependent on how maturity characteristics of the bonds and other money and capital market instruments that cover the provisions relate to the maturity characteristics of the liabilities. It is possible to calculate the prudential filter using the following formula: 17

max VVP VVP ( VVP VVP ) ( VRW VRW ),0 ) vr rr vw mw where: VVP vr is the outcome of the adequacy test at a maximum discount rate of 3% VVP rr and 4% is the outcome of the adequacy test (i.e. on the basis of the risk-free term structure of interest rates) VVP VRW mw is the current value of bonds and other money and capital market instruments which cover the provision for underwriting liabilities (i.e. with the risk-free term structure of interest rates and taking account of the current credit spread) VVP VRW vw is the value of bonds and other money and capital market instruments which cover the provision for underwriting liabilities at the abovementioned discount rate and taking account of the current credit spread. The life insurer or funeral expenses and in-kind benefits insurer is free to calculate the outcome of the prudential filter by means of a suitable approximating formula. If a life insurer or funeral expenses and in-kind benefits insurer takes account of the discount rate referred to in Article 98, paragraph 3, of the Decree in the balance sheet valuation of the technical provisions, the prudential filter need not be calculated. However, this is then assessed in conjunction with the possible application of Article 97, paragraph 1 (a), of the Decree. A requisite solvency margin must also be calculated in respect of the outcome of the prudential filter. This filter is included in Article 65, paragraph 2, of the Decree and reads as follows: For the purposes of this article the difference referred to in Article 98, paragraph 3, is designated as gross technical provisions. 3.2.3.10 Prudential filters for non-life insurers On the basis of Article 98, paragraph 4, of the Decree, the calculation of the available solvency margin of a non-life insurer which carries out the adequacy test does not take account of the positive difference between the outcome of the adequacy test without 18

discounting and the balance sheet value of the technical provisions referred to in Article 121, paragraph 4, of the Decree, for all liabilities which are unconnected with the accident and health classes and which do not result in periodic benefits. In determining the outcome of the adequacy test without applying discounting, the insurer may apply the implicit method for those assumptions that are stated explicitly in the discounting rules for determining the balance sheet value of provisions. In accordance with the provisions of Article 98, paragraph 4, last sentence, of the Decree, the provisions of Article 98, paragraph 4, apply mutatis mutandis to the liabilities involved in the adequacy test which are connected with the accident and health classes or which result in periodic benefits. For the purposes of this prudential filter, reference is made to the provisions in the adequacy test for life insurers. 3.3. Chapter 4. Use of units in collective investment schemes to cover technical provisions of life and non-life insurers 3.3.1. General Chapter 4 contains further rules on the use of assets that serve as cover for the technical provisions in relation to units in collective investment schemes. Investments which are held by insurers to cover technical provisions are subject to specific rules on the nature and use of the investment instruments used. These rules are contained in the Decree. Article 123, paragraph 3, of the Decree provides, among other things, that not more than 5% of the assets to cover the technical provision in relation to the total of the technical provisions should consist of instruments issued by one particular issuing institution (or loans to one particular borrower). Article 124 of the Decree provides that DNB will adopt rules on the use of the assets that serve as cover for the technical provisions and the conditions to be observed in this connection in respect of the categories of assets specified in that article, including units in collective investment schemes. This is implemented in the present chapter of this Regulation. 3.3.2. Application of the look-through principle DNB considers that where units in a collective investment scheme have been designated by the insurer as assets covering technical provisions, the Decree and the underlying European directives allow account to be taken of the underlying assets of the collective investment scheme for the purposes of the rules governing diversification and spreading as referred to in Articles 1 22, paragraph 1, and Article 123 of the Decree. 19

Application of this look-through principle therefore means that in this case the diversification rules referred to in Article 122, paragraph 1, and Article 123 of the Decree are not applicable. In other words, they are not applicable to the units in the collective investment scheme itself, but are applicable to the underlying investments (the assets) of the scheme, taking into account the other investments kept by the insurer. This view is shared by the former Insurance Committee (now known as the European Insurance and Occupational Pensions Committee) which concludes in its interpretation of the former Life Directive now replaced by Directive 2002/83/EC of the European Parliament and the Council of the European Union of 5 November 2002 concerning life insurance (OJ L 345) (Life Directive) that it is not necessary at this point in time to adopt a binding rule as application of the look-through` principle already follows from a teleological interpretation of the matching principle. Furthermore, the principle of financial supervision in the existing Directives already allows supervisory authorities to examine the respect of the matching rules in relation to this type of investment. If Directive 85/611/EEC of the Council of the European Communities of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) (OJ EC L 375) is applicable to the investment scheme, Article 124 of the Decree does not provide a ground for a further rules by DNB. However, there is a basis for further rules in respect of units in a collective investment scheme as referred to in section 1:1 of the Act, other than a UCITS, These rules are related to the application or otherwise of the look-through principle. 3.3.3 Applicability of the statutory requirements concerning investment policy Application of the look-through principle as formulated above does not, however, mean that since insurers are no longer bound, subject to certain conditions, by the statutory maximums in holding units in collective investment schemes, they are entirely free in the implementation of their investment policy. Article 122, paragraph 1, of the Decree does, after all, provide in principle as follows: A life insurer or non-life insurer as referred to in section 2:92, subsection 1, or section 2:93, subsection 1, of the Act ( ) is responsible for ensuring that the nature and the valuation of the assets which serve to cover the technical provisions are in accordance with the nature or, as the case may be, the valuation of the liabilities entered into. These assets shall be adequately diversified and spread. High-risk assets shall be limited to a prudent level. The insurer must therefore take account of the nature of its investment transactions in order to ensure the safety and yields of the investments and of the liquidity in relation to 20

the contracted liabilities. Adequate diversification and spreading is required in order to avoid a concentration of risks. In DNB s view, prudent application of this matching principle in relation to the holding of units in collective investment schemes means that adequacy should be tested both at the level of the units and at the level of the assets of the schemes concerned. It follows that a concentration of assets to cover technical provisions in one or more collective investment schemes may be contrary to the abovementioned principle, but equally a portfolio of assets which, although widely diversified and spread among several collective investment schemes, may produce an unacceptable concentration in view of the total of the investments of these schemes in a given category of assets, a specific investment sector or in a specific investment. Explanatory notes on individual articles Article 2:1 Pursuant to Article 16, paragraph 4 (b), of Directive 73/239/EEC of the Council of the European Communities of 24 July 1973 on the coordination of laws, regulations and administrative provisions relating to the taking-up and pursuit of the business of direct insurance other than life insurance (OJEC L 228) (First Non-Life Directive) this regulation applies first of all to mutual insurance associations that carry on the business of non-life insurance. The Decree declares that these European provisions are also applicable to mutual insurance associations that carry on the business of funeral and inkind benefits insurance. It is noted in this connection that the regulation and supervision of funeral expenses and in-kind benefits insurers does not result from European legislation. Before the entry into effect of the Act and the Decree, there were no other rules of DNB governing the conditions on which supplementary contributions could be taken into account by funeral expenses and in-kind benefits insurers as a component of the available solvency margin. The first paragraph specifies the further conditions for taking supplementary contributions into account as a component of the available solvency margin. The power of the insurer s management board to apportion a negative balance (part a) should applie without additional conditions. In particular, it should be independent of the possible adequacy of the general reserve and the subordinated members account to cover the deficit in relation to the required solvency margin. Naturally, this power of the management board does not alter the fact that alternative cover may be decided upon, for example if the general meeting of members passes a resolution to this effect. In view of the conditions at (a) and (b), a supplementary charge can be prevented only if the balances on the equity capital of the mutual accounts and/or member accounts are 21

sufficient, after paying off the shortfall, to ensure that the available solvency margin will not fall below the level required by law. The condition at (c) is without prejudice to unforeseen circumstances. For example, runoff of claims from closed financial years can affect results in later years, which can hinder correct allocation. The safeguards referred to in paragraph 1 are important not only at the moment when consent is granted but also thereafter. Paragraph 3 therefore provides that DNB may retract consent if the data supplied in order to obtain the consent prove to be incorrect or incomplete or if circumstances or facts have been concealed or if the safeguards offered with the application are, in DNB s view, no longer adequate. In such situations, DNB may retract its consent. The above does not alter the fact that DNB may use the statutory power of intervention, in this case an administrative direction, for the purpose of applying these rules. Article 2:2 This article contains a transitional arrangement for the provisions of chapter 2 of this Regulation for mutual insurance associations which carry on the business of funeral expenses and in-kind benefits insurance. The further rules governing supplementary contributions as component of the solvency margin (Government Gazette 2005, 34), which have been adopted in chapter 2 of the present scheme, applied exclusively to mutual insurance associations that carried on the business of non-life insurance. As the rules included in this chapter on the basis of Article 97, paragraph 1 (b), of the Decree also relate to mutual insurance associations which carry on the business of funeral expenses and in-kind benefits insurance, it is logical that a transitional arrangement should be provided for this group of insurers. If DNB does not grant consent for supplementary contributions to be counted in the case of an insurer who counts this component at the moment when these rules enter into force, DNB will fix a period during which the insurer can take measures to comply with the statutory rules. Article 3:1 When the underwriting iabilities are valued, it is important to note what factors influence the possible cash flows from these liabilities. Article 116, paragraph 1, of the Decree refers in this connection to a calculation of the provision on the basis of a sufficiently prudent prospective actuarial method, taking account of the premiums to be received in the future and all future liabilities; in this connection, a prudent calculation means a 22