Sovereign risk

Insurers holding government bonds or loans to sovereigns in their portfolios must address the associated risks, irrespective of the capital charge. This applies in particular with respect to the prudent person principle, the own credit risk assessment and the own risk and solvency assessment. These requirements are derived from the Insurance Supervision Act and are set out in detail in the EIOPA guidelines on the system of governance and on the own risk and solvency assessment.

New interpretative decision

BaFin developed good practice principles for the treatment of risk in the course of a symposium and a workshop with industry representatives, and summarised them in an interpretative decision which it published on 7 April 2017.¹ Insurers can use this good practice approach as guidance for undertakings' individual treatment of sovereign risk. The principles and processes illustrated could also be applied analogously, where appropriate, to the treatment of risk attaching to other investment classes, making allowance for the circumstances of the specific case.

Derivatives

BaFin set out details of the prudent person principle in its interpretative decision on the use of derivative financial instruments in the context of the prudent person principle (section 124 of the Insurance Supervision Act)² dated 14 July 2017. Among other items, the interpretative decision contains definitions of efficient portfolio management and effective risk transfer and illustrates possible methods of demonstrating effective risk transfer.

Pursuant to section 124 (1) sentence 1 of the Insurance Supervision Act, insurance undertakings falling within the scope of the Solvency II Directive³ must invest their entire assets in accordance with the prudent person principle. They are not required to comply with the Derivatives Circular 3/2000 (VA) or the successor Circular 08/2017 (VA) on derivative financial instruments and structured products⁴. Instead, the use of derivative financial instruments is permitted under section 124 (1) no. 5 of the Insurance Supervision Act if they contribute to reducing risk or to more efficient portfolio management. Arbitrage transactions or short sales are not permitted.

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