The Solvency II prudent person principle compels insurers to show that their investment strategy matches the interests of policyholders. Precisely how they do that in practice is yet to become clear.
The vague wording of article 132 of the directive, which sets out the principle, has left insurers waiting for guidance from local supervisors as to what will be required.
The directive goes only as far as to say: "With respect to the whole portfolio of assets, insurance and reinsurance undertakings shall only invest in assets and instruments whose risks the undertaking concerned can properly identify, measure, monitor, manage, control and report."
An early steer for insurers could come from Denmark, where Finanstilsynet, the local supervisor, has been working with insurers already on the prudent person principle as part of its own pre-Solvency II regulatory changes, which have come into effect ahead of the full European directive.
Insurance Risk spoke to Jan Parner, deputy director-general at Finanstilsynet, about the supervisor's approach so far.
"[Insurers] need to understand that the risks they take on now... are prudent in the manner that is expected under Solvency II," he explained. "They need to start looking into the concept and start discussing with the supervisor if [the company's approach] is prudent or not and not just [find] once [assets are] on the balance sheet that the supervisor comes back and says: ‘Sorry friends – not prudent'."
The Danish supervisor is asking firms to follow three steps in their assessment of investment strategy, said Parner. First, firms should ask themselves whether cashflows on their assets match their liabilities. Second, they should assess the performance of the portfolio in a range of scenarios beyond those they expect. And third, they should consider whether their investment portfolio will perform over the lifetime of their liabilities and not only in the short term, he explained.
"If you start with a concept that is... wrapped in words and not necessarily easily operationalised you can have completely different perceptions of what the concept is," Parner said. "What we need to do now is to make sure that [companies] understand the different aspects of prudent person principle… as a supervisor we are pushing the industry to start discussions and when we have that interaction they will understand what we expect."