Insurers need more clarity from regulators on the scope of the prudent person principle, particularly in the context of self-directed or portfolio bond business where customers effectively select the investments themselves. Such investments are on-balance-sheet and consequently might seem to fall within the scope of the prudent person principle of Article 132 of the Solvency II directive which prescribes that an insurer should only invest in assets and instruments the risks of which it can properly identify, measure, monitor, manage, control and report. Article 132 draws no distinction between self-directed business and other business types where the insurer clearly selects the investments.
One might expect that clarity would come from the Solvency II Delegated Act with its implementing rules covering how insurers should be managed and governed and from EIOPA Guidelines and Implementing Technical Standards. As part of the public consultation on Set I of the Solvency II Guidelines Implementing Technical Standards and Guidelines, there was a “Final Report on Public Consultation No. 14/017 on Guidelines on system of governance” in January 2015. That document is silent on the issue of self-directed business.
However on the EIOPA website there is resolution of comments received during the public consultation. This included in reply to the comment by the Actuarial Association of Europe that “for some unit-linked contracts, there is freedom for the insured to select the unit-linked fund of their own choice, provided they have enough knowledge of financial markets. GL 32 should be amended to take into account this reality”, the EIOPA reply was “Where the policyholder has freedom of choice this would be outside the remit of PPP and this guideline. The guideline is designed to safeguard policyholder interests where the unit-linked funds are selected by the undertaking.”
Whilst this was a reply to a comment on a specific guideline, the reply could be interpreted as a general view by EIOPA that an insurer’s investments made on the basis of a client’s express choice of assets should fall outside the scope of the PPP.
However, it should be noted that EIOPA’s responses to comments during the public consultation are not in any way binding on national supervisors. Furthermore, notwithstanding that this issue was raised in the public consultation, it was not referenced in the final guidelines or in the feedback statement.
The expectation might have been that the guidelines should clearly state whether or not the PPP applies to self-directed business particularly in the interest of regulatory convergence and to avoid distortions to the level playing field for insurers.
EIOPA has stated that it would be premature to provide extensive Guidelines on the prudent person principle at this point in time. Accordingly, the Guidelines on the prudent person principle have been limited to very basic minimum requirements reminding institutions that greater flexibility for investments is linked with firm responsibilities on the governance around the investment activities, and that the level of prudence required is not diminished under Solvency II. EIOPA expects that it may be necessary to draft further Guidelines at a later stage in order to ensure an appropriate level of convergence across Member States.
In summary, insurers need to know now whether or not the PPP applies to self-directed business because they are currently putting in place their systems of governance for Solvency II and they also need to manage their litigation risk arising from any inadvertent non-adherence to the prudent person principle.
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