Supervisory Review of Key Functions

The general qualification requirements already discussed apply to all persons who perform work in a key function, regardless of their level in the hierarchy.¹⁹ There are, however, special requirements in addition to these which arise from the higher qualifications demanded of the key function holders under the insurance supervisory regime. According to art. 42 para. 1 a of the Solvency II Directive, key function holders as laid down in the insurance supervisory regime must meet the following specific requirements for professional qualifications:

Art. 263 SG11 para. 2 of the DVO concretizes these rules at Level II with the following wording:

Guideline 12 then follows at Level 3, along with explanations.²⁰ However, unlike other guidelines and explanations on this matter, this applies only to members of governing bodies.²¹ Other staff in the functions are covered only under the general explanations in No. 3.37 f.

The individual criteria of art. 263 SG11, para. 2 of the DVO are rather widely drawn. They require both professional and formal qualifications as well as relevant knowledge and experience. At the same time, however, they permit reasonable distinctions and the transfer of qualifications. This can be seen in the inclusion of qualifications from the overall financial sector and other areas of business in the criteria. It is also reflected in the consideration given to the specific responsibilities of a key function holder and the person’s skills in relation to the responsibilities.

In contrast, art. 263 SG11, para. 2 of the DVO does not provide detailed specifications for the legal requirement “sound and prudent management” as mandated under art. 42, para. 1 a of the Solvency II Directive.²² The skills required for management pertain mainly to members of the managing board as contained in art. 42, para. 1 of the Solvency II Directive. This is understandable, as the corporate management has to run the undertaking on its own responsibility set forth under sec. 76, para. 1 AktG [German Stock Corporation Act]. Thus the criterion of prudence in art. 42 of the Solvency II Directive should not be separately interpreted to be, as may first appear, an implied limitation on the undertaking’s freedom to act in accordance with its own appetite for risk.²³ This becomes readily apparent in a comparative analysis of the various language versions of this directive.²⁴

Sec. 25, para. 1, sent. 1 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] requires that persons who “have other key functions” are not only proper but also fit. Fitness is defined in sec. 25, para. 1 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] as follows:

The text of sec. 25 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] clearly goes beyond the fitness criteria laid down in the European requirements for key function holders. The Statement of Reasons for the government’s draft reflects this only indirectly by providing for the implementation of art. 42 of the Solvency II Directive and by presuming that sec. 25 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] “integrates the specific rules of sec. 7 a para. 1 of the VAG [German Insurance Supervision Act], earlier version”.²⁵ Nevertheless, and in agreement with art. 263 SG11, para. 2 of the DVO in this respect, the Statement of Reasons for the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] also points out that the specific requirements are based “on the respective key task and the responsibilities a person has while executing it”. “In addition, the nature, scale and complexity of the risks with which the business operations of the undertaking are associated have influence on the fitness requirement”.²⁶

The legal requirements of “professional qualification”, “knowledge and experience” are also found in art. 42, para. 1 of the Solvency II Directive. The explanation of the requirement of “knowledge” in sec. 25, para. 1, sent. 3 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] with its reference to “adequate theoretical and practical knowledge” is not only an appropriate amplification of fitness but is also consistent with the corresponding requirement in art. 263 SG11, para. 2 of the DVO.

Sec. 25, para. 1 of the VAG RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] deviates, however, from art. 42, para. 1 of the Solvency II Directive and art. 263 SG11, para. 2 of the DVO in sentence 3 by specifying the requirement of “management experience” instead of simply “experience” as rendered in the Directive and the DVO, and then again in sentence 4 by requiring “a managerial position held with an insurance undertaking of comparable size and type of business for three years” in order to meet such management experience. Indeed, this is supposed to apply—continuing with the presumption of sec. 7 a, para. 1 sent. 3 of the current VAG [German Insurance Supervision Act]²⁷—only for the “performance of management duties”, meaning that by contrary inference it does not apply to those specified later who have “other key tasks”. Nonetheless, there could be spillover effects.²⁸ Overall, sec. 25, para. 1, sent. 4 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act] sets the fitness standard at a very high level. Especially significant here is the trio of “three years”, “insurance undertaking” and “comparable size and type of business”. It is clear at the outset that the rule is incompatible with moves made by personnel between different sectors as well as with the current one-year orientation period for management positions in the banking sector, which has the approval of BaFin [Federal Financial Supervisory Authority]. And if one were to take the last of the three requirements literally, even the “advancement” of a person from a smaller to a relatively larger undertaking—regardless of the actual magnitude of the undertaking—would hardly be possible in the future.

The fixed 3-year requirement for management experience is as excessive an application of the Solvency II rules as the stipulation of insurance undertakings of comparable size and business type. Under the principle of full harmonization,²⁹ these have no justification in national implementation law and—particularly after the DVO takes effect—have no legal effect due to the primacy of European law. This holds true even more so for the one other stipulation in the triad: that the experience must be in connection with an “insurance undertaking”. Art. 263 SG11, para. 2 of the DVO directly provides for consideration of “knowledge and relevant experience within the insurance sector, other financial sectors or other businesses”. Ultimately, this means that the staff in question may come to an insurance undertaking from another part of the financial services sector—or even from another field of business altogether³⁰—much the same as they can move to a larger insurance undertaking from a relatively smaller undertaking. And no rigid 3-year restrictions apply. Now, if this is the case even for the managing board members, meaning the persons who effectively run the business, it is certainly no different for the key function holders who are subordinate to them. Consequently, the direct reference to “insurance businesses” in sec. 25, para. 1, sent. 3 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act], where key function holders are expressly mentioned, is not compatible with the Solvency II rules. Exclusively relevant, and sufficient in the final analysis, are knowledge and experience within the meaning of art. 263 SG11, para. 2 of the DVO.

Earlier, under the VAG [German Insurance Supervision Act] then in effect, the question arose as to whether knowledge of the German language was a necessary component of fitness for managing board members of insurance undertakings. While the literature in insurance supervisory law sometimes supported this idea, it was rejected from a number of perspectives, including as an interpretation of the relevant criteria—namely, knowledge of the substantive requirements of the responsibilities assumed and actual communication skill in the German language with the aid of language mediators.³¹ This applies even more so today following the completion of harmonization of insurance supervision by the Solvency II project for the time being. The outcome is also a product of basic European freedoms as well as the uniform applicability of supervisory law to insurance groups and other cross-border undertakings of relevance to insurance. Applicability to key function holders proceeds from the fact that they cannot be subject to different rules based on their equivalence in terms of fitness requirements with managing board members of insurance undertakings under the Solvency II Directive. If overall governance is assigned in the future to financial supervision, as provided in sec. 289, para. 3 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act],³² it would mean that BaFin could apply its legal view on German language proficiency even to the general agents and management in the offices of German insurance undertakings in other EU/European Economic Area countries outside Germany in accordance with sec. 54, para. 2, sent. 1 of the VAG-RegE [Government’s Draft of a Tenth Act Amending the German Insurance Supervision Act].

BaFin laid out its view of expertise requirements for supervisory board members in a non-binding notice dated Feb. 22, 2010.³³ The standards described were met with enormous criticism due, for example, to their low qualification requirements, erroneous assumptions on corporate law, and certain implied ways to meet the requirements.³⁴ The notice will be entirely obsolete when the new standards of the Solvency II system take effect. It can therefore have no legal significance for key function holders, even indirectly.

Under art. 41, para. 3, subpara. 1 of the Solvency II Directive, insurance undertakings “shall have written policies in relation to at least risk management, internal control, internal audit and, where relevant, outsourcing”. It must therefore encompass three of the key functions: risk management³⁵ and compliance—which is included by virtue of its membership in the internal control system under art. 46, para. 1, subpara. 2 of the Solvency II Directive—and internal audit. Regarding the actuarial function, the Directive recognizes an obligation to establish policies only indirectly, namely in art. 48, para. 1 i along with art. 41, para. 3, subpara. 1, sent. 2 of the Solvency II Directive. Added to these are further rules in the Solvency II system that also have implications for the need of policies of insurance undertakings. They proceed, i.a., from art. 263 SG11, para. 1, of the DVO, which states that insurance undertakings must establish, implement, and maintain “documented policies”.³⁶

Under art. 41, para. 3, subpara. 2, sent. 2 of the Solvency II Directive, the policies “shall be subject to prior approval by the administrative, management or supervisory body”. For German law, it is not entirely clear whether or not the supervisory board, as positioned in the German dual organizational structure of managing board and supervisory board, is addressed by this. The uncertainly arises from the role of the managing board, which, under sec. 76 of the AktG [German Stock Corporation Act], is fully responsible for the management of the company and thus also for enacting essentially all company policies. The supervisory board can therefore “approve” neither the policies of the undertaking, nor its reports (as suggested by art. 55, para. 2 of the Solvency II Directive), nor any internal model (as suggested by art. 35, para. 5 and 116, para. 1 of the Solvency II Directive). Rather, the policies and reports etc. are directly attributable to managing board. It alone bears the responsibility, and not some other board upstream from it. The text of the Directive in other language versions and the objective pursued by the issuer of the Directive in assigning policy responsibility support the fundamental accountability of the managing board for the policies extensively discussed in the Solvency II Directive. Excluded however, are policies concerning the fit-and-proper requirements for managing board members under art. 263 SG11 of the DVO. The same applies to policies concerning the qualification requirements for supervisory board members³⁷ if the intention is to view supervisory board members as key function holders.³⁸ For the policies affecting members of the managing board, the supervisory board of each company holds sole responsibility. This on its own impedes the use of predetermined, standardized qualification policies across the group for all persons who effectively run the insurance undertaking or hold key functions in it as laid down in the insurance supervisory regime.

The reverse holds true for the managing board, which bears responsibility for policies affecting subordinate staff members in their capacity as key function holders under the insurance supervisory regime. With these policies the managing board can and must govern the basic responsibilities and powers of each key function. Thus, in order to comply with the requirements of art. 263 SG11 of the DVO, it must also identify the group of key function holders under the insurance supervisory regime for the particular undertaking either abstractly or based on job descriptions. Further, it must establish the fit-and-proper requirements for these persons and their subordinate staff. Finally, the DVO also specifies, as mandatory in the subject-matter of such policies, the procedures that must be provided for and followed in order to enforce these requirements within the insurance undertaking.

Art. 263 SG11 of the DVO and the Level 3 Governance Guidelines place particular emphasis on the “assessment” as to whether key function holders meet the fit-and-proper requirements. Guideline 14 (b) and (c) of the Governance Guidelines thus expressly requires that the policies include “a description of the procedure of assessing fitness … both initially and on an ongoing basis” and “a description of the minimum situations that give rise to a reassessment of fitness”.³⁹ Thus an initial assessment of fitness must be made using a specific procedure, as well as reviews—whether regular or initiated by certain events—of assessments already made. This procedure must be included in the policies related to the key functions.⁴⁰ Consequently, numerous issues must be addressed by the policies, such as who is responsible for assessing which key function holder, what procedure must be followed in doing so, what evidence of formal qualifications must be submitted and in what executed form, how often or on what occasion is a review or recall of a current qualifications assessment necessary,⁴¹ and what form of professional training is appropriate and necessary.⁴²

The increasing importance of formalized processes under Solvency II and the flood of documentation requirements for insurance undertakings that comes with it,⁴³ also extends to the assessment of fitness for key function holders. It is only by documenting these internal assessment processes that the managing board can be relieved with respect to have both provided for the necessary organizational processes and induced their actual implementation—as required by art. 263 SG11, para. 1, of the DVO. This may include acts of delegation throughout the operational structure.⁴⁴ However, the managing board itself must always form its own impression in assessing the fitness of the functional leaders and their deputies because key function holders are often very close to the managing board as a result of their distinctive job description and decision-making powers.