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Counterparty Default Risk
3.358 The counterparty default risk charge with respect to reinsurance ceded can
be calculated directly from the definition for each segment and each year.
If the exposure to the default of the reinsurers does not vary considerably
throughout the development years, the risk charge can be approximated
by applying reinsurers’ share of best estimates to the level of risk charge
that is observed in year 0.
3.359 According to the standard formula counterparty default risk for reinsurance
ceded is assessed for the whole portfolio instead of separate
segments. If the risk of default in a segment is deemed to be similar to
the total default risk or if the default risk in a segment is of negligible
importance then the risk charge can be arrived at by applying reinsurers’
share of best estimates to the level of the total capital charge for
reinsurers’ default risk in year 0.
Unavoidable Market Risk
3.360 As explained in CP42 on the risk margin, the main case of unavoidable
market risk is an unavoidable mismatch between the cash-flows of the
insurance liabilities and the financial instruments available to cover the
liabilities. In particular, such a mismatch is unavoidable if the maturity of
the available financial instruments is lower than the maturity of the
insurance liabilities. If such a mismatch exists it usually leads to a capital
requirement for interest rate risk under the downward scenario. The focus
of the simplification is on this particular kind of market risk.
3.361 The contribution of the unavoidable market risk to the risk margin may be
approximated as follows for a given line of business:
CoCMlob,Mkt ≈ CoC·UMRU,lob,≥0
where CoC is the Cost-of-Capital rate, while the approximated sum of the
present and future SCRs covering the unavoidable market risk (UMRU,lob,≥0)
is calculated as follows:
UMRU,lob,≥0 = max{0.5·BENet,lob(0)·(Durmod,lob–n) (Durmod,lob–n+1)·∆rn; 0}
where
BENet,lob(0) = the best estimate net of reinsurance as assessed at time
t = 0 for the undertaking’s portfolio of (re)insurance liabilities
in the given line of business;
Durmod,lob = the modified duration of the undertaking’s (re)insurance
liabilities net of reinsurance in the given line of business
at t = 0;
n = the longest duration of available risk-free financial
instruments (or composition of instruments) to cover the
(re)insurance liabilities in the given line of business; and
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