CEIOPS' Advice for Level 2 Implementing ... - EIOPA - Europa
CEIOPS' Advice for Level 2 Implementing ... - EIOPA - Europa
CEIOPS' Advice for Level 2 Implementing ... - EIOPA - Europa
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3.4.6. Simplified calculation of the adjustment <strong>for</strong> counterparty<br />
default<br />
3.428 Article 81 of the <strong>Level</strong> 1 text stipulates that recoverables from reinsurance<br />
contracts or special purpose vehicles shall take account of expected losses<br />
due to default of the counterparty. This should be done in two steps.<br />
Firstly, the recoverables are calculated without an allowance <strong>for</strong><br />
counterparty default. Secondly, an adjustment <strong>for</strong> counterparty default is<br />
applied to the result of the first step (see CEIOPS <strong>Advice</strong> CP 44_09, <strong>for</strong><br />
details of the calculation of the adjustment).<br />
3.429 In many cases, in particular if the counterparty is of good credit quality,<br />
the adjustment <strong>for</strong> counterparty default will be rather small compared to<br />
the reinsurance recoverables. At the same time, a sophisticated calculation<br />
of the adjustment can be a very complex task. In order to reduce the<br />
burden of the calculation of the adjustment on the undertaking, it appears<br />
appropriate to provide a simplification <strong>for</strong> the calculation of the<br />
adjustment. The simplified calculation can be defined as follows:<br />
⎛<br />
PD ⎞<br />
= − max⎜( 1 − RR)<br />
⋅ BERe<br />
⋅ Durmod<br />
⋅ ; 0⎟<br />
,<br />
⎝<br />
1 − PD ⎠<br />
AdjCD c<br />
where<br />
AdjCD<br />
= Adjustment <strong>for</strong> counterparty default<br />
RR = Recovery rate of the counterparty<br />
BERec<br />
Durmod<br />
= Best estimate of recoverables taking not account of<br />
expected loss due to default of the counterparty<br />
= Modified duration of the recoverables<br />
PD = Probability of default of the counterparty <strong>for</strong> the time<br />
horizon of one year<br />
3.430 A derivation of the <strong>for</strong>mula can be found in the Annex F.<br />
3.431 The simplification should only be applied if the adjustment can be<br />
expected to be small and there are no indications that the simplification<br />
<strong>for</strong>mula leads to a significant underestimation.<br />
3.432 Since the simplification depends to a certain extent on the values<br />
estimated <strong>for</strong> the parameters RR and PD, <strong>for</strong> the sake of harmonization<br />
and comparability, CEIOPS might develop level 3 guidance setting out<br />
appropriate values <strong>for</strong> these parameters, values which would apply those<br />
undertakings with insufficient resources to derive reliably RR and PD<br />
according a market consistent methodology.<br />
3.433 Such values would be updated on regular basis to guarantee they are<br />
consistent with the in<strong>for</strong>mation available in financial markets. The table<br />
included in annex G offers an example of how harmonization and<br />
comparability might be achieved with the relevant level 3 guidance.<br />
88/112<br />
© CEIOPS 2010