Answers to the European Commission on the ... - Eiopa - Europa

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• identify <strong>the</strong> counterparties <strong>to</strong> be used and evaluate <strong>the</strong> credit risk associated with <strong>the</strong>se operations; • identify <strong>the</strong> procedures for ongoing moni<strong>to</strong>ring of <strong>the</strong> arrangements with a review <strong>to</strong> be undertaken at least on an annual basis; and • demonstrate that <strong>the</strong> ART arrangements are appropriate in relation <strong>to</strong> <strong>the</strong> risks <strong>to</strong> be covered. Financial hedging through <strong>the</strong> use of derivatives 12.30 The answers given <strong>to</strong> CfAs 5, 6 and 9 form <strong>the</strong> basis for <strong>the</strong> use of derivatives. Insurers can use derivatives as a risk mitigation (including in this context diversification) mechanism on ei<strong>the</strong>r <strong>the</strong> asset or <strong>the</strong> liability side of <strong>the</strong> balance sheet. In this answer, derivatives used in connection with liabilities, are discussed in <strong>the</strong> section on ART. 12.31 The use of <strong>the</strong>se products should contribute <strong>to</strong> <strong>the</strong> reduction of both market and credit risk, and <strong>to</strong> o<strong>the</strong>r ALM considerations. Insurers must have <strong>the</strong> ability <strong>to</strong> recognise, measure, and prudently manage <strong>the</strong> risks associated with <strong>the</strong> use of derivatives 12.32 CEIOPS considers that besides <strong>the</strong> advice given on reinsurance here it would be crucial <strong>to</strong> define <strong>the</strong> criteria governing <strong>the</strong> Reinsurance Management Strategy in <strong>the</strong> form of supervisory guidance at a later stage. 12.33 The CfA clearly mentions not only reinsurance but also o<strong>the</strong>r risk mitigation techniques, on both <strong>the</strong> asset side and <strong>the</strong> liability side. On this basis CEIOPS will divide CEIOPS’ advice in<strong>to</strong> three main parts: <strong>the</strong> first one addressing reinsurance, <strong>the</strong> second focussing on alternative risk transfer and <strong>the</strong> third concerning derivatives. CEIOPS' Advice Risk mitigation measurement Meaning of risk mitigation (including by means of reinsurance) 12.34 The underlying impact on risk associated with risk mitigation (reinsurance) should be treated consistently, regardless of <strong>the</strong> legal form of <strong>the</strong> protection. 12.35 The prime consideration is <strong>the</strong> extent of risk transfer. The different risk characteristics (including risks transferred and acquired) of various covers will need <strong>to</strong> be taken in<strong>to</strong> account. 12.36 Terms such as 'traditional reinsurance', 'non-traditional reinsurance' and 'Alternative Risk Transfer' are not well-defined in <strong>the</strong> sense that <strong>the</strong>re is no universal common understanding of <strong>the</strong>ir meanings; nor do 142
<strong>the</strong>y au<strong>to</strong>matically reflect <strong>the</strong> level of risk mitigation associated with products. The colloquial usage of terminology is inadequate when seeking <strong>to</strong> quantify <strong>the</strong> effects of risk mitigation, but is useful in making general distinctions between different types of reinsurance management. Reflection in <strong>the</strong> MCR 12.37 In principle, <strong>the</strong> MCR should allow for <strong>the</strong> effects of risk mitigation (reinsurance). The extent <strong>to</strong> which this can be achieved in practice will depend on <strong>the</strong> functional form of <strong>the</strong> MCR. Reflection in <strong>the</strong> SCR 12.38 It is essential that <strong>the</strong> determination of <strong>the</strong> SCR (by application of <strong>the</strong> SCR standard formula or o<strong>the</strong>rwise) allows for <strong>the</strong> impact on an undertaking's risk profile of risk mitigation (reinsurance). 12.39 Provided <strong>the</strong> general requirements for internal models are satisfied, <strong>the</strong>re should be no fur<strong>the</strong>r restriction on allowing for <strong>the</strong> impact of reinsurance on capital requirements when <strong>the</strong> SCR is calculated under this approach. 12.40 As an example, <strong>the</strong> answer <strong>to</strong> CfA 10 outlines a modelling approach for underwriting risk in non-life insurance using fac<strong>to</strong>r-based modelling, supplemented with stress tests <strong>to</strong> take account of low-frequency, highseverity events. The fac<strong>to</strong>rs and volume measures should be adjusted <strong>to</strong> reflect <strong>the</strong> impact of risk mitigation by means of reinsurance. Stress tests should take in<strong>to</strong> account <strong>the</strong> reinsurance programme of <strong>the</strong> insurance undertaking. Simultaneously, <strong>the</strong> risk of reinsurance cover failure should be reflected within <strong>the</strong> assessment of credit risk. 12.41 In principle, <strong>the</strong> determination of an equivalent <strong>to</strong> <strong>the</strong> SCR (by application of <strong>the</strong> SCR standard formula or o<strong>the</strong>rwise) should also be by reference <strong>to</strong> <strong>the</strong> position of <strong>the</strong> undertaking without allowance for <strong>the</strong> impact of risk mitigation (reinsurance) on <strong>the</strong> undertaking's risk profile. For clarity, this should be distinguished from <strong>the</strong> SCR and not be considered a solvency control level. It will be useful <strong>to</strong> supervisors in a number of areas, including in making decisions related <strong>to</strong> Pillar II. 12.42 To be capable of adequately reflecting <strong>the</strong> effects of risk mitigation, <strong>the</strong> risk measure underlying <strong>the</strong> SCR should be TailVaR. 12.43 Conceptually, <strong>the</strong> SCR should be determined by reference <strong>to</strong> <strong>the</strong> risks <strong>to</strong> which an insurer is exposed, considered at <strong>the</strong> level of <strong>the</strong> whole undertaking. Practically, in order <strong>to</strong> adequately reflect <strong>the</strong> effects of risk mitigation, <strong>to</strong> <strong>the</strong> extent that <strong>the</strong> standard formula applies by reference <strong>to</strong> some sub-division of <strong>the</strong>se risks, it will be necessary for <strong>the</strong> allowance in <strong>the</strong> standard formula for <strong>the</strong> effects of risk mitigation <strong>to</strong> also apply at <strong>the</strong> same level of sub-division. 143
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CEIOPS-DOC-07/05 Answers</s
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Style convention The following has
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• Safety measures (CfA 9); • So
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sole purpose is to
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Call for Advice No. 7 Technical pro
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one year). Therefore, capital requi
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perhaps through an explicit additio
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Discounting 7.22 The present value
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exposed to risk fr
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insurance liabilities set by refere
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Profit sharing In practice, for uni
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future cash flows will have <strong
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Explanatory text S
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always have resources to</s
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developed. They would help
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8.28 A fourth option could be envis
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In principle, "the
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8.48 Three alternatives can be cons
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essential part of the</stro
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statistical estimate (with a level
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8.77 It may be argued that
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to use more sophis
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consequence on the
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8.105 In some cases, the</s
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This shall be reviewed, at least an
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ut the exposure <s
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Explanatory text M
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9.15 Solvency II could also employ
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9.28 The life formula yields itself
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underestimate them
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'Prudent person plus' approach 9.52
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Uniform or different rules for tech
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through a prescribed list. Lists ar
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addition a range of stresses so tha
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(including the Rei
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for review of the
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eligibility criteria, or principles
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should not lead to
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• the degree of
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9.156 The senior management shall r
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- going-concern aspects of business
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features. 81 TailVaR is an example
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10.17 The SCR should also reflect <
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10.26 The risk of asset liability m
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Naturally, the pra
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of the individual
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Background 17.1 This document aims
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Review Panel would be a permanent g
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• the developmen
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asis for considering improvements <
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(I) Regulatory arb
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(II) Capital requirements at group
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into a SCR at grou
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18.31 Additionally, it must be deci
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Capital requirements 18.39 The Fram
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(III) Supervisory Review Process of
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18.60 In view of the</stron
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new structure would need to
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future Framework Directive. CEIOPS
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18.94 Model validation in t
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the assumptions us
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Annexes Annex A (Call for Advice No
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pursuing a strategy which t
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Specific principles for non-life in
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Conformity, suitability and suffici
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• existence of significant insuff
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A.64 In the tests
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the rules on <stro
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TVaR1-α for Tail Value-at-risk. In
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Degree of personalisation B.24 Tran
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B.34 There are two approaches <stro
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Segmentation B.44 In general terms,
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technical technical technical techn
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B.61 The second alternative was cho
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Dutch supervisory authority for <st
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Market risk Equity risk this altern
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B.95 In a scenario-based approach,
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B.106 As an alternative one could t
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where: KTSA = the
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Results from the a
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Solvency ratio prior to</st
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Number of instances Risk group Deta
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Conclusion In general, the<
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where: TP gross = technical provisi
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premium risk, the
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“While proportional reinsurance t
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contribute with any additional info
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E.29 Another way <
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programmes on the
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