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

<strong>the</strong> rules on <strong>the</strong> calculation of <strong>the</strong> technical provisions <strong>to</strong> be developed
as part of <strong>the</strong> future solvency framework (cf. CfA 7 – technical
provisions in life insurance).
B.6 If <strong>the</strong> technical provision is defined as a sum of <strong>the</strong> best estimate and a
risk margin that reflects <strong>the</strong> volatility of <strong>the</strong> claims, it may also be
possible <strong>to</strong> choose <strong>the</strong> best estimate as <strong>the</strong> volume measure. However,
such a choice would need <strong>to</strong> be reflected in <strong>the</strong> degree of volatility that
is taken in<strong>to</strong> account in <strong>the</strong> definition of <strong>the</strong> coefficient applicable <strong>to</strong> <strong>the</strong>
volume measure.
- Lapse risk
B.7 With regards <strong>to</strong> lapse risk <strong>the</strong>re are two primary effects of
unanticipated lapse rates. The first involves <strong>the</strong> payment of surrender
or termination values. The relationship of <strong>the</strong> amount of a surrender
payment <strong>to</strong> <strong>the</strong> value of <strong>the</strong> liability being held in respect of a particular
policy is of great importance. When a policy lapses <strong>the</strong> insurer pays <strong>the</strong>
surrender value and 'receives' <strong>the</strong> actuarial reserve that is released by
<strong>the</strong> policy’s termination. If surrender values are lower than policy
reserves, <strong>the</strong> insurer is at risk from lapse rates that are lower than
expected, particularly if high lapse rates were anticipated in <strong>the</strong> pricing
of a product. The case that surrender values exceed policy reserves
results in higher lapse rates being unfavourable <strong>to</strong> <strong>the</strong> insurer.
However, if according <strong>to</strong> IAIS, technical provisions must not be lower
than surrender values, <strong>the</strong>re is no risk in an increase in lapse rates.
B.8 The second primary effect of unanticipated lapse rates is that <strong>the</strong>
insurer may not realise <strong>the</strong> expected recovery from future premiums of
initial policy acquisition expenses. These acquisition expenses may be
recognized implicitly in financial statements through <strong>the</strong> use of
modified net level premium valuation methods. These implicit methods
currently do not include any provision for un-favourable variations in
lapse rates. Under a best estimate plus a risk margin valuation
approach <strong>the</strong>se unfavourable variations should be partly included in <strong>the</strong>
risk margin.
B.9 A capital requirement with respect <strong>to</strong> <strong>the</strong> first type of lapse risk (cf.
B. 7) requires <strong>the</strong> division of an insurance company’s policies in<strong>to</strong> two
classes: first those policies for which <strong>the</strong> technical provisions TP are
greater than surrender values S, and second those policies for which S
> TP. This suggests choosing S–TP and TP-S, as volume measures for
<strong>the</strong> first type of lapse risk.
B.10 For <strong>the</strong> second type of lapse risk (cf. B.8), <strong>the</strong> technical provision
seems <strong>to</strong> be <strong>the</strong> appropriate volume measure. Within a best estimate
plus a risk margin valuation approach <strong>the</strong> technical provision will need
<strong>to</strong> include a provision for <strong>the</strong> impact of unfavourable variations in lapse
rates on <strong>the</strong> expected recovery of <strong>the</strong> acquisition expenses.
- Expense risk
B.11 A detailed understanding of <strong>the</strong> insurer’s expense structure and
expense drivers is a key element when determining <strong>the</strong> expense risk.
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