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

Dutch supervisory authority for <strong>the</strong> Financial Assessment Framework
and by <strong>the</strong> IAA in <strong>the</strong> ultimate loss approach.
Incorporation of scenario outcomes
B.73 For each scenario (Si), one would need <strong>to</strong> specify:
• <strong>the</strong> probability of occurrence (pi); and
• <strong>the</strong> impact on <strong>the</strong> underwriting result (ci).
B.74 The impact should take in<strong>to</strong> account risk mitigation techniques, such as
reinsurance. This may be difficult, particularly in <strong>the</strong> case of nonproportional
reinsurance.
B.75 Supposing that <strong>the</strong> risk capital charge for underwriting risk is given by
technical
RC ρ −α
( UR
= 1
technical
)
where all terms are as defined previously, and <strong>the</strong> random variable
UR technical follows distribution function F, one can
• calculate <strong>the</strong> shifted distribution of F, if scenario Si was <strong>to</strong> occur,
such that Fi(t) = F(t+ci);
• define G <strong>to</strong> be <strong>the</strong> probability-weighted average of <strong>the</strong> shifted
distribution functions Fi…Fn and F; and
• recalculate RC technical assuming that UR technical follows distribution G.
B.76 The 3-step 'shifting technique' allows CEIOPS’ assumptions on
probability and severity of scenarios <strong>to</strong> be incorporated in a pragmatic
way, but it represents just one possible approach. Instead of assuming
a simple shift of <strong>the</strong> underlying UR technical distribution, one might also
consider changes in <strong>the</strong> shape of <strong>the</strong> distribution resulting from <strong>the</strong>
scenarios <strong>the</strong>mselves.
B.77 An alternative approach <strong>to</strong> incorporate <strong>the</strong> results of scenario testing is
used in <strong>the</strong> domestic model employed in Finland. Certain extreme
events are directly incorporated within a fac<strong>to</strong>r-based model, although
undertakings <strong>the</strong>mselves are required <strong>to</strong> define and perform stress
tests for 'supercatastrophes.' These consider <strong>the</strong> impact across all
business segments under an assumption of partial reinsurance failure.
The result is a supplementary capital charge under Pillar I.
B.78 A more straightforward approach might be <strong>to</strong> require a separate
catastrophe provision ra<strong>the</strong>r than (or in addition <strong>to</strong>) a capital charge.
Also, risk mitigation achieved by pooling arrangements for e.g. natural
catastrophes might offer an alternative <strong>to</strong> capital requirements.
251