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

Segmentation
B.79 In general terms, an assessment of underwriting risk involves an
estimation of <strong>the</strong> variability of <strong>the</strong> underwriting result of <strong>the</strong>
undertaking. This requires underlying data that are sufficiently
homogeneous with respect <strong>to</strong> emergence, development and statistical
pattern of claims. For a heterogeneous product, such as commercial
multi-peril or miscellaneous liability insurance, experience may be
segregated in<strong>to</strong> more homogeneous groupings.
B.80 A suitable segmentation of <strong>the</strong> book of business might be explicitly
defined within <strong>the</strong> formula, or some flexibility could be allowed so that
national particularities can be taken in<strong>to</strong> account. The ongoing
relevance of <strong>the</strong> present EU classification 153 requires fur<strong>the</strong>r
consideration with stakeholders. A standard classification that is more
closely aligned with actual undertaking behaviour should have positive
consequences for risk management.
B.81 Both premium and reserve risk may be analysed on <strong>the</strong> basis of
homogenous segments of <strong>the</strong> portfolio <strong>to</strong> take <strong>the</strong> particularities of <strong>the</strong>
single segments in<strong>to</strong> account. Such a segmented approach <strong>to</strong>
underwriting risk would present <strong>the</strong> problem of how <strong>to</strong> aggregate
individual risk charges. Simply adding up <strong>the</strong> individual charges would
neglect diversification effects between different lines of business. This
may lead <strong>to</strong> an overestimation of <strong>the</strong> required risk capital.
B.82 There are two approaches <strong>to</strong> deal with this problem:
• one may determine premium (or reserve) risk capital charges for
each segment and calculate <strong>the</strong> overall premium (or reserve) risk
capital charge using capital aggregation methods; or
• one may determine only <strong>the</strong> first two moments of <strong>the</strong> distribution
of <strong>the</strong> premium (or reserve) risk for each segment and calculate
<strong>the</strong> first two moments of <strong>the</strong> overall premium (or reserve) risk
using a correlation matrix for <strong>the</strong> second moments. Assuming <strong>the</strong>
overall premium (or reserve) risk <strong>to</strong> have a specific twoparametric
probability distribution, one may <strong>the</strong>n calculate <strong>the</strong>
overall premium (or reserve) risk capital charge.
B.83 The Dutch Financial Assessment Framework, for example, follows <strong>the</strong>
first approach. The advantage of this approach is that for <strong>the</strong>
calculation of <strong>the</strong> capital charges of <strong>the</strong> single segments <strong>the</strong> underlying
probability distribution of <strong>the</strong> risk can be chosen according <strong>to</strong> <strong>the</strong>
particularities of <strong>the</strong> segment. The disadvantage of this approach is
that a standardised aggregation of <strong>the</strong> risk capital charges of <strong>the</strong>
segments is problematic. To be in a position <strong>to</strong> aggregate <strong>the</strong>m in a
ma<strong>the</strong>matically precise manner, <strong>the</strong> complete dependence structure of
<strong>the</strong> risks has <strong>to</strong> be known. This is rarely <strong>the</strong> case.
B.84 The Swiss Solvency Test follows <strong>the</strong> second alternative. According <strong>to</strong>
153 The insurance classes defined in <strong>the</strong> First Council Directive 73/239/EEC.
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