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Annex D (Call for Advice No. 12) Possible approaches for modelling risk mitigation effects D.1 How appropriate allowance for <strong>the</strong> risk mitigation effects of reinsurance may be made in <strong>the</strong> SCR standard formula still needs fur<strong>the</strong>r analysis. For example, nei<strong>the</strong>r measures based on reinsurance premiums nor <strong>the</strong> ratio of net <strong>to</strong> gross technical provisions seems adequate in isolation. D.2 As a first indication of one possible approach, examples are given in this annex setting out how premium and provision statistics for non-life business might be used <strong>to</strong> incorporate allowance for <strong>the</strong> effects of reinsurance in <strong>the</strong> SCR standard formula. However, it is recognised that a number of shortcomings still need <strong>to</strong> be overcome. Reserve risk D.3 According <strong>to</strong> its response <strong>to</strong> CfA 10 (see para. 10.82) CEIOPS recommends testing a personalised, fac<strong>to</strong>r-based approach <strong>to</strong> model reserve risk. Technical provisions would be <strong>the</strong> recommended volume measure and <strong>the</strong> fac<strong>to</strong>r should reflect <strong>the</strong> volatility of <strong>the</strong> run-off result. D.4 Under this approach, <strong>the</strong> mitigation effect of reinsurance on reserve risk may be measured by <strong>the</strong> ratio of technical provisions net of reinsurance <strong>to</strong> <strong>the</strong> technical provisions gross of reinsurance at <strong>the</strong> beginning of <strong>the</strong> solvency assessment time horizon. This ratio might be considered as <strong>the</strong> retention ratio of reserve risk. D.5 This approach might be developed for <strong>the</strong> case of proportional covers (in particular, quota-share covers) and, <strong>to</strong> a lesser extent, <strong>the</strong> case of non-proportional reinsurance. D.6 If <strong>the</strong> reserve risk capital charge gross of reinsurance was measured by reserve, gross RC = f ⋅ TP gross <strong>the</strong>n <strong>the</strong> reserve risk capital charge net of reinsurance could be measured by reserve, net RC = f ⋅ TP net 268
where: TP gross = technical provisions gross of reinsurance TP net = technical provisions net of reinsurance f volatility fac<strong>to</strong>r D.7 The fac<strong>to</strong>r f would be calibrated on <strong>the</strong> basis of gross data and on market level. In principle, for <strong>the</strong> determination of <strong>the</strong> risk capital charge net of reinsurance <strong>the</strong> fac<strong>to</strong>r f could be based on net data. However, since <strong>the</strong> volatility net of reinsurance depends in a complex manner on <strong>the</strong> reinsurance program of <strong>the</strong> insurer, this would require ei<strong>the</strong>r <strong>to</strong> personalise <strong>the</strong> volatility fac<strong>to</strong>r in <strong>the</strong> fac<strong>to</strong>r-based approach or <strong>to</strong> make a market-wide assumption on <strong>the</strong> reinsurance program of any insurer. In <strong>the</strong> first case, <strong>the</strong> resulting model would not be feasible for a standardised approach. In <strong>the</strong> second case, <strong>the</strong> resulting model would superficially avoid <strong>the</strong> problem of recognising reinsurance, but would place fur<strong>the</strong>r strain on Pillar II <strong>to</strong> deal with those undertakings for whom <strong>the</strong> industry-average credit for reinsurance would not be appropriate. By calibrating <strong>the</strong> fac<strong>to</strong>r f on <strong>the</strong> basis of gross data, CEIOPS might obtain a prudent estimate of <strong>the</strong> volatility net of reinsurance. However, for small (and some medium)-sized portfolios where gross volatility is high, this approach might result in insufficient allowance for <strong>the</strong> positive impact of reinsurance. D.8 Where <strong>the</strong> entire business of an insurance undertaking is reinsured on a quota-share basis, this approach completely takes in<strong>to</strong> account <strong>the</strong> risk mitigation of proportional reinsurance. It underestimates <strong>the</strong> risk mitigation of non-proportional reinsurance. Fur<strong>the</strong>r consideration needs <strong>to</strong> be given <strong>to</strong> <strong>the</strong> validity of applying this type of approach by reference <strong>to</strong> subdivisions of an insurance undertaking's business (e.g. line of business). Premium risk Normal claims D.9 According <strong>to</strong> its response <strong>to</strong> CfA 10, CEIOPS recommends testing a personalised fac<strong>to</strong>r-based approach <strong>to</strong> model premium risk for normal claims. Premiums would be <strong>the</strong> recommended volume measure and <strong>the</strong> fac<strong>to</strong>r would reflect <strong>the</strong> expected value and <strong>the</strong> volatility of <strong>the</strong> combined ratio without run-off result. The premium risk capital charge can be disjointed in<strong>to</strong> two summands referring <strong>to</strong> <strong>the</strong> following events: • The premiums are lower than <strong>the</strong> expected value of claims and expenses, thus generating an expected loss; and • The claims expenses turn out higher than <strong>the</strong>ir expected value due <strong>to</strong> <strong>the</strong> volatility of claims and expenses. 269
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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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too few categories
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- Choice of volume measures 10.57 W
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Underwriting risk in non-life insur
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volatility of thei
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those insurers this possible increa
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10.103 A factor-ba
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10.112 Assessing whethe</st
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10.121 The SCR should deliver a lev
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whenever its effects on the
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scenario techniques to</str
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Operational risk just ratings infor
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Call for Advice No. 11 Solvency cap
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Costs and Benefits 11.6 It should b
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• Qualitative requirements for <s
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11.19 Risk management criteria set
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individual undertaking is exposed a
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• sensitivity analyses that have
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• visualizations of flows of prod
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Partial models and the</str
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11.58 There should be few descripti
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of the SCR estimat
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equirements to imp
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Call for Advice No. 12 Reinsurance
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Reflection in technical provisions
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• provide an estimate of an under
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particular reinsurer(s)’ aggregat
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they auto<
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einsurer to <stron
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should be a reduction in risk regar
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Call for Advice No. 13 Quantitative
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• the process of
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• handling questions from insuran
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member countries and in the
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components of the
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Background 14.1 Current insurance D
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14.12 In order to
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groups in its answer to</st
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affected; • Impose restrictions o
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14.43 Regarding the</strong
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off all contracts; • to</
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Call for Advice No. 15 Solvency con
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Minimum capital requirement (MCR) D
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adjusted SCR. From a purely technic
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to be implemented.
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capital
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absolute floor (expressed in euros
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Bolkestein agreed to</stron
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16.14 Generally speaking, complianc
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appoint an additional person <stron
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16.28 It should also be noted that
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Time of application 16.41 The asses
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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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