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

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.
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