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

addition a range of stresses so that even in stressed circumstances 69
this applied. While <strong>the</strong> SCR could, in principle, capture this, it might be
that an internal model that met CEIOPS criterion failed <strong>to</strong> do so,
because <strong>the</strong> probability of failure of <strong>the</strong> counterparty was considered
very improbable.
9.92 By exposure CEIOPS means <strong>the</strong> amount by which capital would fall if
<strong>the</strong> counterparty is unwilling or unable <strong>to</strong> meet any part of its liabilities.
Thus all contracts with it would become worthless, except <strong>to</strong> <strong>the</strong> extent
that <strong>the</strong>y were guaranteed by a third party independent of <strong>the</strong>
counterparty, covered by collateral (deposited or mortgaged assets
that <strong>the</strong> insurer could use <strong>to</strong> meet <strong>the</strong> liabilities), covered by a
enforceable right of offset (which enables <strong>the</strong> insurer <strong>to</strong> reduce a
liability <strong>to</strong> <strong>the</strong> counterparty if it fails <strong>to</strong> meet liabilities <strong>to</strong> <strong>the</strong> insurer).
In principle, <strong>the</strong> effect of <strong>the</strong> counterparty's insolvency on investments
in third parties should be taken in<strong>to</strong> account. This definition is intended
<strong>to</strong> take in<strong>to</strong> account <strong>the</strong> effect of any mitigants and of any indirect
exposures. Some technicalities of this proposal would need fur<strong>the</strong>r
analysis.
9.93 Some exceptions <strong>to</strong> such a limit would be worth considering. The
following are discussed below:
• exposure <strong>to</strong> subsidiaries;
• government bonds, and o<strong>the</strong>r loans <strong>to</strong> governments or
guaranteed by <strong>the</strong>m;
• short term bank deposits; and
• reinsurance (because it might be impractical <strong>to</strong> impose this
restriction on reinsurance).
9.94 Subsidiaries can be valued by looking through <strong>to</strong> <strong>the</strong>ir assets and
liabilities and consolidating. 70 The subsidiary’s assets and liabilities can
<strong>the</strong>n be reflected in <strong>the</strong> calculation of <strong>the</strong> parent’s SCR. If this is done
and indirect exposure <strong>to</strong> third parties (including o<strong>the</strong>r group
companies) through <strong>the</strong> subsidiary are fully taken in<strong>to</strong> account, <strong>the</strong>n
direct exposure <strong>to</strong> <strong>the</strong> subsidiary could be excluded from <strong>the</strong> rule. This
exclusion would not apply <strong>to</strong> o<strong>the</strong>r group companies (i.e. parents and
fellow subsidiaries). The aggregate exposure <strong>to</strong> <strong>the</strong> group (o<strong>the</strong>r than
<strong>to</strong> subsidiaries) should be taken in<strong>to</strong> account, <strong>to</strong>ge<strong>the</strong>r with indirect
exposures <strong>to</strong> subsidiaries.
9.95 However, <strong>the</strong> practicalities of this approach need <strong>to</strong> be assessed (e.g.
when <strong>the</strong> insurer is not required <strong>to</strong> consolidate <strong>the</strong>ir subsidiaries). In
particular, it might be argued that this exception should not apply when
<strong>the</strong> subsidiary bears insurance risk.
69 For instance if interest rates fell, <strong>the</strong> value of bonds would rise. If assets and liabilities were broadly
matched, <strong>the</strong> capital might not change significantly, but a bond that was 90% of capital might represent
110% of capital. It would be unfortunate if <strong>the</strong> fall in interest rates led <strong>to</strong> <strong>the</strong> insolvency of <strong>the</strong> issuer.
70 See also answer <strong>to</strong> CfA 18.
67