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

Risk classification
10.23 To <strong>the</strong> extent possible, Pillar I quantitative requirements should be
designed <strong>to</strong> address <strong>the</strong> main financial risks <strong>to</strong> which an insurance
undertaking is exposed. As a general principle, a Pillar I treatment may
be applied <strong>to</strong> any risk which is susceptible <strong>to</strong> quantification or
limitation. However, risks may be excluded from an explicit
requirement in Pillar I if, for example:
• on average, <strong>the</strong> risk is considered marginal;
• simplifying assumptions can be made; or
• a standardised risk treatment would not be practicable.
By contrast, Pillar II should consider all risks, even if <strong>the</strong>y cannot be
quantified. The relative emphasis on Pillar II requirements in <strong>the</strong>
solvency framework will depend on <strong>the</strong> adequacy of Pillar I treatments.
10.24 It should be noted that <strong>the</strong>re is no unique way of breaking down risks
in<strong>to</strong> categories. A categorisation that provides a good fit <strong>to</strong> <strong>the</strong> risk
profile of one undertaking may be less appropriate in o<strong>the</strong>r
circumstances. This will depend largely on <strong>the</strong> nature, scale and
complexity of <strong>the</strong> business undertaken by an individual undertaking. In
addition, <strong>the</strong> practicability criterion means that some subcategories of
risk could be treated in a Pillar I internal model, but not a Pillar I
standardised formula.
10.25 Based on <strong>the</strong> work of <strong>the</strong> IAA, <strong>the</strong> risks faced by a typical insurance
undertaking could be categorised under five major headings:
• underwriting risk: specific insurance risk arising from <strong>the</strong>
underwriting of insurance contracts, associated with both <strong>the</strong>
perils covered and <strong>the</strong> processes followed in <strong>the</strong> conduct of <strong>the</strong>
business;
• market risk: risk arising from <strong>the</strong> level or volatility of <strong>the</strong> market
prices of financial instruments;
• credit risk: <strong>the</strong> risk of default and change in <strong>the</strong> credit quality of
<strong>the</strong> issuers of securities, counterparties (notably reinsurers) and
intermediaries <strong>to</strong> whom an undertaking has an exposure;
• operational risk: risk of loss resulting from inadequate or failed
internal processes, people, systems or from external events;
• liquidity risk: exposure <strong>to</strong> loss in <strong>the</strong> event that insufficient
liquid assets will be available <strong>to</strong> meet <strong>the</strong> cash flow requirements
of policyholder obligations as <strong>the</strong>y fall due, or <strong>the</strong> assets may
only be realised under excessive costs
In view of ongoing work by <strong>the</strong> Joint Forum, liquidity risk has been
added as a separate risk category.
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