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

impact market and credit risk (e.g. when changes in assets values are
connected <strong>to</strong> with-profit insurance contracts).
10.32 Pillar II should cover all aspects of ALM systems that lie outside <strong>the</strong>
scope of quantification in <strong>the</strong> SCR standard formula and cannot be
addressed by economic capital. For example:
Liquidity risk
• <strong>the</strong> duration gap between assets and liabilities needs <strong>to</strong> be
managed actively according <strong>to</strong> an undertaking's business
objectives;
• assumptions on <strong>the</strong> modelling of macro-economic conditions,
assets, liabilities, policyholder behaviour and management
actions need <strong>to</strong> be plausible and consistent with management
strategies;
• ALM systems should be closely integrated with <strong>the</strong> process of
defining business strategies.
10.33 ALM coordinates <strong>the</strong> cash flows on <strong>the</strong> asset and liability side of <strong>the</strong>
balance sheet and thus proves <strong>to</strong> be an effective <strong>to</strong>ol for reducing
liquidity risk in both life and non-life insurance. For a large portfolio of
life business, cash flows should be reasonably predictable on a one year
time horizon because of <strong>the</strong> law of large numbers.
10.34 Effective liquidity planning should address most sources of liquidity risk
and can be tested under Pillar II. O<strong>the</strong>r sources of liquidity risk may be
considered implicitly under Pillar I through <strong>the</strong> assessment of o<strong>the</strong>r risk
categories. For example, in life business, an increase in lapse rates
could be assessed through its impact on an undertaking's market and
underwriting risk exposures.
Methodology for developing <strong>the</strong> standard formula
10.35 The SCR will play a central role in ensuring that insurance undertakings
hold financial resources commensurate with <strong>the</strong> risks <strong>to</strong> which <strong>the</strong>y are
exposed. However, <strong>to</strong> be an effective <strong>to</strong>ol, a standardised, transparent
and well-unders<strong>to</strong>od method for calculating <strong>the</strong> SCR is necessary.
10.36 The calculation of <strong>the</strong> SCR by a standard formula should be technically
feasible for all insurance undertakings. But it should be recognised that
no standard formula would be capable of delivering a good measure of
economic capital requirements in every case. In this respect, <strong>the</strong>
availability of internal models and appropriate Pillar II responses
(where an undertaking is unable <strong>to</strong> develop an adequate model) will be
important safeguards.
10.37 As requested by CfA 10, CEIOPS has considered various modelling
approaches for <strong>the</strong> risk categories under <strong>the</strong> SCR standard formula.
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