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

- Choice of volume measures
10.57 With regards <strong>to</strong> mortality risk, depending on <strong>the</strong> product design, two
natural candidates for a volume measure appear <strong>to</strong> be <strong>the</strong> technical
provision, if <strong>the</strong> risk of longevity is relevant, and <strong>the</strong> capital at risk for
term insurance at <strong>the</strong> beginning of <strong>the</strong> solvency assessment time
horizon.
10.58 A detailed understanding of <strong>the</strong> insurer’s expense structure and
expense drivers is a key element when determining <strong>the</strong> expense risk.
Using a prospective valuation approach of assets and liabilities means
that all possible future cash flows will have <strong>to</strong> be identified and valued.
Expenses that will have <strong>to</strong> be made in future <strong>to</strong> service an insurance
contract are one of those cash flows for which a provision will have <strong>to</strong>
be calculated.
10.59 Usually all future administrative costs and consequent commissions
would need <strong>to</strong> be considered. Where future deposits or premiums are
fac<strong>to</strong>rs in <strong>the</strong> determination of <strong>the</strong> liabilities, expenses related <strong>to</strong> <strong>the</strong>
deposits or premiums would usually be taken in<strong>to</strong> consideration. In
addition, where appropriate, <strong>the</strong> expenses of administering investments
normally would be taken in<strong>to</strong> consideration <strong>to</strong>o.
10.60 For <strong>the</strong> assessment of lapse risk a pre-specified stress test can easily
be applied. The capital requirement is of <strong>the</strong> form of <strong>the</strong> difference
between a special valuation of policy liabilities and <strong>the</strong> normal
valuation. For <strong>the</strong> special valuation, <strong>the</strong> lapse assumption is multiplied
by a specified fac<strong>to</strong>r greater or less than one. For some policies, an
increase in lapse rates will result in an increase in policy liabilities,
while, for o<strong>the</strong>rs, liabilities will increase when assumed lapses fall. As
an example, in Canada, lapse rates increase for policies in <strong>the</strong> first
class and reduce for those in <strong>the</strong> second class. An appropriate change
assumption might need <strong>to</strong> reflect <strong>the</strong> effects of product and market
variations (e.g., <strong>the</strong> level of interest rates or <strong>the</strong> extent <strong>to</strong> which
surrender options, viewed as embedded financial options, go deeper in
/out of <strong>the</strong> money) and portfolio effects, such as <strong>the</strong> duration of <strong>the</strong>
contract.
10.61 A lapse case, which cannot be addressed in a fac<strong>to</strong>r-based approach
are those products for which lapse risk does not act uniformly over <strong>the</strong>
products’ life, such as lapses at early durations which may reduce <strong>the</strong>
undertaking’s exposure <strong>to</strong> later risks for some policies and not for
o<strong>the</strong>rs.
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