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

Underwriting risk in non-life insurance
- Definition and main sub-risks
10.66 Underwriting risk is <strong>the</strong> specific insurance risk arising from insurance
contracts. These risks are based on <strong>the</strong> technicalities of <strong>the</strong> insurance
business: <strong>the</strong> insurance undertaking has <strong>to</strong> ensure future payment
commitments, and <strong>the</strong> volume of such payments must be calculated in
advance.
10.67 A distinction can be drawn between:
• reserve risk: relating <strong>to</strong> existing claims on coverage already
provided; and
• premium risk: relating <strong>to</strong> future claims arising from existing
contracts and from renewals and new business during <strong>the</strong> time
horizon
10.68 Reserve risk stems from two sources: on <strong>the</strong> one hand, <strong>the</strong> absolute
level of <strong>the</strong> technical provisions may fail <strong>to</strong> reflect <strong>the</strong> true expected
value of <strong>to</strong>tal losses and may <strong>the</strong>refore consistently underestimate <strong>to</strong>tal
claim volumes. Alternatively, because of <strong>the</strong> s<strong>to</strong>chastic nature of future
claim payouts, <strong>the</strong> actual claims will fluctuate around <strong>the</strong>ir statistical
mean value. The need <strong>to</strong> address both sources depends on <strong>the</strong>
valuation principles underlying <strong>the</strong> technical provisions. For example,
under a best estimate approach, CEIOPS would implicitly assume that
<strong>the</strong> first source of risk had been addressed (although clearly <strong>the</strong>
potential for estimation error arising from <strong>the</strong> uncertainties in <strong>the</strong>
valuation would still need <strong>to</strong> be considered). The level of reserve risk
should reduce as uncertainties are eliminated and information about
<strong>the</strong> claims and <strong>the</strong>ir ultimate settlement costs become known.
10.69 Premium risk is unders<strong>to</strong>od <strong>to</strong> relate <strong>to</strong> future claims arising during and
after <strong>the</strong> time horizon for <strong>the</strong> solvency assessment. Premium risk is
present at <strong>the</strong> time <strong>the</strong> policy is issued, and before any insured events
will have happened. The risk is that <strong>the</strong> volume of incurred losses for
<strong>the</strong>se claims (comprising both losses paid during <strong>the</strong> time horizon and
provisions made at its end) plus expenses is higher than <strong>the</strong> premiums
received. In assessing premium risk, both renewals and new business
during <strong>the</strong> time horizon should be incorporated.
- Choice of structure for modelling approach <strong>to</strong> underwriting risk
10.70 A scenario-based modelling approach <strong>to</strong> underwriting risk would require
<strong>the</strong> definition of a set of scenarios that adequately describe any
adverse development of <strong>the</strong> underwriting result of <strong>the</strong> insurers’
portfolio. Given <strong>the</strong> heterogeneity of underwriting risk, even within
established 'classes' of insurance business, <strong>the</strong> exclusive application of
such an approach does not seem feasible in <strong>the</strong> context of <strong>the</strong> standard
formula.
10.71 However, by nature of <strong>the</strong>ir construction, fac<strong>to</strong>r-based models may be
less able <strong>to</strong> predict extreme, catastrophic events, which constitute an
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