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

Market risk
• actuarial reassessments (for example, inadequate provisions
arising from asbes<strong>to</strong>sis claims); and
• reinsurer default.
A more restricted range might be applied <strong>to</strong> take account of relative
data availability. For example, CEIOPS might include periodic natural
catastrophes, but exclude extreme, episodic events, such as terrorist
activity.
10.84 Market risk arises from <strong>the</strong> level or volatility of market prices of
financial instruments. Exposure <strong>to</strong> market risk is measured by <strong>the</strong>
impact of movements in <strong>the</strong> level of financial variables such as s<strong>to</strong>ck
prices, interest rates, real estate prices and exchange rates. Main subrisks
include interest rate risk, equity and property risk, currency risk
and concentration risk.
10.85 Adequate measurement of market risk assumes <strong>the</strong> availability of
market-consistent valuations. Market values of financial instruments
(including derivatives) are generally available from listings in <strong>the</strong>
various securities markets. Because of <strong>the</strong> lack of liquid markets of life
insurance liabilities, what is <strong>to</strong> be unders<strong>to</strong>od by <strong>the</strong> market value of
liabilities may be approximated by fair value techniques, but needs
fur<strong>the</strong>r analysis coordinated with CfAs 7 and 8 on technical provisions
and IASB. In particular for life insurers, embedded options and <strong>the</strong>
option of <strong>the</strong> life insurance undertaking <strong>to</strong> adjust profit sharing, may
impact market values of liabilities. Fur<strong>the</strong>rmore, changes in market
conditions may influence policyholders’ behaviour, thus changing
market values of liabilities.
10.86 Market risks may be addressed through stress tests. Stress tests are
defined as shock-based changes in risk fac<strong>to</strong>rs, reflected in a change of
available capital: for example, a fall in <strong>the</strong> interest rate by a certain
fac<strong>to</strong>r. The stress is applied <strong>to</strong> simulate changes in <strong>the</strong> level of
available capital. This simulated change in <strong>the</strong> capital is equal <strong>to</strong> <strong>the</strong>
capital charge for that risk. For example, if <strong>the</strong> capital declines by €1m
when a 40% reduction in equity prices is simulated, <strong>the</strong> capital charge
for equity risk should be €1m.
10.87 The stresses <strong>the</strong>mselves should be fixed in <strong>the</strong> regulation. Fur<strong>the</strong>r
analysis will be necessary <strong>to</strong> determine whe<strong>the</strong>r <strong>the</strong> standard formula
should rely on a harmonised set of market parameters (assuming a
well-diversified <strong>European</strong> or worldwide portfolio) or whe<strong>the</strong>r (in an
objective manner) allowance could be given for specific characteristics
of national markets.
10.88 For companies with a material non-linear market risk exposure a single
pre-specified stress test will better reflect <strong>the</strong> actual market risk
inherent in <strong>the</strong> exposure. A pre-specified stress test may increase <strong>the</strong>
complexity of <strong>the</strong> calculation for those insurers and supervisors may
have <strong>to</strong> dedicate more resources <strong>to</strong> verify those results. However, for
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