Flashcards in Solvency II Pillar 1 Detail Deck (32):
What are the 3 components of assets in SII balance sheet?
1. Investments (market value)
2. Reinsurance recoveries (asset not liab reduction)
List the ideas on how to specify the discount rate?
1. Swap rates or government bond yields
2. Extent to which each should be adjusted e.g. swaps adjusted to allow for credit risk
What are the risk groups the SCR covers
1. non-life/life/health underwriting risk
2. Market risk (equity/prop/interest/credit/currency/concentration/illiquidity)
3. Counterparty default risk
4. ops risk
What are the possible ways to calculate SCR?
1. internal model
2. standard formula
3. sf with part im
4. sf with simplifications
5. sf with undertaking specific parameters
What are the main sections in calculating BSCR (basic SCR)
insurance (life/health/non-life separated)
Under insurance risk module for BSCR, what risks are there?
catastrophe e.g. pandemic
Give 2 examples of stresses in the market/insurance risk modules?
property down 25%
mortality permanently up 15%
How do we calculate the individual SCR from a stress
NAV (unstressed) - NAV (stressed) gives the capital required to survive the stress
e.g. 50 free before, 20 free after means stress causes a 30 decrease. so definitely need 30 as a cap req!
What are type 1 and 2 exposures for counterparty default risk?
1 = counterparty likely to be rates, not diversified default risk (bonds/deposits/reinsurance etc.)
2 = counterparty unlikely to be rates, diversified default risk (receivables from intermediary/policyholders)
What adjustments are made to the BSCR to get the SCR?
SCR=BSCR+SCR(ops risk) + Adj
Where Adj = allowance for deferred tax or loss absorbing technical provisions e.g. reduction of discretionary benefits
Why is good quality data crucial?
1. More consistent/accurate results
2. Wider range of methodologies possible
3. Validation of methods is more reliable and leads to more credible conclusions
4. Effective comparisons over time possible
What tests must the IMAP pass?
1. use test
2. statistical quality standards
3. calibration standards
4. profit/loss attribution
5. validation standards
6. documentation standards
What makes up the liabilities side in the pillars diagram (include free surplus and what technical provisions are)
Technical Provisions = BEL + risk margin
SCR (including MCR)
What type of capital is needed to voer the SCR/MCR?
2 ways to value assets? Why is this a change?
1. market value (MC)
2. Marked to model as long as consistent with market consistent approach ie. amount to exchange between 2 parties etc.
Most of europe were using book values
What is a market consistent basis for technical provisions?
Amount insurer would have to pay in order to immediately transfer its liabs to another insurer
What are technical provisions?
BEL + risk margin
What are BEL?
PV expected future cashflows (ben + expenses - prem) on BE assumptions and risk free disc rate
If a liability is hedgable what can you do?
Use the hedging instrument's MV
How are non-par/par/ul business BEL likely to be determined?
ungrouped/grouped with validation of accuracy/unbunbled unit res and non-unit res
What types of assumptions are there in SII BEL?
Allow for all expected decrements and ph actions
Allow for future premiums up till contract boundary (at which point company can change contract to reflect experience)
Discretionary benefits in WP need to be accounted for and reflect realistic management/ph actions
How will financial guarantees and options be modelled under SII
1. MC stochastic model and sims
2. Deterministic closed form solution
In determining the sII discount rate, how are currencies takeninto account?
Consistent between currencies
Including those with no active bond/swap market or one without long enough durations
What is illiquidity premium and when would an illiquidity premium be used? What is the suggested alternative?
Compensation an investor gets for holding illiquid asset (or a long term insurance liability!)
Used in the discount rate to increase it, hence lower BEL
Alternative is to use counter cyclical premiums - only increase discount rate in times of financial stress
What is a matching adjustment? When is it used?
1. Used for companies with 'hold to maturity' assets and long term predictable liabs which are very well matched even after allowing for impacts on cashflows of defaults/downgrades
2. Allows the company to take account of extra return from illiquid bonds and so use higher discount rate
3. Applies to annuity business
What is the main method to calculate the risk margin above the BEL?
Cost of capital method
Explain what the risk margin is for and how this relates to the technical provisions and BEL
1. TP = BEL + RM
2. Remember that TP is the amount that a company would have to pay to exchange its liabs with another insurer
3. and BEL is the best estimate of its future profits
4. So Risk margin is that extra amount in compensation a company would want to take on the liabs, as it has the risk of experience not being as expected and their being a cost of holding reg. capital against the liabs
What risks are included in the cost of capital method
it's the cost of holding capital for RISKS THAT CAN'T BE HEDGED in financial markets
reinsurance credit risk
residual market risk (like when no assets in market of matching duration of liabs)
Explain how to calculate the risk margin using the cost of capital method in 10 steps.
1. Project future capital required to hold at end of each year assuming run-off business - these amounts are risks that can't be hedged and are subsets of the SCR
2. Multiply amounts in (1) by cost of capital rate
3. Discount each value in (2), using risk free rates to give overall risk margin
In the cost of capital method, why is there a circular reference, how is it overcome?
1. Circular because step (1) of CoC requires SCR, but SCR calculation requires CoC
2. Simplified approaches are used, especially because SCR calc is complex too
Give examples of simplified approaches to calculate step 1 in the CoC method?
1. Select a driver with an approximate linear relationship with capital requirement or components e.g. sum at risk or reserves
2. Express cap reqs as % of the driver e.g. sum at risk at time 0 = 100, SCR = 10, so 10/100=10%. So if at time 2 SaR was 200, then approx SCR = 0.1*200=20
3. Could combine multiple drivers and use correlations