To discount cash flows and determine the bond prices, we use the nominal interest rate term structure of the European central bank and a Smith—Wilson extrapolation [ 42 ] towards an ultimate forward rate UFR for interest rates after 20 years see Fig.
Treatment of solo insurers within the group solvency calculation
We assume that the fictitious insurer has no BOF, so the asset value is equal to the value of the liabilities. To construct the bond portfolio, we pick 5- and year bonds. Via this duration, we determine the amount invested in the 5- and year bonds. For both the characteristics of the portfolio and the composition of the asset portfolio, we will later perform a sensitivity analysis.
We use the mortality table of the Dutch Actuarial Society: AG , 6 developed in , which contains a longevity trend. Note that there is no risk involved in equity, interest rates and longevity other then the stress scenarios. We denote the vector of the SCRs for all three risk classes as an allocation. The data is from the European Central Bank; 8. The data is daily and is from the Bank of England. Euro vs Euribor IR swap rates. The daily data is downloaded from Datastream and covers a period from to To transform the principal components and eigenvectors into a VaR and an ES, we use the method described by Fiori and Iannotti [ 27 ].
We describe and discuss the method we use in Appendix 2. For every dataset, we derive a shock scenario for the annualized interest rate returns. For each maturity, the overall interest rate shock is the average of the four stress shocks. The stress scenarios are then applied to the assets and liabilities of the fictitious life annuity insurer as described in Sect. We calibrate the longevity stress scenarios by assuming that annual mortality rate improvements follow a Gaussian distribution as prescribed by CEIOPS [ 13 ]. The same shock in mortality rates is used for all different ages.
Annual mortality rate changes are calculated per country, per age band and per year based on the data from the Human Mortality Database.
- Ratings & Research.
- Conscious Union with God (Acropolis Preservation Series Book 2)?
- Sams Teach Yourself iPad 2 in 10 Minutes (Sams Teach Yourself -- Minutes).
- Take Me, Break Me, Book 1 (Pierced Hearts).
- Solvency II | Insurance Europe.
We compute the means and standard deviations of the annual mortality rate improvements, and we assume that all annual mortality rate improvements have a Gaussian distribution. In this case we have Gaussian distributions, since we have nine countries and 22 different age bands. This is than summarized into a longevity shock for all age cohorts. We propose to determine the average of all age cohorts to determine the age-independent longevity shock. So, we take the average of all VaRs or ESs. By comparing these allocations for VaR and ES, we can see whether the current method, which uses VaR, underestimates or overestimates certain risks.
The stress scenarios used to determine the SCR are derived as prescribed by EIOPA, that means that the interest rate stress scenarios are calibrated using PCA and the longevity stress scenarios are calibrated assuming Gaussian distributions. We call this the base case. By using ES to determine the shocks, the longevity risk and the interest rate shocks are more harmful and the equity risk shock is milder. These changes do not add up to zero since the amounts of SCR for the different risk measures differ.
This follows from the observation that the tails for equity returns are fat see, e. Historical simulation is a popular method in practice. The empirical performance of historical simulation has been examined by, e. Historical simulation is a resampling method which does not assume any distribution about the underlying risk process.
For this non-parametric model, we assume that the distribution of past returns is a perfect representation of the expected future returns. The advantage is that we do not impose any assumptions about the underlying probability distributions. Historical simulation is heavily sensitive to the length of the sample of past returns see, e. If we apply historical simulation to the three risk classes, the equity SCR remains unchanged as the equity shock was already determined empirically. For the interest rate SCR, we use the annualized absolute interest rate changes of the four datasets as described in Sect.
Per dataset and for each maturity, we calculate the empirical VaR and ES and this leads to a vector of absolute up and down shocks. The percentage interest rate stress vectors per dataset are then computed by dividing it by the average interest rates for each maturity. Since the swap rates are not defined for all maturities between 1 and 20 years, linear interpolation is used to determine the swap rates for these maturities.
The average of the four up and down shock vectors has been taken to determine the overall up and down shock vector. For this dataset, we calculate an empirical VaR and an empirical ES. The empirical VaR or the empirical ES serve as the stress rate for longevity risk for all age cohorts. The first horizontal axis represents the annual holding period return of equity upper graph or the annual longevity changes lower graph. For the second horizontal axis, we display the survival distribution 1—cumulative distribution of the empirical distribution.
This helps us to determine the quantiles of the distribution. The vertical axes represent the frequency. One of the main characteristics of the VaR is that it does not consider the shape of the tail. When the distribution has a heavy tail beyond the VaR level, then this might lead to an underestimation of the risk. In Fig. In this section, we study the sensitivity of our results.
We do this by changing the composition of the asset portfolio and the liability portfolio of the fictitious life annuity insurer. As described in Sect. Figures 9 , 10 , 11 and 12 in Appendix 3 show the change in allocation of the reduced total SCR for the three different risk classes when ES is used to calibrate the shock scenarios instead of VaR for the different asset portfolios. To see how sensitive our results are to the composition of the asset portfolio we can compare these figures with Fig.
When the equity holdings in the portfolio increase, we find a similar trend as in the base case. This figure differs from the base case if we consider the percentage change in SCR per risk class. Whereas the relative change in equity SCR grows in comparison with the base case, the change in longevity SCR and interest rate SCR decreases in comparison with the base case.
From comparing Figs. The percentage change per risk class differs if the equity holdings change in the portfolio, but the main trends remain similar. However, the longevity SCR for the old company is 5. The interest rate SCR for the old company is however 6. So, interest rate risk dominates the effect on the total SCR.
These findings for the young life annuity insurer are qualitatively similar. To see how sensitive our results are to the composition of the liability portfolio we can compare Figs. If we compare Figs. The SST uses a holistic approach by taking all risks into the capital requirement calculations, while solvency II has a modular approach. This difference is driven by increases in SCR for all three risk modules.
The Basel III framework is a global regulatory framework for banks which is planned to be implemented in Basel III was set up in a different manner than solvency II since it is a regulatory framework for a different part of the financial industry. The regulation uses however also stress scenarios to see the impact of shocks on certain risk drivers. Note that longevity risk is much less severe for banks.
First, we calibrate the SCR stress scenarios for equity risk, interest rate risk and longevity risk based on value-at-risk and expected shortfall. These results are robust in terms of variation with the composition of the asset and liability portfolio of the life annuity insurer. To test the sensitivity of our results to the calibration methods used by EIOPA, we compare the results with the SCR allocations when the stress scenarios are determined empirically.
Adding a risk margin based on the total SCR would lead to a circular argument. The coupon rates are based on the 5- and year UK Gilt bonds on December 31st, If the fictitious life annuity insurer applies duration matching, we still find that the down-shock is more harmful than the up-shock. The author thanks Wouter Alblas for excellent research assistance.
Preliminary results of this article were based on his excellent MSc thesis at the University of Amsterdam under the author's supervision. Skip to main content Skip to sections. Advertisement Hide.
- Sparkle: A Novel.
- The Captivity of Elizabeth Hanson: A Quaker Kidnapped by Native Americans in 1725.
Download PDF. Solvency II solvency capital requirement for life insurance companies based on expected shortfall. Open Access. First Online: 14 October We do not consider operational risk, and the adjustment for the risk absorbing effects of technical provisions and deferred taxes. Moreover, we only consider equity risk, interest rate risk and longevity risk.
Market risk and life risk account together for approximately Moreover, EIOPA [ 24 ] shows that the market risk predominantly consists of equity and interest rate risk. Open image in new window. The market SCR is a combination of the different market risks, in this case equity risk and interest rate risk. This negative shock implies that the value of equity decreases with a certain percentage. To determine the solvency capital requirement for interest rate risk, an upward and a downward shock are given to the interest term structure.
These shocks to the interest rates are expressed as the relative amounts compared to the current interest rates. Using an alternative term structure results in a change of the value of the assets and liabilities. The solvency capital requirements for the downward and upward shock are determined by the changes in the BOF if the shocked interest rate curve is used instead of the nominal term structure. The interest rate shock is the worst of the up and down shock.
We focus on the relative impact on the SCR for the three risk classes. In this section, we calibrate stress scenarios for equity risk, interest rate risk, and longevity risk based on the value-at-risk and the expected shortfall. After we calibrate the distribution of the risks, we derive stress scenarios based on the VaR and ES.
These stress scenarios will be applied to the representative life annuity insurer in Sect. EIOPA [ 26 ] proposes stress scenarios given by a shock of the underlying risk. This risk may be multi-dimensional, which is the case for interest rate risk. Interest rate SCR is calculated via shocks for every duration see 7 — 9.
The data from Bloomberg consists of daily returns for a period of 41 years, starting in June until June We convert this into annual holding period returns for every working day, with an overlapping horizon. Even though the differences are small, calibrating with VaR leads to larger stress rates. We get for the fictitious insurer that the down-shock is more harmful than the up-shock.
Solvency II Delegated Act – Frequently asked questions - Europa Nu
This is partially due to the fact that duration is not fully hedged. Reduced total SCR From this table we get that the longevity shocks are more harmful if the SCR is determined empirically. This effect dominates the increase in the reduced total SCR. The stress scenarios used to determine the SCR are this time determined empirically. We also see this in Fig. Comparing Figs. This increase is at the expense of a lower interest rate SCR. By comparing the empirical distribution of the tail of the data used for equity risk and longevity risk we can explain why the differences are largest at approximately The downside tails of the data used for equity risk and longevity risk are shown in Fig.
In this figure, both graphs have two horizontal axis. The first horizontal axis represents the annual holding period return for equity risk and the annual mortality rate changes for longevity risk. On the second horizontal axis, we display the survival distribution 1—cumulative distribution. We show this comparison for the following liability portfolios: young life annuity insurer: policyholders with an average age of 35; base case life annuity insurer: policyholders with an average age of 50; old life annuity insurer: policyholders with an average age of All other assumptions are as in the base case in Sect.
We here ignore all other differences of the SST regulation. Acknowledgements The author thanks Wouter Alblas for excellent research assistance. Acerbi C Spectral measures of risk: a coherent representation of subjective risk aversion. Acerbi C, Szekeley B Backtesting expected shortfall. Risk Mag —6 Google Scholar. Acerbi C, Tasche D On the coherence of expected shortfall. J Bank Financ — Google Scholar. The process towards a new pan-European solvency regime has been slow, repeatedly delayed and widely criticised. Despite negotiations on Omnibus II starting in March , trialogue parties failed to reach a compromise on several key features, most notably the treatment of long-term guaranteed products.
Consequently, the implementation deadline was delayed to 1 January Progress appeared to have stalled altogether over summer as commentators argued that the date was unachievable, with alternatives ranging from to , or even later. The European Parliament adopted this Directive on 22 November, therefore changing the transposition deadline to 31 March and the application date to 1 January On 13 November , following months of uncertainty, agreement was finally reached between the European trialogue parties on the Omnibus II Directive and a final compromise text was published shortly afterward.
The deal includes a package of measures to facilitate insurance products with long-term guarantees and transitional measures both for EU insurers and third countries moving towards equivalence. Insurers will continue to be able to match long-term liabilities with investments in long-term assets such as infrastructure projects. Omnibus II also contains measures to mitigate the effects of artificial volatility, such as a matching adjustment for annuity business, a volatility adjustment, extrapolation of the risk-free interest rate, transitional measures and the extension of the recovery period.
Clarity on the final provisions of Omnibus II and the implementation timetable was welcomed across the industry. The latest transposition and application dates are now unlikely to change meaning firms can resume preparation for the new regime on the basis that provisions to implement Solvency II rules into national law will be passed by 31 March , and the regime will apply in full from 1 January The Prudential Regulation Authority PRA proposes applying the guidelines in a proportionate, risk-based manner according to the nature, scale and complexity of the business.
As Omnibus II negotiations rumbled on, the PRA adopted its own planning period to implementation particularly in relation to firms involved in the internal model approval process. It is worth noting that whilst agreement on Omnibus II remained elusive, work continued on global supervisory initiatives with the International Association of Insurance Supervisors IAIS leading the way. The ICPs act as a benchmark for insurance supervisors and encourage adaptation of national regulatory frameworks to comply with global standards.
The ICS will be introduced by the end of , followed by two years of testing by supervisors and internationally active insurance groups. During and the European Commission undertook a review of EU insurance law in order to improve consumer protection, modernise supervision, deepen market integration and increase the international competitiveness of European insurers and reinsurers. The current solvency system is over 30 years old and financial markets have developed significantly since then, leading to a large discrepancy between the reality of insurance business today and its regulation.
The reforms have been driven forward as a consequence of the European Commission concluding that there are widespread divergences in the implementation of the existing insurance directives across the EU and wishing to ensure that the insurance sector has a comparable regulatory and prudential regime to that of the banking and securities sectors in the EU.
A Review of Solvency II Principles (Forward Looking Risk Assessment)
Solvency rules stipulate the minimum amounts of financial resources that insurers and reinsurers must have in order to cover the risks to which they are exposed. The rules also lay down the principles that should guide insurers' overall risk management so that they can anticipate any adverse events and handle such situations more effectively. The new solvency requirements have been designed to ensure that insurers have sufficient capital to withstand adverse events, both in terms of insurance risk as under the previous regime , and now also in terms of economic, market and operational risk.
Solvency II is to be adopted in accordance with the 'Lamfalussy' process. The Lamfalussy process takes a four-stage approach to the introduction of financial services regulation. In the first stage a framework directive is proposed after a full consultation process. At stage two technical implementing measures or 'delegated acts' under Omnibus II are introduced; much of the detail is added at this stage. The third stage involves work on recommended guidance and non-binding standards which are not included in the legislation.
Finally, the fourth stage of the process requires the European Commission to monitor compliance by Member States. Solvency II will be based on a 'three pillar' framework. The pillar system originates from the approach taken in the Capital Requirements Directive, which followed the international Basel II Accord for banks and investment firms.
Under the first pillar insurers are required to maintain reserves against liabilities technical provisions. A consistent market-based system is applied for assessing liabilities as well as ensuring a greater matching of assets to liabilities. Insurers and reinsurers must adhere to a Minimum Capital Requirement MCR , which is the fundamental level of solvency required of any insurer.
If the MCR is breached, supervisory action will be taken. The Solvency Capital Requirement SCR represents the target level of solvency which an insurer or reinsurer needs to maintain. It is a fully risk-based calculation which can be made either through a standard formula or by using internal models or a combination of both.
Basically the SCR is the amount of capital needed to leave a less than 1 in chance of capital being inadequate over the forthcoming year. The Directive requires that insurers and reinsurers invest their assets in accordance with the 'prudent person' principle and they should invest in such a manner as to 'ensure the security, quality, liquidity and profitability of the portfolio as a whole'. Insurers will be required to submit their own assessment of risk and solvency capital adequacy known as the ORSA. In addition, they must submit details of their internal systems and controls.
Should it be seen to be necessary, supervisors may require a 'capital add-on'. It might be that the supervisor will request that further capital be injected into the SCR following the review process, although this should only occur when the supervisory authority concludes that the risk-profile of the insurer 'deviates significantly' from the assumptions underlying the SCR. The third pillar harmonises disclosure requirements. Insurers are required to report publicly on their financial condition, providing information on capital.
In summer , EIOPA published a series of reports in response to consultations launched towards the end of Insurers are expected to have the necessary competence and expertise to find 'fit-for-purpose solutions' for the practical challenges of the ORSA. EIOPA points out that proportionality is a key feature of the ORSA and insurers should develop tailored processes to fit their own organisational structure and risk management systems. Finally, the report notes that undertakings are required to submit a forward-looking assessment of their overall solvency needs to national supervisory authorities, indicating multi-year tendencies and developments.
EIOPA will revisit each of these reports once the final Level 2 implementing measures have been agreed in order to verify whether any amendments to the criteria change the conclusions reached. At the same time, EIOPA will consider whether any changes made to the Bermudan, Japanese and Swiss solvency and prudential regimes affect the assessments. Once the review is complete the European Commission will decide upon the equivalence of these third countries.
The European Commission has developed a transitional regime for Solvency II equivalence for third countries which either have a risk-based regime similar to Solvency II, or are willing and committed to move towards such a regime over a pre-defined period 5 years in the initial proposal. For those third countries that have indicated that they are interested in being covered by the transitional provisions, the European Commission requested that EIOPA carry out a 'gap analysis'.
EIOPA sent these countries requests for information in order to carry out the analysis. EIOPA's work is of a technical nature only. It will be up to the European Commission to decide which third countries will be included in the equivalence transitional regime. The process is subject to adoption of Omnibus II.
There is no definitive date but the Commission is expected to decide on equivalence sometime in A number of UK consultations were published in which considered the rules required to transpose the Solvency II Directive. The FSA launched the second consultation on transposition in July The consultation closed in October HM Treasury consulted separately on legislative amendments to ensure that UK regulators have the powers necessary to implement the Directive.
The consultation closed on 15 February It is unclear when the outcome of this consultation will be published. This consultation proposed changes to the FSA rules and guidance relating to the operation of unit-linked and index-linked insurance policies primarily contained in COBS 21 to ensure consistency with the requirements of Solvency II. The feedback statement, published in June , confirmed the FSA's intention to make the proposed amendments to COBS 21 and addressed some general points raised by respondents.
The FSA began receiving submissions from those firms that are currently in the pre-application phase of the internal model approval process IMAP on 30 March Initially, the FSA had allocated submission slots to firms between 30 March and mid The FSA also confirmed that internal model applications should be based on the Level 2 text and proposed cross-referencing the text with its guidance materials. Areas of weakness identified included: methodology and assumptions; aggregation and dependency; validation; the use test; model change policy; un-modelled risk; and documentation requirements.
The PRA stated that this was the most pragmatic way forward and allows firms more time to complete the work they need to do for their submissions. EIOPA received over comments during the consultation period and issued final guidelines on 27 September The guidelines were addressed to National competent authorities NCAs which had to decide how best to implement the guidelines into their national regulatory or supervisory framework by the application date of 1 January The statement came into effect on 1 January and will cease to operate on the day prior to implementation of Solvency II, 1 January The statement explains that the PRA expects firms to have regard to the outcomes in the guidelines whilst also continuing to meet the existing PRA rules.
Whilst the guidelines are generally consistent with existing PRA handbook provisions, firms are required to implement the substantive provisions in order to ensure that they are ready for the new regime. The PRA sought to be proportionate in its application of the guidelines to ensure that there is a minimal risk of two regimes running concurrently. For each of the four areas of preparation the statement identifies where firms need to focus their efforts and where the guidelines require more than existing PRA handbook provisions.
The key issues are summarised below.
Disagreement on the treatment of long-term guarantees in times of market stress had stalled EU negotiations on the final Omnibus II text. EIOPA published the results of the LTG assessment which considered the following six regulatory measures aimed at ensuring an appropriate supervisory treatment of long-term guarantee products under volatile market conditions:. Based on the outcome of the assessment, EIOPA supported subject to some minor amendments the inclusion of the extrapolation, classical matching adjustment, extension of the recovery period, and transitional measures.
EIOPA also advised the trialogue parties to replace the CCP with a formulaic, more reliable measure, known as the 'volatility balancer'. EIOPA recommended excluding the extended matching adjustment altogether, whilst retaining the 'classical' matching adjustment. Adams encouraged firms to reassess priorities and make a concerted push to ensure compliance. Firms will need to continue to meet existing regulatory requirements until Solvency II is implemented.
Where possible, the PRA will look for ways that firms may be able to use their preparations for Solvency II to meet the current supervisory regime. It will play a key role in supporting the threshold condition that insurers must have appropriate non-financial resources and robust risk and capital management systems. The PRA thinks it reasonable to expect firms to be ready for Solvency II based reporting six months before implementation, meaning that firms falling within the thresholds should be able to submit their reports in July The PRA will continue to review the practicability of the reporting timetable but warns firms to prepare for higher quality reports and better synchronised reporting under Solvency II.
The first stage of the review looks at the approach and methodology used by firms, and the second stage will focus on the actual calculation of technical provisions. The PRA intends to publish information in the first quarter of on the progress of the first stage as well as an update on the second stage, which has been deferred as a result of Omnibus II delays.
Now that the timetable is certain, firms must be prepared for their IMAP submission slots. Capital add-ons - Article 37 of the Solvency II Directive prescribes the limited circumstances in which a capital add-on can be applied. Supervisors can apply a capital add-on where the risk profile is not in line with that in the SCR or there are significant governance deficiencies. The right is only supposed to be used in 'exceptional circumstances'. Once imposed a capital add-on is to be reviewed at least annually by the regulatory authority.
If the deficiencies that led to its imposition have been remedied then the capital add-on is to be removed. The method and process for calculating and imposing capital add-ons are expected to be set out in the Level 2 legislation and further explained in the Level 3 guidance. Individual members of the group must still comply with their own solo requirements but any surplus arising only at the group level for example, because of any diversification benefits may be treated as additional capital for the individual group members.
In addition, there are also capital instruments for example, hybrid capital and subordinated liabilities which will count towards the Solo SCR but not the Group SCR.
Related Understanding Solvency II, What is different after June 2013
Copyright 2019 - All Right Reserved