Solvency ii - Risk Margin
from the Solvency ii Association, the largest Association
of Solvency ii Professionals in the world
What is the risk
margin?
The risk margin is a
buffer above discounted best estimate cash flows,
to protect against worse than expected outcomes.
The risk margin covers risks like modeling uncertainty (model
risk), parameter risk and structural uncertainty.
The risk margin is
intended to represent the cost a third party
would incur when purchasing the book in case of insolvency.
According to the
QIS4
the risk margin is such as to ensure that the value of technical
provisions is equivalent to the amount that (re)insurance undertakings
would be expected to require to take over and meet the (re)insurance
obligations.
According to the
QIS4 the risk margin is calculated by determining the
cost of providing an
amount of eligible own funds equal to the SCR necessary to support the
insurance and/or reinsurance obligations over their lifetime.
In order to do so,
participants should
produce a projection
of their insurance and/or reinsurance obligations until their
extinction
and then, for each year, participants should determine the amount of
the SCR to be met by an undertaking facing such obligations.
According to Groupe
Consultatif’s Solvency II Pillar I NL working group, the technical provisions would ideally
be established as
the best estimate discounted reserves plus a market
value margin based on the
market cost of hedging (the price at which a transaction might
reasonably be concluded with a purchaser).
The key criteria for a good risk margin:
-
Ease of calculation
-
Stability of calculation between classes and years
-
Consistency between different companies
-
Consistency with overall solvency system
-
Consistency with future IFRS Phase 2
-
As close as possible to market consistency
In addition the risk margins should:
-
Sit on top of best estimate (defined as mean value of discounted
reserves)
-
Capture uncertainty in parameters, models and trends to ultimate
-
Be harmonised across Europe
-
Provide a sufficient level of policyholder protection together with
the MCR/SCR
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From the European Parliament
legislative resolution of 22 April 2009 on the
amended proposal for a directive of the European Parliament and of
the Council on the taking-up and pursuit of the business of
Insurance and Reinsurance (recast)
(32a) The assumptions made about the reference undertaking assumed
to take over and meet the underlying insurance and reinsurance
obligations should be harmonised throughout
the Community.
In particular, the assumptions made about the reference undertaking
that determine whether or not, and if so to what extent,
diversification effects should be taken into account in the
calculation of the risk margin
should be analysed as part of the impact assessment of implementing
measures and should then be harmonised at Community level.
Article 37
Capital add-on
1. Following the supervisory review process supervisory authorities
may in exceptional circumstances set
a
capital add-on
for an insurance or reinsurance undertaking by a decision stating
the reasons.
That possibility shall only exist in the following cases:
(a) the supervisory authority concludes that the risk profile of the
insurance or reinsurance undertaking deviates significantly from the
assumptions underlying the Solvency Capital Requirement, as
calculated using the standard formula in accordance with Chapter VI,
Section 4, Subsection 2 and:
(i) the requirement to use an internal model under Article 117 is
inappropriate or has been ineffective; or
(ii) while a partial or full internal model is being developed in
accordance with Article 117;
(b) the supervisory authority concludes that the risk profile of the
insurance or reinsurance undertaking deviates significantly from the
assumptions underlying the Solvency Capital Requirement, as
calculated using an internal model or partial internal model in
accordance with Chapter VI, Section 4, Subsection 3, because certain
quantifiable risks are captured insufficiently and the adaptation of
the model to better reflect the given risk profile has failed within
an appropriate timeframe;
(c) the supervisory authority concludes that the system of
governance of an insurance or reinsurance undertaking deviates
significantly from the standards laid down in Chapter IV, Section 2,
that those deviations prevent it from being able to properly
identify, measure, monitor, manage and report the risks that it is
or could be exposed to and the application of other measures is in
itself unlikely to improve the deficiencies sufficiently within an
appropriate timeframe.
2. In the cases set out in points (a) and (b) of paragraph 1 of this
Article the capital add-on shall be calculated in such a way as to
ensure that the undertaking complies with Article 101(3).
In the cases set out in point (c) of paragraph 1 of this Article the
capital add-on shall be proportionate to the material risks arising
from the deficiencies which gave rise to the decision of the
supervisory authority to set the add-on.
3. In the cases set out in points (b) and (c) of paragraph 1 the
supervisory authority shall ensure that the insurance or reinsurance
undertaking makes all efforts to remedy the deficiencies that led to
the imposition of the capital add-on.
4. The capital add-on referred to in paragraph 1 shall be reviewed
at least once a year by the supervisory authority and be removed
when the undertaking has remedied the deficiencies which led to its
imposition.
5. The Solvency Capital Requirement including the capital add-on
imposed shall replace the inadequate Solvency Capital Requirement.
Notwithstanding subparagraph 1 the Solvency Capital Requirement
should not include the capital add-on imposed in accordance with
point (c) of paragraph 1 for the purposes of the
calculation of the risk margin
referred to in Article 76(5).
6. The Commission shall adopt implementing measures laying down
further specifications for the circumstances under which a capital
add-on may be imposed and the methodologies for the calculation
thereof.
Those measures designed to amend non-essential elements of this
Directive by supplementing it, shall be adopted in accordance with
the regulatory procedure with scrutiny referred to in Article
304(3).
Article 76
Calculation of technical provisions
1. The value of technical provisions shall be equal to the sum of a
best estimate and a
risk margin
as set out in paragraphs 2 and 3.
2. The best estimate shall correspond to the probability-weighted
average of future cash-flows, taking account of the time value of
money (expected present value of future cash-flows), using the
relevant risk-free interest rate term structure.
The calculation of the best estimate shall be based upon up-to-date
and credible information and realistic assumptions and be performed
using adequate, applicable and relevant actuarial and statistical
methods.
The cash-flow projection used in the calculation of the best
estimate shall take account of all the cash in- and out-flows
required to settle the insurance and reinsurance obligations over
the lifetime thereof.
The best estimate shall be calculated gross, without deduction of
the amounts recoverable from reinsurance contracts and special
purpose vehicles. Those amounts shall be calculated separately, in
accordance with Article 80.
3. The
risk margin
shall be such as to ensure that the value of the technical
provisions is equivalent to the amount insurance and reinsurance
undertakings would be expected to require in order to take over and
meet the insurance and reinsurance obligations.
4. Insurance and reinsurance undertakings shall value the best
estimate and the
risk margin
separately
However, where future cash flows associated with insurance or
reinsurance obligations can be replicated reliably using financial
instruments for which a reliable market value is observable, the
value of technical provisions associated with those future cash
flows shall be determined on the basis of the market value of those
financial instruments.
In this case, separate calculations of the best estimate and the
risk margin
shall not be required.
5. Where insurance and reinsurance undertakings value the best
estimate and the
risk margin
separately, the
risk margin
shall be calculated by determining the cost of providing an amount
of eligible own funds equal to the Solvency Capital Requirement
necessary to support the insurance and reinsurance obligations over
the lifetime thereof.
The rate used in the determination of the cost of providing that
amount of eligible own funds
(Cost-of-Capital rate)
shall be the same for all insurance and reinsurance undertakings and
shall be reviewed periodically.
The
Cost-of-Capital
rate used shall be equal to the additional rate, above the relevant
risk-free interest rate, that an insurance or reinsurance
undertaking would incur holding an amount of eligible own funds, as
set out in Section 3, equal to the Solvency Capital Requirement
necessary to support the insurance and reinsurance obligation over
the lifetime of that obligation.
Article 85
Implementing measures
The Commission shall adopt implementing measures laying down the
following:
(a) actuarial and statistical methodologies to calculate the best
estimate referred to in Article 76(2);
(b) the relevant risk-free interest rate term structure to be used
to calculate the best estimate referred to in Article 76(2)
(c) the circumstances in which technical provisions shall be
calculated as a whole, or as a sum of a best estimate and a
risk margin,
and the methods to be used in the case where technical provisions
are calculated as a whole;
(d) the methods and assumptions to be used in the calculation of the
risk margin
including the determination of the amount of eligible own funds
necessary to support the insurance and reinsurance obligations and
the calibration of the Cost-of-Capital rate;
(e) the lines of business on the basis of which insurance and
reinsurance obligations are to be segmented in order to calculate
technical provisions;
(f) the standards to be met with respect to ensuring the
appropriateness, completeness and accuracy of the data used in the
calculation of technical provisions, and the specific circumstances
in which it would be appropriate to use approximations, including
case-by-case approaches, to calculate the best estimate;
(g) the methodologies to be used when calculating the counterparty
default adjustment referred to in Article 80 designed to capture
expected losses due to default of the counterparty;
(h) where necessary, simplified methods and techniques to calculate
technical provisions, in order to ensure the actuarial and
statistical methodologies referred to in points (a) and (d) are
proportionate to the nature, scale and complexity of the risks
supported by insurance and reinsurance undertakings including
captive insurance and reinsurance undertakings.
Those measures designed to amend non-essential elements of this
Directive, by supplementing it, shall be adopted in accordance with
the regulatory procedure with scrutiny referred to in of Article
304(3).
To read
more:
Risk Margin in the QIS4
Risk Margin in the QIS5
CEIOPS Advice for Level 2 Implementing Measures on Solvency
II: Technical Provisions – Article 86 (d) Calculation of the
Risk Margin
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