Solvency Assessment and Management Third South African Quantitative Impact Study (SA QIS3)

Transcription

1 CONTACT DETAILS Physical Address: Riverwalk Solvency Assessment and Management Third South African Quantitative Impact Study (SA QIS3) Draft Technical Specifications Part 4 of 6: SCR Life Underwriting Risk 2 August

2 SCR.7. SCR.7.1 SCR SCR SCR SCR Life underwriting risk module Structure of the life underwriting risk module This module covers the risks arising from the underwriting of life and health insurance, associated with both the perils covered and the processes followed in the conduct of the business. The scope of the life underwriting risk module includes all the life and health insurance and reinsurance obligations as defined in the subsections TP.4 and TP.5V.2.1 on segmentation. In particular, annuities stemming from non-life insurance contracts are in the scope of the module. Health (re)insurance obligations can be split according to their technical nature into (a) (b) Health insurance obligations pursued on a similar technical basis to that of life insurance (SLT Health); and Health insurance obligations not pursued on a similar technical basis to that of life insurance (Non-SLT Health). In making this distinction TP TP should be considered. Non-SLT Health insurance should only be included in the scope of the Non-SLT health underwriting risk and the catastrophe risk sub-modules (as defined below). SLT Health insurance obligations should be excluded from the scope of the Non-SLT health underwriting risk sub-module, and should be included within the scope of the remainder of the life underwriting risk sub-modules. SCR SCR SCR SCR The calculations of capital requirements in the life underwriting risk module are based on specified scenarios. General guidance about the interpretation of the scenarios can be found in subsection SCR Impairments should be made to the risk mitigating effect of risk mitigating contracts as part of the capital requirement of each sub-risk of life underwriting risk as specified in SCR.5.75B. As specified in SCR A, SCR D, SCR A, SCR.7.49.C and SCR A, for business with an original contract boundary of less than one year, the result of the scenario should be set subject to a minimum of the result as calculated using the relevant simplification provided. In cases where the simplification bites, insurers should disclose the result by increasing the total value of the post-shock liabilities for the relevant risk by the additional amount of stress capital caused by applying the minimum of the simplification. For example, for a particular risk, if the change in Basic Own Funds (ΔBOF) ΔNAV = 100 for business with an original contract boundary of less than one year, and the simplification yields a result of 110, the total value of the post-shock liabilities for the relevant risk should be increased by 10. Description The life underwriting risk module consists of eightnine sub-modules for mortality risk, longevity risk, disability/morbidity risk, lapse risk, expense risk, revision risk, retrenchment risk, Non-SLT health underwriting risk and catastrophe risk. 2

3 Input SCR The following input information is required: Life mort = Capital requirement for mortality risk Life long = Capital requirement for longevity risk Life dis = Capital requirement for disability/morbidity risk Life lapse = Capital requirement for lapse risk Life exp = Capital requirement for expense risk Life rev = Capital requirement for revision risk Life NH = Capital requirement for Non-SLT Health underwriting risk Life CAT = Capital requirement for catastrophe risk Life ret = Capital requirement for retrenchment risk Output SCR The module delivers the following output: SCR Life = Capital requirement for life underwriting risk Calculation SCR The capital requirement for life risk is derived by combining the capital requirements for the life sub-risks using a correlation matrix as follows: SCR life CorrLife r, where rxc c Life r Life c CorrLife r,c = The entries of the correlation matrix CorrLife Life r, Life c = Capital requirements for individual life sub-risks according to the rows and columns of correlation matrix CorrLife and where the correlation matrix CorrLife is defined as follows: Mortality 1 Mortality Longevity Disability Lapse Expenses Revision CAT Longevity Retrenchm ent Non-SLT Heatlh Disability

4 Lapse Expenses Revision CAT Retrenchm ent Non-SLT Heatlh SCR The net capital requirement for life risk is determined as follows: SCR life CorrLife r, c Life rxc r Life c 4

5 SCR.7.2 Mortality risk (Life mort ) Description SCR SCR Mortality risk is the risk of loss, or of adverse change in the value of (re)insurance liabilities, resulting from changes in the level, trend, or volatility of mortality rates. Mortality risk is associated with (re)insurance obligations (such as term assurance or endowment policies) where a (re)insurer guarantees to make a single or recurring series of payments in the event of the death of the policyholder during the policy term. It is applicable to (re)insurance obligations contingent on mortality risk i.e. where an increase in mortality rates leads to an increase in the technical provisions. This is to be considered at product type level (e.g. pure risk products, universal life policies, immediate annuities, pure endowments, endowment assurance, etc.). It is also applicable to (re)insurance obligations contingent on disability / morbidity risk and pursued on similar technical basis to that of life insurance, since mortality risk relates to the general mortality probabilities used in the calculation of the technical provisions. Even if the morbidity product does not insure death risk, there may be a significant mortality risk because the valuation includes profit at inception: if the policyholder dies early he/she will not pay future premiums and the profit of the insurer will be lower than allowed for in the technical provisions. SCR SCR SCR SCR The capital requirement should be calculated as the change in value of Basic Own Funds (where Basic Own Funds (BOF) is the excess of assets over liabilities, valued in accordance with SAM rules, plus subordinated liabilities, less any exclusions from Own Funds)net asset value (assets minus liabilities) following a permanent increase in mortality rates. Impairments should be made to the risk mitigating effect of risk mitigating contracts, as specified in SCR.5.75B. Where (re)insurance obligations provide benefits both in case of death and survival and the death and survival benefits are contingent on the life of the same insured person, these obligations do not need to be unbundled. For these contracts the mortality scenario can be applied fully allowing for the netting effect provided by the natural hedge between the death benefits component and the survival benefits component. The type and extent of management actions assumed in SCR stress scenarios, and the way in which dynamic assumptions should respond to these stresses, will vary depending on whether the stress is assumed to be company-specific or industry-wide. SCR.7.2.5SCR Ranges of whether the scenario is caused by company-specific vs. industry-wide events to be used are (25:75) to (75:25) per cent. Companies should select the mix which results in the highest capital requirement (lowest allowance for management action). Input SCR.7.2.6SCR No specific input data is required for this module. Output SCR.7.2.7SCR The module delivers the following output: Life mort = Capital requirement for mortality risk Calculation 5

6 SCR.7.2.8SCR The capital requirement for mortality risk is defined as the result of a mortality scenario defined as follows: Life mort BOF mortshock where ΔNAVΔBOF = The change in the net value of assets minus liabilitiesvalue of Basic Own Funds (BOF) mortshock = A permanent 15% increase in mortality rates (including the best estimate assumptions for HIV/AIDS extra mortality) for each age and each policy where the payment of benefits (either lump sum or multiple payments) is contingent on mortality risk. Insurers are also required to apply this stress to policies where the payment of benefits is not contingent on mortality risk, as per paragraph SCR SCR.7.2.9SCR The result of the scenario should be determined under the condition that the value of future discretionary benefits can change and that the insurer is able to vary its assumptions in future bonus rates in response to the shock being tested. The resulting capital requirement is Life mort. SCR SCR Furthermore, for business with an original contract boundary of less than one year, the result of the scenario should be set subject to a minimum of the result as calculated using the simplification below, regardless of whether the simplification conditions are met or not. Simplification SCR SCR The simplification may be used provided the following conditions are met: (a) The simplification is proportionate to the nature, scale and complexity of the risks that the insurer faces; and (b) The standard calculation of the mortality risk sub-module is an undue burden for the insurer; or (c) In the case of Group or Grouped Individual business where the technical provisions are calculated at an aggregate level and are not based on individual policyholder cash flow projections. SCR The capital requirement for mortality risk according to the simplified calculation is calculated as follows:15 per cent (the mortality shock rate) of the product of the following factors: where CAR denotes the total positive capital at risk, meaning the sum, in relation to each product type (e.g. pure risk products, universal life policies, pure endowments, endowment assurance, etc.), of the higher of zero and the difference between the following amounts (a) and (b): (a) The sum of: 6

7 i. the amount that the insurance or reinsurance undertaking would currently pay in the event of the death of the persons insured under the contract after deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles; and ii. the expected present value of amounts not covered in the previous indent that the undertaking would pay in the future in the event of the immediate death of the persons insured under the contract after deduction of the amounts recoverable from reinsurance contracts and special purpose vehicles; (a)(b) the best estimate of the corresponding obligations after deduction of the amounts recoverable form reinsurance contracts and special purpose vehicles; (b)(c) q is an insurer-specific expected average death rate (including the best estimate assumption for HIV/AIDS extra mortality) over the next year (weighted by the sum assured), (c)(d) n is the modified duration of the liability cash-flows n, where n is subject to a minimum of 1, and (d)(e) the projected mortality increase (1.1 ((n-1)/2) ), is based on the assumption that the average mortality rate of the portfolio, due to age, increases over the period corresponding to the length of the duration with 10% a per year. 7

8 SCR.7.3 Longevity risk (Life long ) Description SCR SCR SCR SCR SCR SCR Longevity risk is the risk of loss, or of adverse change in the value of (re)insurance liabilities, resulting from the changes in the level, trend, or volatility of mortality rates, where a decrease in the mortality rate leads to an increase in the value of (re)insurance liabilities. Longevity risk is associated with (re)insurance obligations (such as annuities) where a (re)insurer guarantees to make recurring series of payments until the death of the policyholder and where a decrease in mortality rates leads to an increase in the technical provisions, or with (re)insurance obligations (such as pure endowments) where a (re)insurer guarantees to make a single payment in the event of the survival of the policyholder for the duration of the policy term. It is applicable for (re)insurance obligations contingent on longevity risk i.e. where a decrease in mortality rates is likely to lead to an increase in the technical provisions. This is to be considered at product type level (e.g. pure risk products, universal life policies, immediate annuities, pure endowments, endowment assurance, etc.). The capital requirement should be calculated as the change in value of Basic Own Funds (where Basic Own Funds (BOF) is the excess of assets over liabilities, valued in accordance with SAM rules, plus subordinated liabilities, less any exclusions from Own Funds)net asset value (assets minus liabilities) following a permanent decrease in mortality rates and a permanent increase in the rate of future mortality improvements. An alternative scenario is also specified for QIS2, where the capital requirement should be calculated as the change in net asset value (assets minus liabilities) following a permanent increase in the rate of mortality improvement. Impairments should be made to the risk mitigating effect of risk mitigating contracts, as specified in SCR.5.75B. Where (re)insurance obligations provide benefits both in case of death and survival and the death and survival benefits are contingent on the life of the same insured person(s), these obligations do not need to be unbundled. For these contracts the longevity scenario can be applied fully allowing for the netting effect provided by the natural hedge between the death benefits component and the survival benefits component. Note that no floor applies at the level of contract if the net result of the scenario is favourable to the (re)insurer. The type and extent of management actions assumed in SCR stress scenarios, and the way in which dynamic assumptions should respond to these stresses, will vary depending on whether the stress is assumed to be company-specific or industry-wide. SCR.7.3.5SCR Ranges of whether the scenario is caused by company-specific vs. industry-wide events to be used are (25:75) to (75:25) per cent. Companies should select the mix which results in the highest capital requirement (lowest allowance for management action). Input SCR.7.3.6SCR No specific input data is required for this module. Output SCR.7.3.7SCR The module delivers the following output: Life long = Capital requirement for longevity risk 8

9 Calculation SCR.7.3.8SCR The capital requirement for longevity risk is defined as a result of a longevity scenario as follows: Life long BOF longevityshock Life long NAV where longevityshock Field Code Changed ΔNAVΔBOF = The change in the net value of assets minus liabilitiesvalue of Basic Own Funds (BOF) longevityshock = a (permanent) 2010% decrease in mortality rates and a (permanent) 1% increase in future mortality improvements for each age and each policy where the payment of benefits (either lump sum or multiple payments) is contingent on longevity risk SCR.7.3.9SCR The result of the scenario should be determined under the condition that the value of future discretionary benefits can change and that insurer is able to vary its assumptions in future bonus rates in response to the shock being tested. The resulting capital requirement is Life long. Insurers with best estimate technical provisions exceeding R1 billion in respect of longevity business are required to calculate the alternatives set out in SCR.7.30B and SCR.7.30C below. Insurers are requested, where this is possible, (or required for insurers noted in SCR.7.30.A above), to also provide the impact of a higher improvement in mortality in each future year of 1.5% in absolute terms in the annual mortality improvement assumption. This should not be included in the SCR for the purposes of this QIS. Insurers are requested, where this is possible, (or required for insurers noted in SCR.7.30.A above), to also provide the impact of a permanent decrease in mortality rates of 10%, combined with a higher improvement in mortality in each future year of 0.75% in absolute terms in the annual mortality improvement assumption. This should not be included in the SCR for the purposes of this QIS. SCR SCR For business with an original contract boundary of less than one year, the result of the scenario should be set subject to a minimum of the result as calculated using the simplification below, regardless of whether the simplification conditions are met or not. Simplification SCR SCR The simplification may be used provided the following conditions are met: (a) The simplification is proportionate to the nature, scale and complexity of the risks that the insurer faces; and (b) The standard calculation of the longevity risk sub-module is an undue burden for the insurer. SCR SCR The capital requirement for longevity risk according to the simplified calculation can be taken as 20 per cent (the longevity shock rate) of the product of the following factorsis as follows: 9

10 Life long 0.25*q*n*1.1 (n-1)/2 *BE long Field Code Changed where (c) BE long is the best estimate technical provision for contracts subject to longevity risk, (d) q is an insurer-specific expected average death rate over the next year (weighted by the sum assured), (e) n is the modified duration of the liability cash-flows n, where n is subject to a minimum of 1, and (f) the projected mortality increase (1.1((n-1)/2)), is based on the assumption that the average mortality rate of the portfolio, due to age, increases over the period corresponding to the length of the duration with 10% pera year. 10

11 SCR.7.4 Disability-morbidity risk (Life dis ) Description SCR SCR SCR Morbidity or disability risk is the risk of loss, or of adverse changes in the value of insurance liabilities, resulting from changes in the level, trend or volatility of disability and morbidity rates as well as changes to medical inflation relating to medical expenses insurance (applicable to legacy medical expenses business prior to the introduction of the Medical Schemes Act). It is applicable for (re)insurance obligations contingent on a definition of disability or morbidity and pursued on a similar technical basis to life insurance. Disability refers to the inability of the life assured - due to sickness, injury, disease, illness or infirmity - to engage in his/her own occupation or any other occupation for which he is suited in terms of training, education and experience. SCR.7.4.2SCR Morbidity refers to sickness, injury, disease, illness or infirmity, either directly observed or leading to the need for a defined surgical procedure or hospitalisation. SCR.7.4.3SCR The (re)insurance obligations may be structured such that, upon the diagnosis of a disease or the policyholder being unable to work as a result of sickness or disability, recurring payments are triggered. These payments may continue until the expiry of some defined period of time or until either the recovery or death of the policyholder. In the latter case, the (re)insurer is also exposed to the risk that the policyholder receives the payments for longer than anticipated i.e. that claim termination rates are lower than anticipated (recovery risk). SCR.7.4.4SCR The disability-/morbidity risk sub-module is based on a distinction between different classes of disability-morbidity insurancemedical expense insurance and income protection and lump sum disability/morbidity insurance: (a) Medical expense insurance obligations (med_expme) obligations are obligations which cover the provision of preventive or curative medical treatment or care including medical treatment or care due to illness, accident, disability and infirmity, or financial compensation for such treatment or care. Medical expense insurance is a form of indemnity insurance. For medical expense (re)insurance, the determination of the disability/morbidity capital requirement cannot be based on disability or morbidity probabilities. A large part of the risk in medical expense (re)insurance is independent from the actual health status of the insured person. For example, it may be very expensive to find out whether the insured person is ill or to prevent the insured person from becoming ill these expenses are usually covered by the health policy. If an insured person is ill, the resulting expenses significantly depend on the individual case. It can also happen that an insured person is ill but does not generate significant medical expenses. Technically the business is not based on disability /morbidity probabilities but on expected annual medical expenses. It is envisaged that only two types of contracts will fall in this category: major medical expense business, historically written on Short-term insurance licences but pursued on a similar technical basis to Life assurance; and indemnity cover that forms part of workers compensation business pursued on a similar technical basis to Life assurance business. (b) Income protection and llump sum disability /morbidity(ip/ls) insurance obligations obligations e are obligations where the payment of benefits (lump sum either by single payment or by a fixed number of instalments) is contingent on disability risk e.g. capital disability policies. These obligations typically have much stricter definitions and conditions than morbidity obligations and deferred periods are generally longer (between 11

12 6 and 12 months). As a result, short term fluctuations will be lower.which cover financial compensation in consequence of illness, accident, disability or infirmity other than obligations considered as medical expenses insurance obligations. Obligations which provide compensation to a policyholder for medical scheme contributions during a period of illness, disability or incapacity should be included here. (c) Income protection disability insurance obligations (ipd) are obligations where the payment of benefits is by multiple payments contingent on disability risk e.g. Permanent Health Insurance (PHI) and Total and Temporary Disability (TTD) policies. Deferred periods for these contracts vary from 1 week to 6 months hence the short term fluctuations will be higher than for lump sum disability obligations. (d) Lump sum morbidity insurance obligations (lsm) are obligations where the payment of benefits (lump sum either by single payment or by a fixed number of instalments) is contingent on morbidity risk. The experience of these contracts is only dependent on morbidity rates, unlike disability contracts which are also influenced by moral and economic risks. Although deferred periods are short (1 to 3 months) or do not exist, definitions and conditions are more objectively defined than for lump sum disability contracts hence short term volatility would be limited. Examples include: critical illness; hospital cash back; and major medical policies historically written on Life licences and pursued on a similar technical basis to Life assurance (here the benefit levels are agreed upfront, as opposed to medical expense insurance obligations which provide indemnity against medical costs). (a) Variable payment morbidity insurance obligations (vpm) are obligations where the payment of benefits is contingent on morbidity risk as well as the duration of the morbidity. The experience of these contracts is only dependent on morbidity rates, unlike disability contracts which are also influenced by moral and economic risks. Deferred periods are very short or do not exist. Definitions and conditions are reasonably subjective and subject to seasonal illness patterns, volatility would be high over the short term. An example is hospital cash. SCR SCR SCR SCR Capital requirements should be assessed separately for medical expense insurance obligations and income protection and lump sum disability/morbidity insurance obligations. Impairments should be made to the risk mitigating effect of risk mitigating contracts, as specified in SCR.5.75B. When reassessing the value of the technical provision after the stress events, allowance may be made for future management action and risk mitigating techniques. The approach taken for the recalculation of the best estimate to assess the impact of the stress should be consistent with the approach taken in the initial valuation of the best estimate. The type and extent of management actions assumed in SCR stress scenarios, and the way in which dynamic assumptions should respond to these stresses, will vary depending on whether the stress is assumed to be company-specific or industry-wide. SCR.7.4.5SCR Ranges of whether the scenario is caused by company-specific vs. industry-wide events to be used are (25:75) to (75:25) per cent. Companies should select the mix which results in the highest capital requirement (lowest allowance for management action). 12

13 Input SCR.7.4.6SCR The following input are needed: Dis med_exp = Capital requirement for disability-morbidity risk for medical expense (re)insurancecapital requirement for disability/morbidity risk for medical expense (re)insurance Dis ip/lsil = Capital requirement for disability/morbidity risk for income protection and lump sum disability (re)insurance Output SCR.7.4.7SCR The module delivers the following output: Life dis = Capital requirement for disability risk Calculation SCR.7.4.8SCR The capital requirement for disability risk is determined as follows: Life dis = Dis med_exp + Dis ip/lsil Disability/morbidity risk for medical expense (re)insurance SCR SCR For medical expense (re)insurance, the determination of the disability/morbidity capital requirement cannot be based on disability or morbidity probabilities. A large part of the risk in medical expense (re)insurance is independent from the actual health status of the insured person. For example, it may be very expensive to find out whether the insured person is ill or to prevent the insured person from becoming ill these expenses are usually covered by the health policy. If an insured person is ill, the resulting expenses significantly depend on the individual case. It can also happen that an insured person is ill but does not generate significant medical expenses. Moreover, technically the business is not based on disability /morbidity probabilities but on expected annual medical expenses. Input SCR.7.4.9SCR The calculation is scenario-based. Input information is the effect of two specified scenarios on the value of Basic Own Funds (BOF).Input information is the effect of two specified scenarios on the net value of assets minus liabilities (NAV). Output SCR SCR The sub-module delivers the following output Dis med_exp Calculation = Capital requirement for disability/morbidity risk for medical expense (re)insurance 13

14 SCR SCR The capital requirement is computed by analysing the scenarios claim shock up and claim shock down defined as follows: Scenario Permanent absolute change of claim inflation Permanent relative change of claims claim shock up +1% +5% claim shock down 1% 5% SCR SCR If the annual claims inflation assumption is x, the claims inflation assumption to be used in the claim shock up scenario should be x+1%. If the annual claims rate assumption is y, the claims rate assumption to be used in the claim shock up scenario should be y*(1+5%). SCR SCR The scenario claim shock down needs only to be analysed for policies that include a premium adjustment mechanism which foresees an increase of premiums if claims are higher than expected and a decrease of premiums if claims are lower than expected. Otherwise, undertakings should assume that the result of the scenario claim shock down is zero. In a first step, capital requirements for increase and decrease of claims are calculated: Dis med_exp, up = NAVBOF claim shock up Dis med_exp, down = NAVBOF claim shock down Wwhere BOF = Basic Own Funds (i.e. the excess of assets over liabilities, valued in accordance with SAM rules, plus subordinated liabilities, less any exclusions from Own Funds) BOF = the change in Basic Own Funds (BOF) as a result of applying the relevant stress scenario. 14

15 ΔNAV is the change in the net value of assets and liabilities under the scenario. The scenario is assumed to occur immediately after the valuation date. The result of the scenarios should be determined under the condition that the value of future discretionary benefits can change and that insurer is able to vary its assumptions in future bonus rates in response to the shock being tested (in line with section SCR.32 Loss absorbing capacity of technical provisions and deferred taxes). Moreover, the revaluation should allow for any relevant adverse changes in policyholders behaviour (option take-up) in this scenario. SCR SCR The relevant scenario (up and down) is the most adverse scenario taking into account the loss-absorbing capacity of technical provisions: Dis med _ exp max( Dis med _ exp, up ; Dis med _ exp, down Disability/morbidity risk for income protection and lump sum disability / morbidity (re)insurance ) SCR For income protection and lump sum disability (re)insurance, the determination of the capital requirement for disability/morbidity risk is based on disability or morbidity probabilities. Input SCR SCR The calculation is scenario-based. Input information is the effect of a specified scenario on the value of Basic Own Funds (BOF).No specific input data is required for this module. Output SCR SCR The risk module delivers the following output: Dis = Capital requirement for disability/morbidity risk for il income protection and lump sum disability/morbidity (re)insurance Calculation SCR SCR The capital requirement for disability risk is defined as the result of a disability scenario as follows: Dis lsd BOF disshock lsd where ΔNAV = Change in the net value of assets minus liabilities BOF = Basic Own Funds (i.e. the excess of assets over liabilities, valued in accordance with SAM rules, plus subordinated liabilities, less any exclusions from Own Funds) BOF = the change in Basic Own Funds (BOF) as a result of applying the relevant stress scenario. 15

16 Ddisshock lsdil = A combination of the following changes applied to each policy where the payment of benefits (either lump sum or multiple payments) is contingent on disability risk: An increase of 35% in disability/morbidity rates for the next year, t Together with a (permanent) 25% increase (over best estimate) in disability/morbidity rates at each age in following years Plus, where applicable, a permanent decrease of 20% in morbidity/disability recovery rates. SCR SCR The result of the scenario should be determined under the condition that the value of future discretionary benefits can change and that the insurer is able to vary its assumptions in future bonus rates in response to the shock being tested. The resulting capital requirement is Dis ip/ls. SCR Furthermore, for business with an original contract boundary of less than one year, the result of the scenario should be set subject to a minimum of the result as calculated using the simplification below, regardless of whether the simplification conditions are met or not. Simplification SCR SCR The simplification may be used provided the following conditions are met: The simplification is proportionate to the nature, scale and complexity of the risks that the insurer faces; and The standard calculation of the disability-morbidity risk sub-module is an undue burden for the insurer; or In the case of Group or Grouped Individual business where the technical provisions are calculated at an aggregate level and are not based on individual policyholder cash flow projections. SCR SCR In the case of Group or Grouped Individual business where the technical provisions are calculated at an aggregate level and are not based on individual policyholder cash flow projections. The capital requirement for for each class of insurance (i.e. medical expense insurance and income protection and lump sum disability/morbidity insurance) should be calculated separately. SCR SCR The capital requirement for the disability risk according to the simplified calculation is the sum of: (a) the capital requirement for an increase of 35% in morbidity/ disability inception rates for the first year, (b) the capital requirement for an increase of morbidity/disability inception rates by 25% for all subsequent years and (c) the capital requirement in respect of the risk that the duration of claims is greater than expected, represented by a 20% decrease in the termination rates (including policies in payment), where the individual elements are calculated as sketched below. 16

17 SCR SCR The individual elements sketched in the previous paragraphs should be calculated by using the following bases of calculation: (a) For the increased morbidity/disability inception rates during the first year, 35% of the product of the following factors: the total disability sum assured at risk (in year one) and an insurer-specific expected average rate of transition from healthy to sick over the first year (weighted by the sum assured/ annual payment). (b) For the increased morbidity/disability inception rates during all subsequent years, 25% of the product of the following factors: the total disability sum assured at risk in year two, an insurer-specific expected average rate of transition from healthy to sick over the second year (weighted by the sum assured/annual payment), the modified duration of the liability cash-flows (n)(subject to a minimum of one), less one and the projected disability increase (1.1 ((n-2)/2) ), based on the assumption that the average disability rate of the portfolio, due to age, increases over the period corresponding to the length of the duration with 10% a year. (c) With respect to the risk that the duration of claims is greater than expected, 20% of the product of the following factors: technical provisions (best estimate) for contracts subject to disability claims, an insurer-specific expected termination rate (i.e. average rate of transition from sick to healthy/dead over the next year), the modified duration of the liability cash-flows n, subject to a minimum of 1,and the projected disability increase (1.1 ((n-2)/2) )(1.1((n-1)/2)). 17

18 SCR.7.5 SCR SCR SCR Lapse risk (Lifelapse) Description Lapse risk is the risk of loss or change in liabilities due to a change in the expected exercise rates of policyholder options. In relation to the policyholder options that the lapse sub-module covers, a comprehensive approach is taken. The module takes account of all legal or contractual policyholder options which can significantly change the value of the future cashflows. This includes options to fully or partly terminate, decrease, restrict or suspend the insurance cover as well as options which allow the full or partial establishment, renewal, increase, extension or resumption of insurance cover as well as, where relevant, the rate of non-payment of premiums. In the following, the term lapse is used to denote all these policyholder options. Non-SLT Health insurance obligations are excluded from the scope of this module. SCR.1.1.5SCR Impairments should be made to the risk mitigating effect of risk mitigating contracts, as specified in SCR.5.75B. SCR Where there is a direct causal relationship between a specific risk and policyholder behaviour, the relevant policyholder behaviour should be reflected in that module. Non-causal relationships are reflected in the lapse risk module (LifeLapse) and the correlation matrix makes allowance for these interrelationships. Ranges of whether the scenario is caused by company-specific vs. industry-wide events to be used are: Lapse level: (50:50) to (75:25) per cent Mass lapse: (25:75) to (75:25) per cent Companies should assess the impact of different ranges and reflect that which leads to the highest capital requirement (lowest allowance for management action). Input SCR.7.5.4SCR No specific input data is required for this module. Output SCR.7.5.5SCR The module delivers the following output: Life lapse = Capital requirement for lapse risk (not including the loss-absorbing capacity of technical provisions) Calculation SCR.7.5.6SCR The capital requirement for lapse risk should be calculated as follows: = where 18

19 C = Where { { where = Homogenous group indicator. = Capital requirement for the risk of a permanent change of the rates of lapsation for homogeneous group i Life lapse = Capital requirement for lapse risk Lapseshock mass = Stress factor for risk of a mass lapse event as defined in SCR below. Lapse down, i = Capital requirement for the risk of a permanent decrease of the rates of lapsation for homogeneous group i, based on the change in the value of Basic Own Funds (BOF)assets less liabilities as a result of applying the lapseshock down stress scenario (per SCR below), subject to a floor of zero. Therefore: = max BOF lapseshock ;0 Lapse up, i = Capital requirement for the risk of a permanent increase of the rates of lapsation for homogeneous group i, based on the change in the value of Basic Own Funds (BOF)assets less liabilities as a result of applying the lapseshock up stress scenario (per SCR below), subject to a floor of zero. Therefore: down = max BOF lapseshock ;0 Lapse mass, i = Capital requirement for the risk of a mass lapse event for homogeneous group i, based on the change in the value of Basic Own Funds (BOF)assets less liabilities as a result of applying the lapseshock mass stress scenario (per SCR below), subject to a floor of zero. Therefore: = max BOF lapseshock ;0 max NAV lapseshock BOF = Basic Own Funds (BOF) is the excess of assets over liabilities, valued in accordance with SAM rules, plus subordinated up mass mass ;0 Field Code Changed 19

20 liabilities, less any exclusions from Own Funds. SCR.1.1.6SCR Homogenous groups should appropriately distinguish between policies of different lapse risk. For the purposes of QIS2, homogenous groups should be determined according to the granularity at which lapse assumptions are set in the calculation of the best estimate. The following provides guidance in the setting of homogeneous groups: Homogenous groups of policies for assessing lapse risk should be defined at a granular enough level such that no further split of policies within the homogenous group as a result of a specific product feature (e.g. ability to review premiums, premium paying pattern, presence of guarantee, etc.) will result in a significant change in the assessment of lapse risk assessed using the standard formula. In determining their homogenous groups insurers should have regard to the level at which assumptions are set for assessing technical provisions or the granularity at which they perform their experience investigations. Offsetting policies should be allowed for, unless the offsetting is as a result of the policies not belonging to the same homogenous group. Unbundled benefits that form part of the same policy can be considered to form part of the same homogenous group, unless it is possible to lapse the benefits separately. As a minimum homogenous groups should be specified at a product type level. SCR.7.5.7SCR The result of the calculations should be determined under the condition that the value of future discretionary benefits can change and that the insurer is able to vary its assumptions in future bonus rates in response to the shock being tested. The resulting capital requirement is Life lapse. SCR.7.5.8SCR Furthermore, for business with an original contract boundary of less than one year, the result of the calculations for Lapse down and Lapse up should be set subject to a minimum of the result as calculated using the simplification below, regardless of whether the simplification conditions are met or not. SCR.7.5.9SCR Insurers are requested, in addition, to also provide the impact of assuming, for purposes of calculating Lapse mass,i that total renewal expenses after the shock remain at the same level as before the shock for a period of 2 years. This should not be included in the SCR for the purposes of this QIS, but will be required for the qualitative questionnaire. In the base case, per policy expenses are assumed to remain unchanged as the stress is applied i.e. total renewal expenses reduce in proportion to the reduction in the number of policies. SCR SCR The capital requirement for the risk of a permanent decrease of the rates of lapsation should be calculated based on the following stress scenario: lapseshock down = Reduction of 50% in the assumed option take-up rates in all future years for all homogeneous groups adversely affected by such risk. Affected by the reduction are options to fully or partly terminate, decrease, restrict or suspend the insurance cover. Where an option allows the full or partial establishment, renewal, increase, extension or resumption of 20

21 insurance cover, the 50% reduction should be applied to the rate that the option is not taken up. The shock should not change the rate to which the reduction is applied to by more than 20% in absolute terms. SCR SCR The capital requirement for the risk of a permanent increase of the rates of lapsation should be calculated based on the following stress scenario: SCR SCR lapseshock up = Increase of 50% in the assumed option take-up rates in all future years for all homogeneous groups adversely affected by such risk. Affected by the increase are options to fully or partly terminate, decrease, restrict or suspend the insurance cover. Where an option allows the full or partial establishment, renewal, increase, extension or resumption of insurance cover, the 50% increase should be applied to the rate that the option is not taken up. The shocked rate should not exceed 100%. Therefore, the shocked take-up rate should be restricted as follows: R up (R) min(150% R;100%) and R down ( R) max( 50% R; R 20%), where R up = shocked take-up rate in lapseshock up R down = shocked take-up rate in lapseshock down R = take-up rate before shock SCR SCR The capital requirement for the risk of a mass lapse event Lapse mass should be calculated based on the following stress scenario: lapseshock mass = The combination of the following changes: the lapsesurrender of 4540% of the insurance policieshomogeneous groups with a positive surrender strain that are not defined as Group or Linked business; the lapsesurrender of 70% of the insurance policieshomogeneous groups with a positive surrender strain that are defined as Group or Linked business. The mass lapse event should allow for the increase in per policy expenses by keeping the total expenses (expenses excluding acquisition costs) constant for two years after the mass lapse event. Where the contract boundary is shorter than 2 years, (re)insurers must still 21

22 allow for the increase in per policy expenses by keeping the total expenses constant for two years after the mass lapse event. SCR SCR Group business is defined as one of the following: (a) Group Business: Insurance where an insurance policy is issued to a policyholder other than an individual that covers a group of persons identified by reference to their relationship to the entity buying the contract provided this excludes grouped individual business. (b) Grouped Individual Business: Insurance where an insurance policy is issued to a policyholder other than an individual. In terms of the policy an identifiable individual(s) or member(s) is the life insured(s). Only the individual(s) or member(s) may terminate the cover. SCR SCR Linked business is defined as follows: (a) Business that relates to liabilities under a linked policy, where a linked policy means a long-term policy of which the amount of the policy benefits is not guaranteed by the long-term insurer and is to be determined solely by reference to the value of particular assets or categories of assets which are specified in the policy and are actually held by or on behalf of the insurer specifically for the purposes of the policy. A further feature of linked business is that it contains no guarantees on charges that the insurer may apply to the policyholder. Simplifications Factor-based formula for scenario effect SCR SCR A simplified calculation of Lapse down and Lapse up may be made if the following conditions are met: SCR SCR (a) The simplified calculation is proportionate to nature, scale and complexity of the risk; and (b) The quantification of the scenario effect defined above would be an undue burden; or (c) In the case of Group or Grouped Individual business where the technical provisions are calculated at an aggregate level and are not based on individual policyholder cash flow projections. Lapse and Lapse where down up 50 % The simplified calculations are defined as follows: l up down up n down 50 %l n S, up S down 22

23 l l down; up = estimate of the average rate of lapsation of the homogenous groups with a negative/positive surrender strain n n down; up = average period (in years), weighted by surrender strains, subject to a minimum of 1, over which the homogenous groups with a negative/positive surrender strain run off S S down; up = sum of negative/positive surrender strains 23

24 SCR.7.6 Expense risk (Life exp ) Description SCR SCR SCR Expense risk arises from the variation in the expenses incurred in servicing insurance and reinsurance contracts. This includes the risk arising from the variation in the growth of expenses over and above that of inflation. Non-SLT Health insurance obligations are excluded from the scope of this module. The type and extent of management actions assumed in SCR stress scenarios, and the way in which dynamic assumptions should respond to these stresses, will vary depending on whether the stress is assumed to be company-specific or industry-wide. SCR.7.6.2SCR Ranges of whether the scenario is caused by company-specific vs. industry-wide events to be used are (25:75) to (75:25) per cent. Companies should select the mix which results in the highest capital requirement (lowest allowance for management action). Input SCR.7.6.3SCR No specific input data is required for this module. Output SCR.7.6.4SCR The module delivers the following output: Life exp = Capital requirement for expense risk Calculation SCR.7.6.5SCR The capital requirement for expense risk is determined as follows: Life exp BOF expshock where: ΔNAVΔBOF = Change in the net value of assets minus liabilitiesbasic Own Funds (BOF) BOF = Basic Own Funds (BOF) is the excess of assets over liabilities, valued in accordance with SAM rules, plus subordinated liabilities, less any exclusions from Own Funds. expshock = Increase of 10% in future expenses compared to best estimate anticipations, and an increase of the greater of an absolute addition of 2% to the base level of expense inflation and a 20% increase in the base level of expense inflationincrease of 10% in future expenses compared to best estimate anticipations, and an increase by 1% per annum in the best estimate expense inflation rate assumption. SCR.7.6.6SCR An expense payment should not be included in the scenario, if its amount is already fixed at the valuation date (for instance agreed payments of acquisition provisions). For policies with adjustable expense loadings the analysis of the scenario should take into account realistic management actions in relation to the loadings. 24

25 SCR.7.6.7SCR The result of the scenario should be determined under the condition that the value of future discretionary benefits can change and that the insurer is able to vary its assumptions in future bonus rates in response to the shock being tested. The resulting capital requirement is Life exp. SCR.7.6.8SCR Furthermore, for business with an original contract boundary of less than one year, the result of the scenario should be set subject to a minimum of the result as calculated using the simplification below, regardless of whether the simplification conditions are met or not. Simplification SCR.7.6.9SCR The simplification may be used provided the following conditions are met: (a) The simplification is proportionate to the nature, scale and complexity of the risks that the insurer faces; and (b) The standard calculation of the expense risk sub-module is an undue burden for the insurer; or (c) In the case of Group or Grouped Individual business where the technical provisions are calculated at an aggregate level and are not based on individual policyholder cash flow projections SCR SCR The simplification is defined as follows: n n Life n E 1 k 1 exp 0.1 *((1 ) 1) *((1 i) 1) E k i where E = Amount of Eexpenses incurred in servicing life (re)insurance obligations during the last year. n = modified duration in years of the cash-flows included in the best estimate of those obligationsaverage period in years over which the risk runs off, weighted by renewal expenses, subject to a minimum of 1. i = weighted average inflation rate included in the calculation of the best estimate of those obligations, weighted by the present value of expenses included in the calculation of the best estimate for servicing existing life obligationsexpected inflation rate (i.e. inflation assumption applied in calculation of best estimate) k = Stressed inflation rate (i.e.i + 1%)as determined in SCR