scenarios under Solvency II

Transcription

1 Solvency Consulting Knowledge Series Health Catastrophe scenarios A new and important risk is appearing in QIS5 Contacts Martin Brosemer Tel.: mbrosemer@munichre.com Daniel Cantzler Tel.: dcantzler@munichhealth.com Isabelle De Morcourt Tel.: idemorcourt@munichhealth.com Dr. Thomas Schaffrath-Chanson Tel.: tschaffrath@munichre.com August 010 On the way to QIS5 Europe s insurance sector is devoting ever greater attention to Solvency II, and even as the date of its introduction is moved forward, it is obvious that Solvency II is already fundamentally changing the way that insurers handle and manage their risks. The introduction of Solvency II is now scheduled for 1 January 013. The QIS5 study will be an important step in calibrating the standard formula, which is still under discussion. Insurers may be right to ask whether the standard formula will adequately reflect their specific books of business. Each insurer s decision whether to develop its own (partial) internal model will depend, on the one hand, on how the standard formula is finally calibrated and, on the other hand, on how well this calibration reflects their respective risk profiles. Most insurers will probably use the standard formula for some time and assess the results before deciding whether or not to create a model of their own. From the perspective of industry outsiders such as analysts, the standard formula results may show/suggest better comparability with an insurer s key risk capital figures. Companyspecific or partial models, on the other hand, will deliver results that better reflect the company s risk profile and provide a basis for a more sophisticated risk-management system, a better overview of its own operations and risk-adjusted steering of the business. This paper provides a brief description of the methodology employed in the health module and sheds light on the inherent structure of catastrophe scenarios from an actuarial perspective. This may offer readers some help in preparing for the QIS5 exercise. The health module The calibration and structure of the standard formula have been changed several times over the last few years. Since QIS4, the health module has undergone the following major changes: The former sub-module for workers compensation has now been integrated in the sub-module Health NonSLT (non-similar to life techniques). For catastrophes, QIS5 defines a separate sub-module whereas under QIS4 this was covered under the short-term and accident submodule.

2 Page /6 Fig. 1: Structure of the standard approach SCR Adj BSCR SCR op SCR market SCR health SCR def SCR life SCR non-life SCR intang Mkt fx Mkt prop Health SLT Health NonSLT Health CAT Life Mort Life Long Life CAT NL Prem&Res NL Lapse NL CAT Health Mort Health Prem&Res Health CAT Mkt int Life Dis/Morb Health Long Health NSLTLapse Mkt eq Life Lapse Health Dis/Morb Mkt sp Life Exp Health SLTLapse Mkt conc Health SLTExp Life Rev Adjustment for the risk-mitigating effect of future profit sharing Health SLTRev Fig. 1 shows the risk tree of the QIS5 1 technical specification published in July 010. Description of the health module In view of the diversity of health business in European markets, the QIS5 technical specification explicitly defines Health insurance as follows: Health insurance obligations are all types of insurance compensating or reimbursing losses (e.g. loss of income) caused by illness, accident or disability (income insurance), or medical expenses due to illness, acci 1 insurance/docs/solvency/qis5/drafttechnical-specifications_en.pdf (This paper takes into account the Errata to the QIS5 Technical Specifications, Version of 10 August 010) dent or disability, whether preventive or curative (medical insurance). This definition contributes to a better understanding of the lines of business included in the health module. The catastrophe risk, contrary to the Level advice, has become a separate sub-module. The structure of the health underwriting risk (SCR health ) is described in detail below: Health insurance obligations pursued on a similar technical basis to that of life insurance (Health SLT ) Health insurance obligations not pursued on a similar technical basis to that of life insurance consultations/consultationpapers/cp7/ CEIOPS-DOC-68-10%0_L_%0Advice_on_ Calibration_Health_Underwriting_%0Risk.pdf (Health NonSLT ). The relevant lines of business are: Medical expenses Income protection Workers compensation Non-proportional health reinsurance Health insurance obligations catastrophe risk (Health CAT ) including Arena disaster Concentration scenario Pandemic scenario In practice, however, health products are highly heterogeneous, and it is not always immediately apparent whether a product falls into the SLT or non-slt category. Annex C of the QIS5 technical specification gives some explicit guidance on how to classify health insurance products.

3 Page 3/6 SCR health is calculated using the equation (see Formula 1) where Health r and Health c are the capital charges for the respective health underwriting sub-modules specified in the rows and columns of the CorrHealth correlation matrix (see Table 1). Formula 1 SCR health = Table 1 CorrHealth rxc Health r Health c rxc In view of the circumstance that the methodologies used in the SLT and non-slt sub-modules are quite similar to those used for the life/non-life underwriting risks, the focus of this paper may now be shifted to the new catastrophe (CAT) sub-module. CAT scenarios CorrHealth Health SLT Health NonSLT Health CAT Health SLT 1 Health NonSLT Health CAT Fig. : Risk tree of Health CAT sub-module The CAT sub-module was defined by the Catastrophe Risk Task Force (CTF) set up by CEIOPS in July 009. The CTF s purpose was to provide CEIOPS with input and advice on how to design and calibrate standardised scenarios for testing under QIS5. The catastrophe risk for each scenario has to be calibrated, in order to be congruent with all the other modules, at the 99.5% VaR (Value at Risk) for undertakings that are exposed to extreme or exceptional events. Arena (inc. accident) Country 1 Country Country 3 Health CAT Concentration (inc. riders) Country 1 Country Country 3 Pandemic Pan EEA The CTF s findings were incorporated in the final QIS5 technical specification published in July 010. The structure of the CAT sub-module is shown in Fig.. 3 Formula The standardised scenarios in the CAT module are: Health CAT = Health Arena + Health Concentration + Health Pandemic Arena disaster Concentration scenario Pandemic scenario The overall capital requirement for this module is calculated by means of the following formula, taking into consideration the stochastic independency of the three scenarios (see Formula ): 3 publications/submissionstotheec/ceiops- DOC CAT-TF-Report.pdf

4 Page 4/6 The above selection of scenarios was based on the assumption that the occurrence of such events would be extremely unlikely or exceptional and therefore give rise to losses and adverse changes in the values of insurance and reinsurance liabilities. These scenarios should capture the main exposure and catastrophe risks that affect health products and related lines of business. (i) Arena disaster The arena (and concentration) scenario is of relevance for the following product types: Accidental death Permanent total disability Disability (short- and long-term) Medical/injury The basic purpose of an arena disaster scenario is to capture the insured risk of a catastrophic event affecting large numbers of people in a single place at one time. The total capital charge for the health catastrophe risk in the arena scenario H CAT_ARENA net of mitigation is estimated as defined in Formula 3. Formula 3 H CAT_ARENA = (H CAT_ARENA_CTRY ) CTRY Where Table Variable S x P R P E P P Fig. 3: Full arena capacity by country People 100,000 products H CAT_ARENA_CTRY = 0.5 S R P x P E P Meaning Arena capacities as outlined in the arena/stadium table for each country (capacity between 10,000 and 100,000) Proportion of accidental deaths/disabilities (short- and long-term) and injuries IP P /Pop Where IPP is the number of insured persons of the undertaking in the country which are covered by product type P and Pop 4 is the total population in the country Exposure measure i.e. average sum insured per insured person for product type p Product type (accidental death, permanent total disability, longterm disability, short-term disability, medical/injury) Undertakings that write business in more than one country should assess the arena and concentration scenarios separately for each country and determine the total capital required for each scenario (see Table ). 4 In contrast to the approach initially taken by CEIOPS 5, in which the equation for H CAT_ARENA failed to consider diversification, the QIS5 technical specification takes into account diversification effects that result in reduced capital requirements. 80,000 60,000 40,000 0,000 0 ES UK IT IE DE FR HE PT HU PO NL AT BE DK FI RO LV BG SE CZ CR MT SK NO CY CZ IS LT SI EE LU The arena capacities parameter S is determined by consulting a table that indicates the capacity of the largest arena in each EU member state (see Fig. 3). It is then assumed that the catastrophe occurs when the arena is full and affects 50% of the people present. 4 The total population figures Pop which are to be used for the calculation of the ratio RP will be provided in the helper spreadsheet for CAT risk. 5 consultations/consultationpapers/cp7/ CEIOPS-DOC-68-10%0_L_%0Advice_on_ Calibration_Health_Underwriting_%0Risk.pdf

5 Page 5/6 (ii) Concentration scenario This scenario is intended to capture the risk of a catastrophe affecting the largest concentration of exposures, for example a densely populated office block in a financial hub. The total capital charge for the concentration scenario H CAT_CONC is estimated as follows: H CAT_CONC = (H CAT_CONC_CTRY ) CTRY where products H CAT_CONC_CTRY = C x P E P See Table 3. (iii) Pandemic scenario The last scenario is intended to capture the risk that a pandemic could result in claims for non-lethal injuries. The products affected are: Permanent total disability Disability (short- and long-term) Critical illness Medical insurance is not listed as an affected product for two reasons: first, because it is thought that the pandemic risk would have only a small impact on medical covers and, second, because the medical risk should be captured in the premium and reserve risk sub-module. The total capital charge for the pandemic scenario H CAT_PAN is estimated as follows: products H CAT_PAN = R E P See Table 4. While the reinsurance market used to be driven primarily by price and the availability of capacity, once Solvency II takes effect, reinsurance will also become a more effective instrument of risk transfer and capital management. The prescribed formulas for calculating the capital required for the Health CAT submodule will now be used to analyse the impact of reinsurance on capital requirements. Reinsurance The QIS5 technical specification explicitly recognises the use of proportional and non-proportional reinsurance to mitigate risks. Depending on how it is structured, proportional reinsurance is likely to yield a proportional reduction in the risk capital requirements at the sub-module level. The impact of non-proportional reinsurance is shown by the following example, which was calculated using the Health CAT sub-module according to the QIS5 standard. The impact of non-proportional reinsurance on other modules such as counterparty default risk was not examined. Fig. 4 shows the breakdown of the Health CAT sub-module capital requirements for a sample health insurer offering medical, disability and accidental covers. For the sake of simplicity, we have assumed that the company writes business in only one country. Table 3 Variable x P E P C P Meaning Proportion of accidental deaths/disabilities (short- and long-term) and injuries Exposure measure, i.e. average sum insured per insured person for product type P Number of lives insured by the undertaking in its largest known concentration of lives working in a single building, plus the lives known to be covered and working within a 300-m radius Product type (accidental death, permanent total disability, longterm disability, short-term disability, medical/injury) Table 4 Variable Meaning E P Exposure measure i.e. average sum insured by product type P R Proportion of lives affected by the pandemic = 0.075

6 Page 6/6 The concentration and pandemic scenarios are clearly the main risk drivers. The equation for the concentration scenario includes the variable C, which stands for the number of lives insured in the insurer s largest known concentration. This worstcase scenario requires extensive risk capital, but the level of risk capital required may also be influenced by a catastrophe excess of loss (CatXL) reinsurance cover. This non-proportional reinsurance cover limits the insurer s retention in the event that a group of its insureds is affected by a single event. In this example, the CatXL cover reduces the amount of risk capital required by the insurer for the concentration risk by almost 100%, since the insurer then has to cover only its retention (for example, three persons). At an aggregate level, the overall capital-relief effect of the total Health CAT is about 0%, as in this the effect is attenuated by diversification (see Fig. 5). Conclusion The coming months will be crucial for the entire insurance industry, as companies analyse the impact of QIS5 and try to determine whether the standard formula takes adequate account of their respective business profiles. Transparency will increase, and this will motivate the sector to consider new solutions and break new ground in risk management. Solvency II will make customised reinsurance solutions a more im portant instrument for reducing corporate risk capital requirements. Fig. 4: Breakdown of gross capital requirements m Arena Conc Pandemic Diversification H_CAT Fig. 5: Breakdown of net capital requirements m Münchener Rückversicherungs-Gesellschaft Königinstrasse 107, 8080 München, Germany Order number Arena Conc Pandemic Diversification H_CAT