Standard Formula - Non Life & USPs. Julia Moore & Tony Ward Central Bank of Ireland
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1 Standard Formula - Non Life & USPs Julia Moore & Tony Ward Central Bank of Ireland
2 Agenda QIS 5 Feedback Next Steps Main Developments Premium & Reserve Catastrophe Lapse USPs
3 QIS 5 Feedback Catastrophe Module Premium and Reserve Risk Calibrations Lapse risk Allowance for NP Reinsurance Classifications
4 Main message. Less complexity
5 Next Steps Country reports & EIOPA report Cat Task Force Re-calibration exercise - Joint Working Group on Non-life and NSLT Health Calibration Discussions at EIOPA & Commission
6 Main Developments Re-calibration of Premium and Reserve Risk module Catastrophe Module update Lapse risk simplification Market risk, counterparty default risk
7 NL/Health NSLT Premium & Reserve Risk Premium risk Re-calibration of parameters Volume measure for premium risk Max(WP(t-1), WP(t), EP(t)) => Max (EP(t-1), EP(t)) Adding in EP(t+1, t+2,.) where contract recognition date falls in next 12 months Captures entire contract boundary Non life, health and captive simplification Non proportional adjustment factor 100% with three exceptions Now a USP
8 NL/Health NSLT Premium & Reserve Risk (cont d) Reserve risk Recalibration of parameters Volume measure unchanged Simplification of the aggregation formula
9 Lapse & Aggregation Lapse simplification Removal of the permanent increase/decrease in lapse rates Only the mass lapse remains Geographical diversification benefit restricted Set to 1 for Credit & surety and all nonproportional lines 1 for a USP firm
10 Re-calibration of Premium and Reserve Risk Line of business level impact Premium risk Reserve risk LOB QIS5 IA Change QIS5 IA Change Change Medical expense 4.0% 5.0% 25.0% 10.0% 5.0% -50.0% 1.8% Income protection 8.5% 9.0% 5.9% 14.0% 14.0% 0.0% 3.0% Workers' compensation 5.5% 8.0% 45.5% 11.0% 11.0% 0.0% 11.4% Non proportional health reinsurance 17.0% 17.0% % 20.0% - - Motor vehicle liability 10.0% 10.0% 0.0% 9.5% 9.0% -5.3% -3.1% Motor, other classes 7.0% 8.0% 14.3% 10.0% 8.0% -20.0% 9.5% Motor liability + other -0.7% Marine, aviation, transport (MAT) 17.0% 15.0% -11.8% 14.0% 11.0% -21.4% -17.8% Fire and other property damage 10.0% 8.0% -20.0% 11.0% 10.0% -9.1% -17.3% Third-party liability 15.0% 14.0% -6.7% 11.0% 11.0% 0.0% -2.3% Credit and suretyship* 21.5% 12.0% -44.2% 19.0% 19.0% 0.0% -33.8% Legal expenses 6.5% 7.0% 7.7% 9.0% 12.0% 33.3% 21.6% Assistance 5.0% 9.0% 80.0% 11.0% 20.0% 81.8% 88,9% Miscellaneous 13.0% 13.0% 0.0% 15.0% 20.0% 33.3% 8,1% Non-proportional reinsurance - property 17.5% 17.0% -2.9% 20.0% 20.0% 0.0% -1,6% Non-proportional reinsurance - casualty 17.0% 17.0% % 20.0% - 0% Non-proportional reinsurance - MAT 16.0% 17.0% 6.3% 20.0% 20.0% 0.0% 1,5%
11 Catastrophe Module - Structure Methods 1 and 2 replaced Nat Cat Man Made Cat Other Non Life Cat NP Property Cat EEA and non EEA Health Mass accident scenario Pandemic medical expenses
12 Catastrophe Module Natural Windstorm, Earthquake, Flood, Hail, Subsidence Non EEA exposures now included Geographical diversification for non-eea exposures Country correlation updated for all perils Updated calibrations
13 Catastrophe Module Non Proportional Property Factor based approach 250% (gross) No diversification benefit allowed no change
14 Catastrophe Module Man Made MV Liability, Marine, Aviation, Liability, Credit & Surety, Fire Marine, Aviation, Fire Simplified Updates in the liability scenario Updates in the credit scenario (not final) Updates in the motor scenario
15 Catastrophe Module Other Non Life Applies to: MAT (direct, prop & NP) Misc. Financial Loss (direct, prop) NP Casualty (excl GL) Non Proportional Credit & Surety Reinsurance Factor Based approach (gross)
16 Catastrophe Module - Health Mass accident All except Workers Compensation Replaces arena disaster in QIS 5 5 events considered Accident concentration Workers compensation and income protection 5 events considered Pandemic All except Workers Compensation Medical expenses
17 Market Risk Spread risk Bonds Structured products Interest rate risk Calibration Concentration & Counterparty default Equity risk Pillar 1 dampener
18 QIS 5 Feedback Catastrophe Module Premium and Reserve Risk Calibrations Lapse risk Allowance for NP Reinsurance (but not stop loss) Classifications
19 Tony Ward 29 November 2011
20 What? By substituting USPs for SF parameters Non-life σ standard deviation Premium risk Reserve risk» By line of Business (LoB), in accordance with SCR non-life underwriting risk module
21 What? By substituting USPs for SF parameters Non-life Adjustment Factor for Non-Proportional Reinsurance» By line of Business (LoB), in accordance with SCR non-life underwriting risk module
22 What? By substituting USPs for SF parameters Non-life Adjustment Factor for Non-Proportional Reinsurance» By line of Business (LoB), in accordance with SCR non-life underwriting risk module Note: Cannot replace both σ (for Premium Risk) and NP Factor in same LoB
23 What? By substituting USPs for SF parameters NOTE! These are the ONLY USPs permissible! L2 text
24 When? The Risk Profile of the firm is such that the SF calculation does NOT sufficiently approximate the SCR to the (one-year, prospective) 99.5 th percentile
25 When? The Risk Profile of the firm is such that the SF calculation does NOT sufficiently approximate the SCR to the (one-year, prospective) 99.5 th percentile Assumption The Risk Management and Assessment processes of the firm sufficiently comply with Solvency II Directive (L1) Articles 44 (Risk Management) & 45 (ORSA), enabling it to determine the above
26 Bear in mind always that the goal is for the SCR to reflect the (one-year, prospective) 99.5 th percentile SF (with/without simplification) SF (without simplification) SF (without simplification) USPs Partial IM Full IM 99.5%
27 Bear in mind always that the goal is for the SCR to reflect the (one-year, prospective) 99.5 th percentile SF (with/without simplification) SF (without simplification) SF (without simplification) USPs Partial IM Full IM 99.5%
28 How? (Assuming USP is appropriate measure) Firm MUST formally apply to use USPs CANNOT use until in receipt of explicit approval L3 draft
29 How? (Assuming USP is appropriate measure) Firm MUST formally apply to use USPs CANNOT use until in receipt of explicit approval L3 draft NO Transitional Arrangements also L3 draft (by omission stakeholder discussion) Therefore, firms would have to use SF only during interim
30 Justification for use of USPs, including calculation methods Selection of method(s) NOTE: Only standardised methods may be used... WITHOUT ANY CHANGES! Otherwise, the process is classified as a Partial IM And becomes subject to IM Approval Process
31 Justification for use of USPs, including calculation methods (Draft) L3 text states that, A clear border between USPs and (partial) IM is necessary... There is to be NO possibility for a firm to bypass the IM process via the USP process
32 Selection of method(s) NOTE: Only standardised methods may be used... WITHOUT ANY CHANGES! BUT! The full list of allowable Methods has not yet been finalised at EIOPA level
33 BUT! The full list of allowable Methods has not yet been finalised at EIOPA level Timetable Expected Pre-consultation Q Expected Public Consultation May 2012
34 Justification for use of USPs, including calculation methods If USPs are not being used for all lines of business (Draft) L3 - Explain whether USP considered at any time Provide reasons (for each line where USP not used) why Never considered for USP Once considered for USP, but abandoned/postponed
35 Justification for use of USPs, including calculation methods Selection of method(s) If the firm is unable to demonstrate that one method is more accurate than another (available) method,...the method providing the most conservative result shall be used. (L2 text)
36 Data Within the standardised methods there are additional data requirements, including: Length of series sufficiently long (depends on LoB) Credibility Factors likely if t < 10/15 years (Draft) L3 (short/long-tail respectively) Net of reinsurance (including for following year) Expenses to be included (in claims data)
37 Data & Assumptions Including when Central Bank is considering directing USP use USP may be appropriate, but data cannot be used May be difficult to divide into homogenous groups May not be sufficiently granular
38 Data & Assumptions Including when Central Bank is considering directing USP use USP may be appropriate, but data cannot be used May be difficult to divide into homogenous groups May not be sufficiently granular Simply may not be enough data It may be possible to use external data (more requirements)
39 Methods Premium Risk Assumptions (Method A ) Loss ~ LogN (Aggregate) losses are distributed lognormally
40 Methods Premium Risk Assumptions (Method A ) Loss ~ LogN (Aggregate) losses are distributed lognormally Expected Loss Exposure (Earned Premium x Loss Ratio)
41 Methods Premium Risk Assumptions (Method A ) Loss ~ LogN (Aggregate) losses are distributed lognormally Expected Loss Exposure (Earned Premium x Loss Ratio) σ 2 (Variance of Loss) quadratic in exposure Exposure (mixing parameter = 0) Exposure 2 (mixing parameter = 1)
42 Methods Premium Risk Assumptions (Method A ) Loss ~ LogN (Aggregate) losses are distributed lognormally Expected Loss Exposure (Earned Premium x Loss Ratio) σ 2 (Variance of Loss) quadratic in exposure Exposure (mixing parameter = 0) Exposure 2 (mixing parameter = 1) Maximum Likelihood Estimation (MLE) is appropriate
43 Methods Reserve Risk Assumptions Log-Normal Method Underlying Risk ~ LogN (Aggregate) losses are distributed lognormally
44 Methods Reserve Risk Assumptions Log-Normal Method Underlying Risk ~ LogN (Aggregate) losses are distributed lognormally The assumption of proportionality from best estimate (for claims outstanding) at t=0 to t=1 (one year s time) means that Basic Chain Ladder properties are (implicitly) assumed to hold...
45 Methods Reserve Risk Assumptions Log-Normal Method Underlying Risk ~ LogN (Aggregate) losses are distributed lognormally The assumption of proportionality from best estimate (for claims outstanding) at t=0 to t=1 (one year s time) means that Basic Chain Ladder properties are (implicitly) assumed to hold... Triangle Method Assumes Basic Chain Ladder assumptions hold
46 Methods NP Factor per LoB Loss ~ LogN Parameters used to calculate NP Factor are estimated using method of moments techniques
47 Data & Assumptions So, if Data and assumptions adequately reflect risk profile Data meets quality criteria Firm clearly explains how use of USPs leads to a more appropriate (SCR) result
48 Data & Assumptions So, if Data and assumptions adequately reflect risk profile Data meets quality criteria Firm clearly explains how use of USPs leads to a more appropriate (SCR) result The application will likely be approved
49 USPs may be most suitable for firms writing highvolume, vanilla -type or standard business (low/no underwriting decisions at inception) (travel, PPI, household, motor...)
50 USPs may be most suitable for firms writing highvolume, vanilla -type or standard business (low/no underwriting decisions at inception) (travel, PPI, household, motor...) Where a small number of risks/lobs deviate significantly (from SF) in respect of parameters that can be better described by USPs In general, it is reasonably obvious that the greater the number of risks/lobs that deviate, the more likely that an Internal Model will better reflect the risk profile
51 Processing of application 6 months (from receipt of complete ) Draft L3
52 Processing of application 6 months (from receipt of complete ) Draft L3 College of Supervisors (CoS) If lead supervisor (Group) need to discuss, in particular Data appropriateness and representativeness Choice of standardised method If solo supervisor, need to inform CoS
53 Processing of application Central Bank may approve on a partial basis For example: Premium Risk Yes Reserve Risk - No
54 Once approved Continuous Compliance Firms are obliged to immediately inform Central Bank if no longer complying with requirements for USPs 3 months to restore position (Draft L3 text)
55 Once approved Continuous Compliance Firms are obliged to immediately inform Central Bank if no longer complying with requirements for USPs 3 months to restore position (Draft L3 text) It would appear that Central Bank has little option other than to withdraw USP approval if not restored in time (L2)
56 Once approved Continuous Compliance Firms are obliged to immediately inform Central Bank if no longer complying with requirements for USPs 3 months to restore position (Draft L3 text) It would appear that Central Bank has little option other than to withdraw USP approval if not restored in time (L2) May require re-approval (proportionality)
57 Once approved Continuous Compliance Changes Change of method requires re-approval Grounds more appropriate (NOT simply lower SCR!)
58 Once approved Continuous Compliance Changes Change of method requires re-approval Grounds more appropriate (NOT simply lower SCR!) Change (material) of USP value allowed...subject to supervisory approval
59 Once approved Continuous Compliance Firm CANNOT revert to SF without approval However, in the case of non-compliance, as well as considering need for re-approval, Central Bank will also need to consider whether to direct firm to revert to SF calculation of SCR
60 Thank you
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