PAM 22 March 2010 - Susanne Kaske-Taft Solvency II – Capital drivers & reinsurance solutions FIAR...

PAM 22 March 2010 - Susanne Kaske-Taft

Solvency II – Capital drivers & reinsurance solutions

FIARMay 22-26, 2011Alexandra Storr

Solvency II | Example: Capital drivers & reinsurance solutions

Required capital

Capital drivers under Solvency II Under Solvency I a lot of

fundamentals of the insurance business model have been neglected in the regulatory regime

Under Solvency II the real risk landscape of an insurance company should be considered in the calculation of the solvency capital requirements

Therefore the solvency capital requirements under Solvency II are influenced by a number of capital drivers compared to Solvency I

Insufficient diversifcation

Counterpartydefault risk

Volatility of reserve run-off

Exchange rate mismatch

Highly volatile peak risks

Duration mismatch (ALM)

Equity & property price risk

Embedded options & guarantees

Frequency

Unexpected widening of bond spreads

Availabke capital

Ability to increase capital


SummarySolvency II & reinsurance


Insufficient diversification

Sta

ndard

Form

ula

Part

ial in

tern

al m

odel

Inte

rnal m

odel

Loss Portfolio Transfer & Adverse Development Cover

Transfer of peak risks

Insurance Linked Securities

Large exposure to increasing life spans Longevity swap

Identify the individual capital drivers …

Examples:

… find the most efficient reinsurance solution …

Examples:

… value the capital benefit based on the model used

Reinsurance is a powerful capital management tool under Solvency II

Natural catastrophe risk


Solvency IIExamples of Capital drivers and Reinsurance solutions

Capital drivers Reinsurance solutions P&C


Insufficient diversification

High volatile peak risks

Standard Formula Partial Internal Model

Internal Model

(Structured) Quota share / LPT & ADC / Run off

(Structured) Quota share

(Structured) Excess of Loss

Frequency (Structured) Aggregate XL


Insufficient diversification and quota share

5


Insufficient diversification will lead to an increase in solvency capital requirement compared to Solvency I

(Missing) diversification on the asset side will be a capital driver, too

Better diversified insurers are able to deal with financial consequences of risks relatively easier and therefore more efficiently

Most affected: Captives Monoliners Small local players Niche players

Capital driver under Solvency II– Insufficient diversification


Value proposition of a Quota Share under Solvency II:Gross situation:

BSCR (99.5 % VaR): 12.7 mio EUR

UW risk 10.2 mio EUR

Market risk 2.5 mio EUR

Credit risk ----------------

Reinsurance:

20 % Quota Share / 23 % Commission

Net situation:

BSCR (99.5 % VaR) 10.6 mio EUR

• UW risk 8.2 mio EUR

• Market risk 2.1 mio EUR

• Credit risk 0.3 mio EUR

= Capital relief of the 200-year event= EUR 2.2 m

P&C Quota Share under Solvency II

The quota share reduces the Solvency Capital Requirement (SCR) for the insurance risk under Solvency II according to the proportion ceded to the reinsurer

Insurer’s share (retention) ) 80 %

0

50

100

150

200

250

300

Risk 1 Risk 2 Risk 3 Risk 4 … Risk n

Reinsurer’s share (cession) ) 20 %

Loss


Example:Highly volatile peak risk and Excess of Loss covers

8


Portfolio A contains only low risks

Portfolio B contains only high risks

Solvency II will require insurers to back their book of business with solvency capital that reflects the economic risk

In contrast to Solvency I where often only the premium volume is decisive

Portfolios with the same premium volume can have a totally different capital requirement

If one of the portfolios (Portfolio B) contains high volatile peak risks where the resulting aggregate claims distribution is more skewed to the right than for a Portfolio A of risks with low volatility

VaR 99.5%

Claims amount Claims amount Claims amount

VaR 99.5%

Capital driver under Solvency II– Highly volatile peak risk

Claims amount

Claims amount

Claims amount

Probability Probability Probability

Probability Probability Probability

Premium volume

Portfolio B

Premium volume

Portfolio A


Value proposition of an Excess of Loss under Solvency II:

For a given safety level the ratio of net premiums relative to required risk capital after reinsurance will increase considerably with a XL treaty.Risk mitigation None Quota

share (50 %)

WXL

Gross premium 7.000.000 7.000.000 7.000.000

R/I premium - 3.500.000 1.260.000

Net premium 7.000.000 3.500.000 5.740.000

Capital requirement

12.300.000 6.150.000 3.500.000

Net premium / Capital requirements

57 % 57 % 164 %

P&C XL per risk under Solvency II

0

50

100

150

200

250

300

1 2 3 4 5 6

number of losses

am

ou

nt

of

losses

loss burden reinsurance cover not covered

An XL reinsurance treaty reduces not only the absolute variability of the reinsured’s retained losses but also their relative variability.

The premium ceded to the reinsurer is in relative terms considerably smaller compared to the reduction of required capital through a non-proportional reinsurance treaty.

Indicator: Recognition as reinsurance

000.000.7

000.740.5

000.300.12

000.500.3 = 0.28 < 0.82

gross Reserves & Premium

net Reserves & Premium

gross tsrequiremen Capital

net tsrequiremen Capital


Example:Frequency risk and Aggregate-XL

11


Capital driver under Solvency II– Exposure to frequency risk

0%

2%

4%

6%

8%

10%

12%

14%

Portfolio A Portfolio B Primary insurers are normally well protected against losses from a severity perspective (vertical protection) through the core Catastrophe Excess of Loss (CXL) programme

A growing risk-taking ability often implies a growing deductible for the CXL programme which exposes the insurer to frequency risk below the deductible

Often, there is no protection against frequency risk below the deductible (missing horizontal protection)

Within Solvency II, the required solvency capital is determined by the distribution of the overall aggregate annual loss

This in turn is the result of the combination of the distribution of the claims amount (severity) and of the distribution of the claims frequency

Probability

Number of losses

The aggregate claim is the result of the combination of the distribution of the claims amount (severity) and of the distribution of the claims frequency

The more dangerous the claims frequency for any given severity, the more capital required to back the portfolio

Portfolio B requires more capital than Portfolio A


Value proposition of a Structured Stop Loss & Aggregate XL & under Solvency II:

Insurance risk:

Level of the capital relief determined by the design of the cover and the additional structural elements

Especially if the structured elements influence the risk mitigation or

utilize the diversification in time or over lines of business

Qualitative aspects:

Multi-year covers are providing certainty regarding price and capacity for a

specified future periods

This could be used as a qualitative argument for the regulator (Pillar 2)

P&C Aggregate XL under Solvency II

0

100

150

200

Loss ratio per year / %

140%

Year 1 Year 2 Year 3

Term limit 400 mio EUR

200 mio EUR

150 %

200 mio EUR

200 mio EUR

160 %


Example:Volatility of reserve run-off and LPT & ADC

14


While the final payments to a policyholder or a beneficiary will not yet be precisely known, the run-off contributes to the absolute volatility of an insurer’s result

This implies that the client will need, from an economic perspective, risk capital in order to support the run-off of a portfolio of liabilities

The inclusion of the volatility of reserve run-off may decrease or (more likely) increase the capital requirement

1. Timing risk

2. Reserving Risk

1 2 3 4 5

Reserved

Paid

Claims incurred (one AY)

100% estimate at end AY

Time

0 1 2 3 4 5 6

Expectedpayoutpattern

Slowerpayoutpattern

Faster payoutpattern

Total claims amount to be paid

Time

Capital driver under Solvency II– Volatility of reserve run-off


Loss Portfolio Transfer (LPT) & Adverse Development Cover (ADC)under Solvency II

Value proposition of a LPT/ADC under Solvency II:

Insurance risk: LPT removes the timing risk ADC removes the reserving risk

=> both consequently remove the necessity to set aside regulatory capital

Market risk:

Reduction of market risk due to the reduction of investments

Reserve risk (a)

Timing risk (b)

Time

“Adverse Development” Cover (a)

Claims

Expected claims (Claims provision on balance sheet)

Investment risk (c)

“Loss Portfolio Transfer” Cover(b+c)

“Loss Portfolio Transfer” premium(Net present value of claims provision)

Run-Off solution

Remarks:

Normally the capital relief from transferring the LPT part will be lower than the relief achieved by reinsuring adverse claims (ADC)

So far in some European countries the LPT is not recognized as reinsurance


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Although all the information used was taken from reliable sources, Swiss Re does not accept any responsibility for the accuracy or comprehensiveness of the details given. All liability for the accuracy and completeness thereof or for any damage resulting from the use of the information contained in this presentation is expressly excluded. Under no circumstances shall Swiss Re or its Group companies be liable for any financial and/or consequential loss relating to this presentation.

PAM 22 March 2010 - Susanne Kaske-Taft Solvency II – Capital drivers & reinsurance solutions FIAR...

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