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De-risking under solvency ii


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Under the new Solvency II regime, insurers face new challenges in managing their risks. This presentation gives the basics of what an insurance company can do and how Solvency II changes the necessary actions.

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De-risking under solvency ii

  1. 1. 1De-risking under Solvency IIDe-risking under Solvency IIDavid KunAtradius Credit Insurance / Functional Finances
  2. 2. 2Pre-Conference Workshop materialOverview Background De-risking techniques for Insurers Risk Mitigation and the Solvency Ratio De-risking under Stress Synthetic versus Actual CapitalContents of this presentation
  3. 3. 3Pre-Conference Workshop materialRisks of an Insurance Undertaking An insurance company is trading risk The only way to minimize risk is to stop the business De-risking is a balancing act between Profit and Risk Optimizing de-risking needs a Risk Appetite and somemeasures of Profit and Risk In Solvency II, some Risk measures are pre-definedBackground 1
  4. 4. 4Pre-Conference Workshop materialWays to handle risk Acceptance – an Undertaking can choose to acceptthe risk Rejection – an Undertaking can reject the risk usingexception clauses such as specific risks or add policyconditions such as Own Risk (aka Aggregate First Loss) Migration – risk can be passed to another entity, e.g. incase of Reinsurance Hedging – the risk can be matched by some internalor external hedging instrument under specific conditionsBackground 2
  5. 5. 5Pre-Conference Workshop materialDe-risking techniques for Insurers Part of the risk carried by the Undertaking can be passed on toother parties The largest advantage of this method is that the risk mitigationamount adapts to the risk scenario The most typical example is Reinsurance, when theUnderwriting risk is passed on to another Insurer There are other areas of risk migration, e.g. an IRS can be usedto migrate interest rate risk Besides the obvious credit risk, Solvency II also recognizes thecredit risk of Risk MitigationMigrating risk
  6. 6. 6Pre-Conference Workshop materialDe-risking techniques for Insurers Part of the risk can be matched with corresponding, oppositedirection flows, resulting in lowered net risk Hedging can be done internally, e.g. using ALM or externally,e.g. purchasing hedging instruments Hedge instruments will always be recognized in the BalanceSheet and the SCR calculation Hedge is only possible for specific stress levels, e.g. inExpected Value or at the VaR levelHedging is nowadays an option for Underwriting Risk as well(e.g. Mortality / Longevity CAT Bonds)Hedging
  7. 7. 7Pre-Conference Workshop materialRisk mitigation and Solvency Ratio Standard Formula (SF) Some risk mitigation techniques are not recognized byStandard Formula Some of the secondary effects (e.g. changes inCommissions) can’t be incorporated in the SF There are major differences between the SF for variousLoB’s from Risk Mitigation perspective Undertakings may need to consider the SF effect whenmaking Risk Mitigation decisionsReduction of SCR I
  8. 8. 8Pre-Conference Workshop materialRisk mitigation and Solvency Ratio Standard Formula continued Some Risk modules explicitly allow recognition of RiskMitigation such as hedge instruments Some Risk modules are explicitly gross of Risk Mitigation(or at least gross of Reinsurance) Risk mitigation also introduces extra charges, e.g.Counterparty Default Risk on Reinsurance Assets (Partial) Internal models Internal Models may be necessary to fully benefit from theRisk Mitigation applied by the UndertakingReduction of SCR II
  9. 9. 9Pre-Conference Workshop materialRisk mitigation and Solvency Ratio Risk Mitigation techniques have a Balance Sheeteffect as well Best Estimate (Technical Provisions) of the ReinsuranceAssets is a Tier 1 asset Assets used for hedging also play an important role The Solvency Ratio is hence impacted both on theSCR and the Own Funds side of the ratioReinsurance and Hedge Assets
  10. 10. 10Pre-Conference Workshop materialCase study Atradius purchases XL layers that are not expected tobe used These layers are there to reduce capital requirementsand for de-risking under major (catastrophic) stress Most of the Standard Formula doesn’t recognize therisk mitigating effect of these layers Premium and Reserve risk allows 0 benefit Large Buyer CAT risk recognizes the benefit in fullNon-working XL layers in Standard Formula
  11. 11. 11Pre-Conference Workshop materialDe-risking under stress Solvency II explicitly states that secondary effectsdon’t imply dedicated Capital Requirements Exception: CDR on Risk Mitigation! Risk Mitigation techniques have different efficiencyunder stress scenarios Stresses may have secondary effects, e.g.Underwriting Risk stress can affect Market Risk or viceversa Longevity Risk will have a large impact on Duration Market stress can cause increase in Credit UW RiskSecondary effects in Solvency II
  12. 12. 12Pre-Conference Workshop materialSynthetic versus Actual Capital One way of interpreting Reinsurance is as SyntheticCapital (as opposed to Risk Mitigation) This comes in addition to the already discussedReinsurance Asset which is actual capital Synthetic Capital may or may not be cheaper Synthetic Capital may vary with the level of Stress Actual Capital is fully recognized in the Solvency Ratio Actual Capital is easier to understand for shareholdersPros and cons
  13. 13. 13Pre-Conference Workshop materialThank you very much for your attention!Question?