This document discusses de-risking techniques for insurers under Solvency II. It outlines various ways insurers can handle risk, including accepting it, rejecting it, migrating it to another entity through reinsurance or hedging instruments, or hedging it internally or externally. While risk mitigation helps reduce an insurer's solvency capital requirement, some techniques are not fully recognized in the standard formula. Additionally, risk mitigation introduces counterparty default risk that must be considered. The effect of risk mitigation differs under stress scenarios and secondary effects may impact other risk types. Reinsurance arrangements can provide actual capital benefits versus synthetic capital from the insurer's perspective.

1. 1De-risking under Solvency II
De-risking under Solvency II
David Kun
Atradius Credit Insurance / Functional Finances

2. 2Pre-Conference Workshop material
Overview
 Background
 De-risking techniques for Insurers
 Risk Mitigation and the Solvency Ratio
 De-risking under Stress
 Synthetic versus Actual Capital
Contents of this presentation

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Risks 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 some
measures of Profit and Risk
 In Solvency II, some Risk measures are pre-defined
Background 1

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Ways to handle risk
 Acceptance – an Undertaking can choose to accept
the risk
 Rejection – an Undertaking can reject the risk using
exception clauses such as specific risks or add policy
conditions such as Own Risk (aka Aggregate First Loss)
 Migration – risk can be passed to another entity, e.g. in
case of Reinsurance
 Hedging – the risk can be matched by some internal
or external hedging instrument under specific conditions
Background 2

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De-risking techniques for Insurers
 Part of the risk carried by the Undertaking can be passed on to
other parties
 The largest advantage of this method is that the risk mitigation
amount adapts to the risk scenario
 The most typical example is Reinsurance, when the
Underwriting risk is passed on to another Insurer
 There are other areas of risk migration, e.g. an IRS can be used
to migrate interest rate risk
 Besides the obvious credit risk, Solvency II also recognizes the
credit risk of Risk Mitigation
Migrating risk

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De-risking techniques for Insurers
 Part of the risk can be matched with corresponding, opposite
direction 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 Balance
Sheet and the SCR calculation
 Hedge is only possible for specific stress levels, e.g. in
Expected Value or at the VaR level
Hedging is nowadays an option for Underwriting Risk as well
(e.g. Mortality / Longevity CAT Bonds)
Hedging

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Risk mitigation and Solvency Ratio
 Standard Formula (SF)
 Some risk mitigation techniques are not recognized by
Standard Formula
 Some of the secondary effects (e.g. changes in
Commissions) can’t be incorporated in the SF
 There are major differences between the SF for various
LoB’s from Risk Mitigation perspective
 Undertakings may need to consider the SF effect when
making Risk Mitigation decisions
Reduction of SCR I

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Risk mitigation and Solvency Ratio
 Standard Formula continued
 Some Risk modules explicitly allow recognition of Risk
Mitigation 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 the
Risk Mitigation applied by the Undertaking
Reduction of SCR II

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Risk mitigation and Solvency Ratio
 Risk Mitigation techniques have a Balance Sheet
effect as well
 Best Estimate (Technical Provisions) of the Reinsurance
Assets is a Tier 1 asset
 Assets used for hedging also play an important role
 The Solvency Ratio is hence impacted both on the
SCR and the Own Funds side of the ratio
Reinsurance and Hedge Assets

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Case study
 Atradius purchases XL layers that are not expected to
be used
 These layers are there to reduce capital requirements
and for de-risking under major (catastrophic) stress
 Most of the Standard Formula doesn’t recognize the
risk mitigating effect of these layers
 Premium and Reserve risk allows 0 benefit
 Large Buyer CAT risk recognizes the benefit in full
Non-working XL layers in Standard Formula

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De-risking under stress
 Solvency II explicitly states that secondary effects
don’t imply dedicated Capital Requirements
 Exception: CDR on Risk Mitigation!
 Risk Mitigation techniques have different efficiency
under stress scenarios
 Stresses may have secondary effects, e.g.
Underwriting Risk stress can affect Market Risk or vice
versa
 Longevity Risk will have a large impact on Duration
 Market stress can cause increase in Credit UW Risk
Secondary effects in Solvency II

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Synthetic versus Actual Capital
 One way of interpreting Reinsurance is as Synthetic
Capital (as opposed to Risk Mitigation)
 This comes in addition to the already discussed
Reinsurance 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 shareholders
Pros and cons

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Thank you very much for your attention!
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