Our latest Life Insurers’ Solvency II Risk Capital Survey, the first since the directive went live, reflects the shift in participants’ attention from the specifics of calibration methodologies to embedding the internal model and operating it within business as usual. The results reveal considerable variations in the modelling of the matching adjustment (MA) under credit spread stress and the ongoing management of MA portfolios, with implications for the resulting amount of capital that can be offset. Other key findings include the range of potential approaches to the recalculation of the transitional measure for technical provisions (TMTP).
Our 2016 survey set out to capture the final post-IMAP approval stresses for key risks and compare key judgements around the day-to-day operation of the internal model. The analysis covered seven internal model/partial internal model insurers and three insurers which are using the standard formula model. We hope that the results are informative particularly when seeking to understand wider market practice.
All participants who use an MA make an allowance for the portion of the increase in credit spread that feeds through to the adjustment. However, there is no consensus on the size of this allowance and hence variations in the capital offset from the MA under stress.
The ability to clearly articulate and justify the approach and assumptions in applications to the Prudential Regulation Authority (PRA) contribute to the variation. Given the impact on capital requirements of having MA approval on day 1 there was potentially an incentive to take a conservative approach to the MA application to get initial approval. We expect to see further applications from insurers to extend the scope of MA portfolios as they maximise their eligible assets.
We also expect companies to engage with the PRA over the requirement to recalculate the TMTP every 24 months, or more frequently following a material change in risk profile. Many insurers want to avoid maintaining the Solvency I systems and processes required to facilitate full recalculation, but will need to seek regulatory approval to use simplifications and approximations. Again, the need for a clearly articulated approach and ability to justify underlying assumptions will be key in presenting a credible case to the PRA.
Credit, equity, longevity and persistency risks remain the highest individual contributors to participants’ solvency capital requirement (SCR). As observed in previous years, the modelling of credit risk varies markedly between market participants, resulting in a range of stresses being applied. However, we see a continuation in the trend towards modelling credit spread risk separately to transition and default risk, which is perhaps indicative of continued regulatory pressure.
It’s useful to look at what peers are doing to determine whether your approach is markedly different and, if so, how this can be justified or changed if necessary.
This isn’t just a matter of regulatory approval. Your internal model is now a central element of key business decisions, making the credibility of key judgements and underlying assumptions critical in steering the business.