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3.5.
Calculations
3.5.1. General considerations
3.221.The group SCR is calibrated on the same basis as the SCR of
a solo insurer – it aims to limit the probability of ruin to 0.5%
for all the parts of the group.
The group capital requirement
equals the amount of external economic capital needed in a group
to meet all the quantifiable risks, less the net impact of risk
mitigation techniques, deriving from the business conducted by the
entities that form the group.
3.5.2. Group specific risks
3.222.In order to reflect the total risks that the group may face,
the group SCR should reflect the risks that arise at the level of
the group and that are specific to the group.
The Level 1 text is clear on
this and states in Article 101(3) that the SCR should reflect all
quantifiable risks to which an
insurance or reinsurance undertaking is exposed to.
3.223.The lessons learnt from the financial crisis illustrate the
importance of group-specific risks, such as reputational risk,
contagion risk, impact of intra-group transactions13, operational
risk.
QIS4 also reported that
entities within groups may face significant reputational risks and
other group-specific risks.
Assessment Methodology
3.224.CEIOPS considers that group-specific risks should be
addressed using the following approach:
• First, the group shall be required to calculate the group SCR
either with the standard formula or an internal model.
• Second, supervisors shall acquire information on group-specific
risks through, among other means, the group supervisory review
process, stress tests or other quantitative or qualitative
measures;
• Third, if the group uses the standard formula and then there is
a significant deviation from the assumptions underlying the
standard formula calculation (e.g. due to complex structures,
etc.), the group supervisor shall adopt the necessary measures to
correct this situation.
For this purpose the group supervisor may require :
a. the use of an internal model pursuant to Article 117; or
b. the use of group specific parameters for underwriting modules
(see CEIOPS-CP-57/09) where the deviation arises from the
application of those modules.
• Alternatively, if the group uses an internal model, then the
requirements of Articles 110 to 124 shall apply meaning that any
deficiency due to group specific risks will have to be adressed in
the same way as for any other risks.
• Finally, if the group is unable to fulfil the requirements above
within an appropriate timeframe, the group supervisor, in
consultation with the supervisors concerned, may decide as a last
resort measure to impose a group capital add-on.
3.225.The following sections describe some of the different types
of risks that arise at the level of the group and possible
assessments.
This list should not be
considered as exhaustive.
3.5.2.1 Reputational Risk
3.226.Reputational
risk is defined as the risk of potential loss to an undertaking
through deterioration of its reputation or standing due to a
negative perception of the undertaking’s image among customers,
counterparties, shareholders and/or supervisory authorities.
To that extent it may be
regarded as less of a separate risk, than one consequent on the
overall conduct of an undertaking.
3.227.The administrative or management body of the undertaking
should be aware of potential reputational risks it is exposed to
and the correlation with all other material risks.
3.228.The undertaking should pay great attention to understanding
and recognising key values affecting the reputation, considering
expectations of the stakeholders and sensitivity of the
marketplace.
3.229.As set out in Article 101, operational risk excludes risks
arising from strategic decisions and reputation risk. Reputational
risk is therefore a separate risk type.
3.230.Reputational risk can manifest itself in reduced customer
retention and satisfaction, in new customer acquisitions becoming
difficult and in declining turnover rates and higher refinancing
costs.
In addition, there are
negative internal effects such as lower employee satisfaction,
higher labour turnover, less identification with the company and
less job appeal to potential employees.
3.231.Additionally to the input to the group SCR, the reputational
must be taken into account as part of the group’s overall risk
strategy.
It is essential that
reputational risk is included in the business strategy and linked
with the other risk types.
This includes defining
functions and responsibilities, the available instruments and the
risk tolerance.
3.5.2.2 Contagion Risk
[Contagion risk is the risk that an individual entity will be
adversely affected by the actions of another entity within the
group due to the relationships, direct or indirect, that exist
between them]
3.232.Following the definition from IAIS,14 contagion risk mainly
deals with possible adverse impacts on one entity of the group due
to intra-group relationships.
Contagion risk can be
understood as a spill-over effect of risks that have manifested in
other parts of the group.
For instance, a reputational
risk affecting one undertaking may impact another undertaking
within the same group, solely based on the relationship that
exists between the undertakings.
Contagion risk can therefore
stem from various sources, making it difficult to come to a
standardised approach to dealing with contagion risk.
3.233.Additionally to the input to the group SCR, contagion risk
should be reflected in the group's Own Risk and Solvency
Assessment.
3.234.Groups should deal with contagion risk within their Own Risk
and Solvency Assessment.
Because of the difficulties
associated with measuring contagion risk in a standardised way,
CEIOPS does not foresee the possibility to cover contagion risk
explicitly in a quantitative way on top of all the other risks in
the standard model, though it may be possible for groups to
adequately capture contagion risk within an internal model.
3.235.Insurers that operate as part of a corporate group or a
financial conglomerate usually have various contracts which bind
them to each other in good times but also in times of need.
Therefore such insurers are
more exposed to contagion than others.
Contagion risk can arise from
the reputational impact of a misbehaving group member especially
if they are using the same branding.
Furthermore depending on intra
group contract, moral obligations to support a group member with
monetary problems
might cause the insurer itself to loose its ability to fulfil its
liabilities.
Moreover problems associated with one part of a group can be
transferred to other parts by market reluctance to deal with a
group member of a tainted group.
Another type of contagion
relates to intra-group exposures.
This risk varies with the size and the nature of the exposures
involved.
3.236.A specific problem for financial conglomerates is that the
illiquidity from the banking sector might spillover to the
insurance member caused by the exchange of liquidity for bonds or
similar illiquid assets.
3.237.The supervisor may need to “ring-fence” the insurer i.e.
prohibiting any dealings including financial and operational
linkages between the insurer and other members of the same group.
A cost for the group could
arise due to the effect of restricted possible asset transfer
within the group.
Positive effects of the group consortium can therefore not be
utilized.
3.238.Groups are highly exposed to contagion risks but it is not
restricted to them. Many customers do not distinguish between
insurance companies.
Hence, if a few companies within the same branch fail the
expectations of their customers, the whole branch could suffer
from it.
For example, if some life
insurers pass on only a small profit participation to their
customers the canvass gets harder for the whole branch.
3.239.In non-life insurance a catastrophe could lead to the
financial instability of some insurers which, because of the
interconnectedness of the branch, could cause decreasing share
prices of insurance companies that are financially sound.
This may decrease the
reputation and the trust of customers in the whole branch.
If some insurance companies
misbehave in the adjustment of claims and the media broadcasts
this, the reputation of
the whole branch could also suffer.
3.5.2.3 Operational Risk
3.240.At solo level, the capital charge for operational risk is
added to the Basic Solvency Capital Requirement (BSCR) and
therefore does not provide any diversification benefit.
At group level the operational
risk capital requirements are also summed without providing any
diversification benefits.
3.241.Under QIS 4 large groups commented that summing the solo
operational risk capital charges does not reflect the operational
risk at group level in the case where certain services are shared
by the legal entities or provided at the group level.
The effectiveness of managing
risks through dedicated centralised resources will not be
reflected in the standard formula,
therefore, any diversification effects are lost.
3.242.It is unclear why a group should be subject to less
operational risk, as anecdotal evidence suggests that this risk
does not diversify well.
Where a group might
standardise the use of certain services, which may improve the
degree of control and lessen the impact of operational risk, there
is also a greater complexity at group level.
Further, it would be expected
that the operational risk is equal for a group and for an
essentially similar solo undertaking.
The current calculation takes
this into account.
3.5.2.4 Strategic risk
3.243.Strategic risk is defined as the risk of the current and
prospective impact on earnings or capital arising from adverse
business decisions, improper implementation of decisions, or lack
of responsiveness to industry changes.
3.244.Strategic risk is a function of the incompatibility between
two or more of the following components: the undertaking’s
strategic goals, the business strategies developed and the
resources deployed to achieve these goals, and the quality of
implementation and the economic situation of the markets the
undertaking operates in.
3.245.The resources needed to carry out business strategies are
both tangible and intangible.
They include communication
channels, operating systems, delivery networks, and managerial
capacities and capabilities.
The undertaking’s internal
characteristics should be evaluated against the impact of
economic, technological, competitive, regulatory, and other
environmental changes.
3.246.The overall strategy of the undertaking should incorporate
its risk management practices.
In this sense, the undertaking
should have a process for setting strategic-high-level objectives
and translating these into detailed shorter-term business and
operation plans.
3.247.It is the responsibility of the group to ensure that
strategic risk is adequately managed not only at solo level, but
also at group level.
3.5.2.5 Intra group
transactions and concentration risks
3.248.Concentration risk comes both from the fact that some
entities of the group are not consolidated and from the
interdependency between the different entities of the group that
exposes the parent entity to a holistic failure of the group.
3.249.Although not reflected in the consolidated balance sheet,
intra-group transactions risk should be considered and are
captured by Article 249.
Intra group transactions and risk concentration are further
discussed in CEIOPS Consultation Paper CEIOPS-CP-61/09.
3.250.Finally, the FCD review is assessing the treatment of
participations with respect to the reporting of
risk concentration
(RC) and intra-group transactions (IGT).
The JCFC has noted some of the
difficulties that financial conglomerates can have in accessing
information on participations and how to treat unregulated
entities in the group reporting requirements.
CEIOPS notes that the
reporting of RC and IGT in the Level 1 text is consistent with the
FCD, and that the outcomes of the FCD review may also be relevant
to Solvency II.
3.5.2.6 Internal reinsurance
3.251.A reinsurance
arrangement entered into within a group should not result in a
decrease in the group SCR in the absence of financing external to
the group.
Group regulatory capital
requirements are only permitted to be reduced therefore if the
risk is being transferred outside of the group.
3.252.Exceptions to this principle may be a party external to the
group is involved in the reinsurance arrangement for example by
providing finance as part of the arrangement.
3.253.The analysis should include the impact of the default of the
main entity of the group responsible of external reinsurance,
taking into account not only the impact in the moment of default
but also taking into account the necessity of a new hedging.
CEIOPS’ advice
3.254.Operational risk including legal risk is covered in a
quantitative way in the SCR calculation.
It is not considered a
group-specific risk.
3.255.At group level the operational risk capital requirements are
summed.
3.256.In order to reflect the total risks that the group may face,
the group SCR shall reflect the risks that arise at the level of
the group and that are specific to the group.
3.257.CEIOPS considers that group-specific risks shall be
addressed using the following approach:
• First, the group shall be required to calculate the group SCR
either with the standard formula or an internal model.
• Second, supervisors shall acquire information on group-specific
risks through, among other means, the group supervisory review
process, stress tests or other quantitative or qualitative
measures;
• Third, if the group uses the standard formula and then there is
a significant deviation from the assumptions underlying the
standard formula calculation (e.g. due to complex structures,
etc.), the group supervisor shall adopt the necessary measures to
correct this situation.
For this purpose the group supervisor may require :
a. the use of an internal model pursuant to Article 117; or
b. the use of group specific parameters for underwriting modules
where the deviation arises from the application of those modules.
• Alternatively, if the group
uses an internal model, then the requirements of Articles 110 to
124 shall apply meaning that any
deficiency due to group specific risks will have to be adressed in
the same way as for any other risks.
• Finally, if the group is unable to fulfil the requirements above
within an appropriate timeframe, the group supervisor, in
consultation with the supervisors concerned, may decide as a last
resort measure to impose a group capital add-on.
3.5.3. Interest rate risk and currency risk
Explanatory text
3.258.The effect of interest rate shocks can be calculated on the
consolidated approach by working with the components of the
SCR(Mktint) calculated for each solo entity or with-profit fund.
The calculation needs to take
into
account that upward and downward shocks on interest rate cannot
happen at the same time for the same currency. The SCR(Mktint) for
the group can then be expressed as follows:
where the index i refers to
the calculation of SCR(Mktint) for each of the entities taken into
consideration, including each with-profit fund.
3.259.The currency risk for non-EEA countries should only apply on
the net asset value minus the capital requirement of the
subsidiary or the subgroup (e.g. if the net asset value of the
subsidiary is 100 and its capital requirement is 80, the currency
risk applies only to 100 – 80 =20).
3.260.The local currency is the currency in which the undertaking
prepares its local regulatory accounts.
All other currencies are
referred to as foreign currencies.
A foreign currencies is
relevant for the scenario calculations if the amount of basic own
funds depends on the exchange rate between the foreign currency
and the local currency.
3.261.For each relevant foreign currency C, the C upward and C
downward shocks are respectively the immediate effect expected on
the net value of asset and liabilities in the event of a x%
change, rise and fall respectively in value of the foreign
currency against the local currency, taking account of all the
participant's individual currency positions and its investment
policy (e.g. hedging arrangements, gearing etc.).
The C shock is the more
adverse of the C upward shock and the C downward shock.
3.262.As for interest rate risk above the effect of foreign
exchange rate shocks can be calculated on the consolidated
approach by working with the components of the
SCR(Mktfx)
calculated for each solo entity or with-profit fund.
The calculation needs to take
into account that upward and downward shocks on exchange rate
cannot happen at the same time.
The SCR(Mktfx) for the Group
can then be expressed as follows:
3.263.where the index i refers
to the calculation of SCR(Mktfx) for each of the entities taken
into consideration, including each with-profit fund.
The index C refers to the
relevant currency, and m is the total number of relevant
currencies.
3.5.4. Group SCR floor
3.264.For the purposes of the accounting consolidation-based
method the Level 1 text defines the group SCR floor as a minimum
amount of group SCR under which the group SCR cannot drop.
This amount is defined in
Article 228(2) as follows:
“The consolidated group Solvency Capital Requirement shall have as
a minimum the sum of the following:
(a) the minimum capital requirement (Minimum Capital Requirement)
as referred to in Article 127 of the participating insurance or
reinsurance undertaking;
(b) the proportional share of the Minimum Capital Requirement of
the related insurance and reinsurance undertakings.
That minimum shall be covered by eligible basic own funds as
determined in Article 98(5).
For the purposes of determining whether such eligible own funds
qualify to cover the minimum consolidated group Solvency Capital
Requirement, the principles set out in Articles 219 to 227 shall
apply mutatis mutandis.
The provisions set out in
paragraphs 1 and 2 of Article 137 shall apply by analogy.”
3.265.CEIOPS gave the reasons for setting a group SCR floor in its
previous advices to the European Commission – Call for Advice 1816
and Consultation Paper 1417.
3.266.Given the nature of the accounting consolidation-based
method, it is most likely that the group SCR will be lower than
the sum of SCRs of all insurance undertakings within the group due
to diversification effects.
It is therefore necessary to
ensure that the group SCR is at least above the sum of all Minimum
Capital Requirements. Otherwise, the group is only able to comply
with solo MCRs by the mean of double use of eligible own funds
items or internal creation of capital.
3.267.When using the deduction and aggregation method for the
group SCR calculation, it is clear that the group SCR by nature of
this method cannot be lower than the sum of solo SCRs and no
diversification is recognized.
Defining the group SCR floor for the deduction and aggregation
method just clarifies that the assessment of group solvency has no
impact on the MCR of the different entities of the group.
3.268.The Level 1 text states that the group supervisor, after
consultation with other competent authorities concerned, may allow
the group to apply a combination of the two prescribed methods for
the group SCR calculation.
In such case it is not clear whether the group SCR floor defined
in Article 228(2) should apply.
However, to avoid double
gearing CEIOPS considers the group SCR floor should be applied
when using the combination of both
admissible methods.
3.269.The solo MCR figure used for the group SCR floor calculation
shall be the MCR determined after applying the corridor referred
to in Article 127(3) or after applying the absolute floor referred
to in Article 127(1)(d).
3.270.Since non-compliance with the group SCR floor inevitably
means noncompliance with solo MCR of one or several related
undertakings, it is necessary that the necessary actions at group
level are coordinated within the college of supervisors.
3.271.The calculation of the proportional share set out in article
228(2)(b) shall be the same as the one used for the calculation of
the group SCR, i.e. the percentage used for the establishment of
the consolidated as stated in Article 219.
CEIOPS’ advice
3.272.The Level 1 text states that the group supervisor, after
consultation with other competent authorities concerned, may allow
the group to apply a combination of the two prescribed methods for
the group SCR calculation.
In such case it is not clear whether the group SCR floor should
apply.
However, to avoid double gearing CEIOPS considers the group SCR
floor should be applied when using the combination of both
admissible methods.
3.273.The solo MCR figure used for the group SCR floor calculation
shall be the MCR determined after applying the corridor referred
to in Article 127(3) or after applying the absolute floor referred
to in Article 127(1)(d).
3.274.The calculation of the proportional share set out in article
228(2)(b) shall be the same as the one used for the calculation of
the group SCR, i.e. the percentage used for the establishment of
the consolidated as stated in Article 219.
3.5.5. Group technical provisions
3.275.CEIOPS considers that the group best estimate of insurance
liabilities should be the sum of solo best estimate of insurance
liabilities with only the elimination of the part of the best
estimate resulting from internally reinsured activities in order
to avoid double counting of commitments as in the consolidated
accounts.
As at solo
level, gross technical provisions shall be calculated at group
level.
3.276.The group risk margin is a part of group technical
provisions and should be equal to the sum of solo risk margin in
any case as it is already calculating net of reinsurance.
CEIOPS’ advice
3.277.CEIOPS considers that the group best estimate of insurance
liabilities should be the sum of solo best estimate of insurance
liabilities with only the elimination of the part of the best
estimate resulting from internally reinsured activities in order
to avoid double counting of commitments as in the consolidated
accounts.
3.278.The group risk margin is a part of group technical
provisions and should equal to the sum of solo risk margin in any
case as it is already calculating net of reinsurance.
Consultation Paper No. 60
Draft CEIOPS’ Advice for Level 2 Implementing Measures on Solvency
II: Assessment of Group Solvency
1.
Assessment of Group Solvency - Introduction
2.
Level 1 Text
3.
Advice from CEIOPS
4.
Third Countries
5.
Calculation Method
6.
Fungibility and Transferability
7.
Transferability of Own Funds
8.
Calculations
9.
Annex 1 to Annex 5
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