Beautiful Models

IthasbeenawhilesinceIpostedondearoldSolvencyII(here)。

Ashighlightedinthepreviouspostonpotentiallosses,theinsurancesectorisperceivedashavingrobustcapitallevelsthatmitigatesagainstthecurrentpricingandinvestmentreturnheadwinds。

ItisthereforeinterestingtolookatsomeofdetailemergingfromthenewSolvencyIIframeworkinEurope,includingthemandatorydisclosuresinthenewSolvencyandFinancialConditionReport(SFCR)。

TheJune2017FinancialStabilityreportfromEIOPA,theEuropeaninsuranceregulatory,containssomeinterestingaggregatedatafromacrosstheEuropeaninsurancesector。

Thegraphbelowshowssolvencycapitalrequirement(SCR)ratios,primarilydrivenbythestandardformula,averagingconsistentlyaround200%fornon-life,lifeandcompositeinsurers。

Theratioistheregulatorycapitalrequirement,ascalculatedbyamandatedstandardformulaorafirm’sowninternalmodel,dividedbyassetsexcessliabilities(asperSolvencyIIvaluationrules)。

Astheriskprofileofeachbusinessmodelwouldsuggest,thevariabilityaroundtheaverageSCRratioislargestforthenon-lifeinsurers,followedbylifeinsurers,withtheleastvolatilebeingthecompositeinsurers。

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Forsomereason,whichIcan’tcompletelycomprehend,theEIOPAFinancialStabilityreporthighlightsdifferencesintheSCRbreakdown(asperthestandardformula,expressedasa%ofnetbasicSCR)acrosscountries,asperthegraphbelow,assuminglyduetothedifferentprofilesofeachcountry’sinsurancesector。

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AreviewacrossseveralSFCRsfromthelargerEuropeaninsurersandreinsurerswhouseinternalmodelstocalculatetheirSCRshighlightsthedifferencesintheirriskprofiles。

Ahealthwarningonanysuchcomparisonshouldbestressedgiventhedifferentriskcategoriesandmodellingmethodologiesusedbyeachfirm(thevaryingtreatmentofassetcreditriskorbusiness/operationalriskaregoodexamplesofthedifferingapproaches)。

ThegraphbelowshowseachmainriskcategoryasapercentageoftheundiversifiedtotalSCR。

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Bywayofputtingtheinternalmodelcomponentsincontext,thegraphbelowshowstheSCRbreakdownasapercentageoftotalassets(whichobviouslyreflectsinsuranceliabilitiesandtheassociatedcapitalheldagainstsame)。

Thiscomparisonisalsofraughtwithdifficultyasan(re)insurerstotalassetsisnotnecessarilyareliablemeasureofextremeinsuranceexposureinthesamewayasriskweightedassetsisforbanks(usedasthedenominatorinbankcapitalratios)。

Forexample,somelifeinsurerscanhavelowinsurancerelatedliabilitiesandassociatedassets(e。

g。

formortalityrelatedbusiness)comparedtootherinsuranceproducts(e。

g。

mostnon-lifeexposures)。

Notwithstandingthatcaveat,thegraphbelowshowsamarkeddifferencebetweenfirmsdependinguponwhethertheyareareinsurerorinsurer,orwhethertheyarealife,non-lifeorcompositeinsurer(otheritemssuchasretailversuscommercialbusiness,localorcross-border,specialtyversushomogeneousarealsofactors)。

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InitialreactionsbycommentatorsontheinsurancesectortothedisclosuresbyEuropeaninsurersthroughSFCRshavebeenmixed。

Somehaveexpresseddisappointmentatthelevelandconsistencyofdetailbeingdisclosed。

Regulatorswillhavetheirhandsfullinensuringthatsufficientlyrobuststandardsrelatingtosuchdisclosuresaremet。

RegulatorswillalsohavetoensureafairandconsistentapproachacrossallEuropeanjurisdictionsisadoptedincalculatingSCRs,particularlyforthosecalculatedusinginternalmodels,whilstavoidingthepitfallofforcingeverybodytousethesameassumptionsandmethodology。

RecentreportssuggestthatEIOPAislookingforagreaterroleinapprovingallinternalmodelsacrossEurope。

SystemicmodelriskundertheproposedBaselIIbankingregulatoryrulespublishedin2004isarguablyoneofthecontributorstothefinancialcrisis。

OnlytimewilltellifSolvencyIIhasavoidedthemistakesofBaselIIinthehandlingofsuchbeautifulmodels。

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