Undertaking-specific parameters: a viable option for calculating capital requirements

Companies using the Solvency II standard formula should consider using undertaking-specific parameters in calculating their risk capital.

Undertaking-specific parameters (USPs) are an important element of the Solvency II standard formula. They allow for better assessment of undertaking-specific risk profiles in the standard formula, which in turn lead to a more accurate calculation of the solvency capital requirement (SCR).  A more pinpointed assessment of unique risks is important for specialist undertakings, as it allows them to produce an SCR that is calibrated for the specific risk environment.

Even though USPs require additional duties and administration, for many companies they are worth the extra effort.

The case for USPs

There are two reasons to use USPs for an undertaking: the first is to better reflect a company's risk profile. If historical net results or appropriate external data show lower market volatility on premium and reserve risk, re/insurers can replace the market-average parameters with the company-specific parameters based on its USPs to receive a lower SCR, provided the switch is approved by the regulator.

The other reason:  If a new re/insurance programme cannot be adequately reflected in the standard formula, a company can use USPs. The new structure can be applied to the historical gross book on an as-if basis for the reserve risk as well as for the premium risk. This way, the company can derive USPs which better reflect the undertaking's situation.

Using USPs

There are four sub-modules of the standard formula in which parameters can be replaced:

Non-life premium and reserve risk • Standard deviation for premium risk and for reserve risk
• Adjustment factor for non-proportional reinsurance
Non-SLT (similar-to-life) health
premium and reserve risk
• Standard deviation for premium risk and for reserve risk
• Adjustment factor for non-proportional reinsurance
SLT health revision risk • Instantaneous permanent increase of annuity benefits

Life revision risk

• Instantaneous permanent increase of annuity benefits

A credibility mechanism is required when applying USPs. Depending on the number of years in which data are available, more or less weight is given to the undertaking versus the market-average parameter.

Regulators usually support the use of USPs as they help better reflect the risk profile of the undertaking under the standard formula. However, the use of undertaking-specific parameters needs supervisory approval and therefore requires additional effort and duties. For example, the undertaking has to show evidence of complete, accurate, and appropriate data. For USP calculation, standardised methods given by the European Insurance and Occupational Pensions Authority need to be used and their use needs to be justified.

Swiss Re is ready

USPs are an important element of the Solvency II standard formula. Swiss Re has the talent and expertise to work with clients to explore different ways of implementing this useful feature.

Published 12 October 2012

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