Captives
and Solvency ii
Captive
Insurance and Captive Reinsurance Companies after the Solvency ii
Directive
from the Solvency ii
Association, the largest Association of Solvency ii Professionals
in the world
PROPORTIONALITY - LEVEL 2
MEASURES
CEIOPS-CP-45/09, 2 July 2009,
Consultation Paper No. 45
Draft CEIOPS’
Advice for Level 2 Implementing Measures on Solvency II: Technical
Provisions – Article 85 h, Simplified
methods and techniques to calculate technical
provisions
3.2.3
Reinsurance recoverables
3.2.3.1
Introduction
3.147 This sub-section
considers the use of simplified approaches for
the determination of non-life reinsurance recoverables and technical
provisions net of reinsurance.
3.148 The approaches
considered represent Gross-to-Net techniques meaning that it is
presupposed that an estimate of the technical
provisions gross of reinsurance (compatible with the Solvency II
valuation principles) is already available.
The techniques are applied to
derive estimates of reinsurance recoverables and the provisions net
of reinsurance on basis of
these gross
estimates.
3.149 A special feature of
the Gross-to-Net techniques is that they
represent an indirect approach for calculating the value of
reinsurance recoverables (the reinsurance assets), since following
such techniques the value of reinsurance recoverables is derived in
a subsequent step as the excess of the gross over the net estimate.
Accordingly, this sub-section
considers how such an indirect approach could be designed to be
compatible with the
Solvency II Framework and in particular
Article 80 of the Level 1 text.
3.150 This sub-section is
also intended to provide a conceptual framework
for the use of Gross-to-Net techniques under Solvency II,
supplementing CEIOPS’s draft advice on the valuation of reinsurance
recoverables contained in the consultation paper on Article
85(a).
3.151 Finally, it should
be noted that where this sub-section addresses the issue of
recoverables (and corresponding net valuations), this is restricted
to recoverables from reinsurance contracts, and does not include
consideration of recoverables from SPVs.
Relevant
implementing measures
3.152 As has been
previously noted, the legal basis for implementing measures
regarding simplified approaches for calculating technical provisions
are given in Article 85(h) of the Level 1 text, which
states:
“where
necessary, simplified methods and techniques to calculate technical
provisions, in order to ensure the actuarial methods and statistical
techniques referred to in point (a) are proportionate to the nature,
scale and complexity of the risks supported by insurance and
reinsurance undertakings.”
3.153 It is noted that
Article 85(a) refers back to Article 76(2) which covers the
calculation of the best estimate gross of reinsurance.
However, Article 80 stipulates
that the determination of reinsurance recoverables shall comply with
Articles 75 to 79.
This implies that any
implementing measure specifying further the requirements under these
Articles should also have regard to the determination of reinsurance
recoverables.
This would
include the specification of any simplified methods as referred to
under Article 85(h).
3.154 The only direct reference
to reinsurance recoverables among the implementing measures for the
valuation of technical provisions is given in Article 85(g) which
refers to “the methods to be used when calculating the counterparty
default adjustment” required under Article
80.
3.155 The list of
implementing measures as given in Article 85 does not refer directly
to the calculation of the best estimate of technical provisions net
of reinsurance.
In particular, there is no reference to the (possibly simplified) methods to
be applied when converting best estimates of technical provisions
gross of reinsurance to best estimates of technical provisions net
of reinsurance.
3.156 However, any such
method to determine technical provisions net of reinsurance gives
rise to a method to determine reinsurance recoverables (as the
difference between gross and net provisions) which are implicitly
covered by the implementing measures under Article 85 as explained
above.
Gross-to-net
techniques: the story so far
3.157 Annex A of this paper
contains a detailed analysis of the gross-to-net techniques
(“proxies”) developed in the Report on Proxies elaborated by
CEIOPS/Groupe Consultatif Coordination Group59 as well as the
gross-to-net techniques which were tested (based on the
recommendations contained in this report) in the QIS4
exercise.
3.158 This description of gross-to-net techniques has been
included purely for informational purposes; it is intended to
provide an overview on the range and technical specificities of such
methods developed so far.
CEIOPS considers that further
technical work is necessary before it could be decided whether it
would be appropriate to include (some of) these techniques in Level
2.
3.2.3.2
Analysis
3.159 This sub-section
considers in general terms under which circumstances it would be
appropriate to use gross-to-net
techniques for a valuation of net technical provisions (and,
following this, reinsurance recoverables) under the Solvency II
framework, having regard to the proportionality assessment framework
outlined in section 3.1.
3.160 It first considers
the compatibility of such techniques with
the valuation principles set out in the Level 1 text. Further to
this, the potential scope of an application of gross-to-net
techniques is analysed.
Finally, it is considered
which level of detail/granularity would generally be needed in an
application of gross-to-net techniques.
3.161 In the advice,
these considerations are used for setting general high-level
criteria to be followed by an (re)insurance undertaking applying
gross-tonet techniques under the Solvency II
framework.
3.2.3.2.1 Compatibility of Gross-to-Net
Calculations with the Level 1 Text
Reinsurance recoverables
and net technical provisions 3.162 As has been set out, the
determination of reinsurance recoverables should follow the same
principles as for the determination of gross technical provisions
(i.e. it shall comply with Articles 75 to 79 of the Level 1 text),
with an additional adjustment (imposed by Article 80) to take into
account of expected losses due to counterparty
defaults.
3.163 In this context, the
technical provisions net of reinsurance are given (defined) as the
difference between the technical provisions gross of reinsurance and
the reinsurance recoverables:
Net provisions = gross provisions – reinsurance
recoverables
Role of
gross-to-net techniques in Solvency II
Framework
3.164 The technical
“gross-to-net” methods considered in this sub-section are designed
to calculate the value of net technical provisions in a direct
manner, by converting best estimates of technical provisions gross
of reinsurance to best estimates of technical provisions net of
reinsurance.
The value of the
reinsurance recoverables is then given as the excess of the gross
over the net valuation:
Reinsurance recoverables = gross provisions –
net provisions
3.165 It is noted that
the
level 1 text contains no direct reference to any such gross-to-net
methods.
However, since a determination
of the value of technical provisions net of reinsurance gives rise
to a determination of
reinsurance recoverables (and vice versa),
an application of gross-to-net valuation techniques – and more
broadly of any methods to derive net valuations of technical
provisions – may be integrated into the Solvency II Framework by
using a three-step approach as follows:
• Step
1: Derive valuation of technical provisions net of
reinsurance.
• Step 2:
Determine reinsurance recoverables as difference between gross and
net valuations.
• Step 3:
Assess whether valuation of reinsurance recoverables is compatible
with Article 80.
In the following, these
steps are examined in more detail.
Step 1:
Derivation of technical provisions net of
reinsurance
3.166 The starting point
for this step is a valuation of technical provisions gross of
reinsurance.
For non-life insurance
obligations, the value of gross technical provisions would generally
be split into the following components
per homogeneous group of
risk or (as a minimum) lines of business:
PPGross = the best
estimate of premiums provisions gross of
reinsurance;
PCOGross = the best
estimate of claims provisions gross of
reinsurance;
RM = the risk
margin.
3.167 From this, a
valuation of the best estimate technical provisions net of
reinsurance within a given homogeneous risk group or line of
business may be derived by applying Gross-to-Net techniques to the
best estimates components referred to
above.
3.168 The technical
provisions net of reinsurance in the given homogeneous risk group or
line of business would then exhibit the same components as the gross
provisions, i.e.
PPNet = the best estimate
of premiums provisions net of reinsurance;
PCONet = the best estimate
of claims provisions net of reinsurance;
RM = the risk
margin.
Step 2:
Determination of reinsurance recoverables as difference between
gross and net valuations
3.169 On basis of the
results of step 1, the reinsurance recoverables (RR) per homogenous
risk groups (or lines of business) may be calculated as follows
(using the notation as introduced above):
RR = (PPGross – PPNet) +
(PCOGross – PCONet)
3.170 Note that implicitly
this calculation assumes that the value of reinsurance recoverables
does not need to be decomposed into best estimate and risk margin
components.
Step 3:
Assessment of compatibility of reinsurance recoverables with Article
80
3.171 In this step, it
would need to be assessed whether the determination of the
reinsurance recoverables in step 2 is consistent with Article 80 of
the Level 1 text.
3.172 In particular, this
would require an analysis as to whether the issues referred to in
the second and third paragraph of Article 80, i.e. the time
difference between direct payments and recoveries and the expected
losses due to counterparty risks, were taken into
account
3.173 To achieve
consistency with the required adjustment related to expected losses
due to counterparty defaults, it would generally be necessary to
integrate an analogous adjustment into the determination of net of
reinsurance valuation components in step 1. Such an adjustment would
need to be treated separately (in the context of Article 85(g)
as
well as the relevant aspects of the SCR counterparty risk module)
and would not be covered by one of the gross-to-net techniques
discussed in this subsection.
3.2.3.2.2 The Scope of
Gross-to-Net Techniques
3.174 It follows
from the
summary of the QIS4-results that Gross-to-Net techniques have been
extensively used by all kind of participating non life insurance
undertakings (irrespectively of their size).
This illustrates clearly the
present difficulties of applying Article 80 to calculate reinsurance
recoverables (reinsurance assets) in a direct
manner.
3.175 Accordingly, it
seems reasonable that an option to use simplified gross-to-net
techniques – following their integration under the Solvency II
Framework as illustrated in the previous sub-section 3.2.3.2.1 –
should apply to all non-life insurance undertakings, including
undertakings being able to stipulate the best estimate of technical
provisions on a gross basis by
using adequate actuarial methods
and statistical techniques.
3.176 However, any
gross-to-net valuation technique to be used would need to lead to a
valuation which is compatible with the Solvency II valuation
principles and proportionate to the underlying risks.
Therefore
it can be expected
that the Gross-to-Net methods to be applied would in general need to
be more sophisticated than the Gross-to-Net proxies tested in QIS4.
(This is especially the case
for the proxy based on the ratio of net to gross provisions for
RBNS-claims of a reference portfolio.)
3.177 Moreover, non-life
insurance undertakings would be expected to use of Gross-to-Net
methods in a flexible way be applying them to either premium
provisions or provisions for claims outstanding or to a subset of
lines of business or accident (underwriting) years, having regard to
e.g. the complexity of their reinsurance programmes, the
availability of relevant data, the importance (significance) of
the sub-portfolios in question or by using other relevant
criteria.
3.178 An undertaking would typically use a simplified
Gross-to-Net technique when e.g.
• The undertaking has not
directly estimated the net best estimate
• The undertaking has
used a case by case approach for estimating the gross best estimate
• The undertaking cannot ensure the appropriateness,
completeness and accuracy of the data
• The underlying
reinsurance programme has changed
3.2.3.2.3 Degree of Detail and
Corresponding Principles/Criteria
3.179 It seems unlikely that a
Gross-to-Net simplified technique being applied to the overall
portfolio of a non-life insurance undertaking would give
reliable and reasonably accurate approximations of the best
estimate of technical provisions net of reinsurance.
Accordingly, non-life insurance undertakings should in general
carry out the Gross-to-Net calculations at a sufficiently
granular level.
In order to
achieve this level of granularity
a suitable starting point would be:
• to distinguish between
homogenous risk groups or as a minimum lines of business;
• to
distinguish between the premiums provisions and provisions
for claims outstanding (for a given homogenous risk group or line
of business); and
• with respect to the provisions for claims
outstanding, to distinguish between the accident years not
finally developed and – if the necessary data is available and of
sufficient quality – to distinguish further between provisions
for RBNS-claims and IBNR-claims, respectively.
3.180 A further
refinement that may need to be applied when stipulating
the Gross-to-Net techniques would be to take into account the
type of reinsurance cover and especially the relevant (i.e. most
important) characteristics of this cover.
3.181 Below, the
technical options being available to carry out
Gross-to-Net valuations at a more granular level are analysed in
more detail.
3.182 When applying such refinements,
the following
general considerations should be made:
• Whereas
increasing
the granularity of Gross-to-Net techniques will generally lead to
a more risk-sensitive measurement, it will also increase their
complexity, potentially leading to additional
implementation costs for the undertaking.
Therefore, following
the principle of proportionality, a more granular approach should
only be chosen where this is necessary regarding the nature,
scale and complexity of the underlying risks (and in particular
the corresponding reinsurance
program).
• For certain kinds of
reinsurance covers (e.g. in cases where the cover extends across
several lines of business, so that it is difficult to allocate
the effect of the reinsurance risk mitigation to individual
lines of business or even homogeneous groups of risk, or where
the cover is only with respect to certain perils of a LOB),
increasing the granularity of Gross-to-Net techniques as
described below will not suffice to derive an adequate
determination of provisions net of reinsurance.
In such cases,
individual approaches tailored to the specific reinsurance cover
in question would need to be used.
• As an alternative to
Gross-to-Net calculations, it may be contemplated to use a direct
calculation of net provisions based on
triangular claims data on
a net basis.
However, it should be noted that such a technique
would generally require adjustments of the underlying data
triangle in order to take into account changes in the reinsurance
program over time, and therefore would generally be rather
resource intensive. Also, an application of such
“direct” techniques may not yield a better quality valuation than
an application of more granular Gross-to-Net techniques as
discussed below.
3.2.3.2.4 Distinguishing between
lines of business
3.183 There are
several reasons for
distinguishing between lines of business when stipulating
Gross-to-Net techniques:
• An insurance undertaking’s reinsurance
programme may differ substantially between lines of business
(where the undertaking is operating).
• Even if the
undertaking’s reinsurance programme is the same for all lines of
business, the impact of this programme on the
technical provisions may differ substantially between the lines
of business due to e.g. differences between the relevant claims
distributions and especially whether the line of business is
exposed to large claims or not.
3.184 All five types of
Gross-to-Net techniques briefly described in annex A.1 should in
principle be able to capture the distinction between lines of
business.
However, for the Gross-to-Net technique based on
historic accounting data only (i.e. type (1)), this is likely to
depend on the
reporting requirements in force. Moreover, the
Gross-to-Net technique based on the premium model (i.e. type (5))
applies – for obvious reasons– only to the premium
provisions.
3.2.3.2.5 Distinguishing between premium provisions
and provisions for claims outstanding
3.185 For both the
premium provisions and the provisions for claims outstanding it
is assumed at the outset that the Gross-to-Net methods should be
stipulated for the individual lines of business.
Premium
provisions
3.186
With respect to the premium provisions, the
relationship between the provisions on a gross basis (PPGross,k),
the provisions on a net basis (PPNet,k) and the Gross-to-Net
“factor” (GNk(ck)) – for line of business (or homogeneous
risk
group) no. k – can be represented in a somewhat simplified manner
as follows:
PPNet,k = GNk(ck)×PPGross,k
where ck is a
parameter-vector representing the relevant characteristics of the
reinsurance programme covering the CBNI claims related to line
of business no. k at the balance sheet day.
3.187 With respect
to the various types of Gross-to-Net techniques briefly described
inannex A.1, it is only the alternative approaches (4) and
(5) that in general are able to stipulate Gross-to-Net techniques
to be used for converting best estimates of gross premium
provisions to best estimates of net premiums provisions.
3.188
However, if the reinsurance programme for the current accident year
(the current business year) is the same as the programme for the
preceding year(s), type (2) or (3) – or a combination of
these – may also be used in this context, cf. also the comments
given in last paragraph of section A.2.
3.189
For lines of
business where premiums, claims and technical provisions
are related to the underwriting year (and not the accident year),
the distinction between premium provisions and provisions for
claims outstanding is not clear-cut.
In these cases the technical
provisions related to the last underwriting year comprise both
premiums provisions and provisions for claims outstanding and
the distinction between Gross-to-Net techniques for the two kinds
of technical provisions makes no sense.
Provisions for claims
outstanding
3.190 With respect to the provisions for claims
outstanding, separate Gross-to-Net techniques should be
stipulated for each accident year not finally developed (for a
given line of business (or homogenous risk group)).
Accordingly,
the relationship between the provisions on a gross
basis (PCOGross,k,i), the provisions on a net basis (PCONet,k,i)
and the Gross-to-Net “factor” (GNk,i(c,k,i)) for line of business
(or homogeneous risk group) no. k and accident year no. i, can be
represented in a somewhat simplified manner as
follows:
PCONet,k,i
= GNk,i(ck,i)×PCOGross,k,i
where ck,i is
a parameter-vector representing the relevant characteristics of
the reinsurance programme for this combination of line of business
and accident year.
3.191 With respect to the types of
Gross-to-Net approaches described in annex A.1, type no. (2), (3)
and (5) can be applied to stipulate techniques proxies for the
individual accident years (for a given line of business),
cf. also the description of the most advanced Gross-to-Net
technique tested in QIS4.
3.192 However, some refinements of
these methods may be considered in order to make the Gross-to-Net
techniques more sophisticated:
a) stipulation of separate
Gross-to-Net techniques for individual development years or a
suitable grouping of the development years (for a given accident
year);
b) stipulation of separate Gross-to-Net techniques for
RBNS-claims and IBNR-claims;
c) stipulation of separate
Gross-to-Net techniques for “large” claims and “small” claims
(“frequency” claims) – given some suitable thresholds for the
separation of “large” and “small” claims; and
d) stipulation of
separate Gross-to-Net techniques for proportional
and non-proportional reinsurance programs.
3.193 A rationale
for introducing separate techniques for the individual
development years or groups of development years may be that
claims reported and settled at an early stage (after the end of
the relevant accident year) in general have a claims
distribution that differs from the distribution of claims
reported and/or settled at a later stage.
Accordingly, the impact
of a given reinsurance programme (i.e. the ratio between expected
claims payments on a net basis and expected claims on a gross
basis) will differ between development years or groups of
development years.
3.194 A rationale for introducing separate
techniques for RBNS-claims and IBNRclaims may be that the
insurance undertakings in general will have more information
regarding the RBNS-claims and should accordingly be able
to stipulate the Gross-to-Net technique to be applied on the
gross best estimate for RBNS-provisions in a more accurate
manner.
On the other hand the Gross-to-Net technique to be
applied on the gross best estimate for IBNR-provisions is then
likely to be stipulated in a less precise manner, especially if
more sophisticated techniques are not available.
3.195 Finally, a
rationale for making a split between “large” claims and
“small” claims may be that the uncertainties related to expected
claim amounts on a net basis for claims classified as “large” may
in some (important) cases be small or even negligible compared to
the uncertainties related to the corresponding claim amounts on a
gross basis.
However, this supposition depends (at least
partially) on the thresholds for separation of “large”
and “small” claims being fixed for the individual lines of
business.
3.196 None of the Gross-to-Net techniques briefly
described in annex A.1 and A.2 are able to capture all these
refinements, even if some aspects related to refinements (a) and
(b) are touched upon (in an indirect manner) when discussing the
properties of the most advanced Gross-to-Net techniques tested in
QIS4.
Moreover, it would be relatively straightforward to
adjust type no. (5) in order to capture refinement (c) and to
some extent also
refinement (a).
3.197 However, in order to
take into account these (possible) refinements it will in general
be necessary to develop more sophisticated techniques than those
being described in annex A.
On the other hand,
these
refinements should only be introduced if they in fact lead to an
increased accuracy of the best estimate of provisions for claims
outstanding net of reinsurance.
3.198 In this context, it may be
argued that refinement (c) should be prioritised as this may be
relevant for as least some of the commercial lines of business
and is probably also the easiest refinement to implement.
Before introducing this refinement it should also be considered
whether the thresholds to be fixed in order to separate “large”
and “small” claims could depend on the size of the undertaking
(or the size of undertaking’s portfolio within the line of
business in question) or the nature of the reinsurance
programme.
3.2.4 Risk Margin
3.199 This sub-section considers
approaches for the calculation of the risk margin in the
technical provisions based on simplified techniques.
For general
considerations on the conceptual framework underlying
this calculation, including:
• the assumptions made
on the reference undertaking to which the insurance obligations
are transferred;
• the calibration of the Cost-of-Capital rate;
and
• the estimation of the future SCRs related to the
reference undertaking,
we refer to CEIOPS’ consultation paper
on the calculation of the risk margin in technical
provisions.
3.200 As was highlighted in the QIS4 Technical
Specifications, in carrying out the risk margin calculations
“[t]he main practical difficulty […] is deriving the SCR for
future years for each segment”.
It should be stressed that this
is the case even if on basis of the best estimate calculations
reliable figures and parameters would be available as input to
the calculation of future SCRs.
3.201 Acknowledging these
practical difficulties, the QIS4 technical
specifications proposed that
“[t]he calculation of the different
risk charges for the future SCRs can either be done by the direct
application of the SCR formulae or through simplifications”.
In
line with this statement and in order to reduce the burden of
calculation the QIS4 Technical Specifications introduced several
layers of simplifications and proxies which could be applied in
the calculation of the risk margin.
3.202 With respect to
these simplifications for the risk margin, CEIOPS’ QIS4 Report
stated that:
“The majority, if not all, of undertakings
(independently of their size) used simplifications to project the
SCR for the purposes of calculating the risk margin.
The risk
margin proxy and helper tab for non-life were also extensively
used by undertakings.”
3.203 In light of the considerations in
sub-section 3.2.1 this indicates that it may be appropriate to
include in Level 2 at least some level of detail concerning the
calculation of the risk margin using simplified techniques.
In
the following, first considerations are made on appropriate
overall criteria which could be specified for application of
simplified calculations of the risk margin in this
context.
3.204 With respect to specific simplified valuation
techniques for the risk margin, CEIOPS considers that further
technical work is necessary before it could be decided whether
such techniques could appropriately be included in Level
2.72
Principles and criteria for the risk margin
calculations
3.205 As a general principle, where an (re)insurance
undertaking applies a simplified valuation method, this should be
proportionate to the underlying risks and compatible with
the Solvency II valuation principles.
This would apply
irrespectively of whether the method is specified under Level
2 implementing measures or not.
3.206 To support this aim, it
may be helpful to establish (in Level 2 or Level 3) certain
general principles and criteria which undertakings should
adhere to when taking decisions with respect to the methods to be
applied in the risk margin calculations, especially in the
context of simplified calculations.
3.207 Such general principles
and criteria could include the following:
• In general, the risk
margin calculations and accordingly the projections of future
SCRs should be as accurate as possible. If the
undertaking is
able to carry out a full projection of all future SCRs – for all
or some lines of business – it would be expected to do so.
• A
simplification may be used when there is reasonable evidence
that an application of a simpler method would not lead to
materially different results.
Where the undertaking applies
simplified methods, it should be able to justify their use and to
assess the potential impact on the accuracy of the calculations
of using the actual simplified method.
• Where simplified
methods are applied, they should be used in a flexible manner
meaning that the undertaking should consider e.g. to what extent
the relevant data and other information required in order to make
accurate SCR-projections are available (including the time and
effort (costs) needed to obtain this information).
• When an
undertaking considers whether or not it would be appropriate to
apply a (simplified) valuation technique for the risk
margin, it
should carry out separate assessments for each risk module in
each line of business.
This means that a decision to
use simplifications in one risk module and/or in one line of
business should have no (definitive) impact on the decisions made
for other risks or lines of business.
As an integral part of this
assessment, the undertaking should consider what kind of
simplified methods would be most appropriate for the given line
of business.
The chosen method should be proportionate to the
nature, scale and complexity of the risks in the line of business
in question.
• When the undertaking has decided to use a
simplified method for a given line of business, it should
consider whether the method shouldbe used for the projections of
the overall SCR (for the given line of business) or only for
certain (sub-)risks relevant for such projections.
In this
context, the undertaking should also consider whether it should
carry out the simplified projections of future SCRs
individually for each future year or calculate all future SCRs in
one step (simultaneously) – but still for a given line of
business.
A hierarchy of simplifications for calculating the
risk margin
3.208 Based on the general principles and criteria
referred to above, a possible hierarchy regarding the methods to be
used for projecting future SCRs per line of business can be
summarised as follows:
(1) make a full calculation of all future
SCRs without using any simplifications;
(2) use
simplifications to some or all modules and sub-modules to be used
for future SCR-calculations;
(3) use simplifications to derive
the whole SCR for each (future) year, e.g. by using the
proportional approach; and
(4) estimate all future SCRs “at
once”, e.g. by using the duration approach.
3.209 According to
this structure, the simplifications are getting simpler step
by step.
To assist undertakings in deciding which simplified
methods would be appropriate to determine the risk margin, each
step in this hierarchy should be accompanied with appropriate
eligibility criteria based on quality and materiality
considerations.
PROPORTIONALITY - LEVEL 2
MEASURES
CEIOPS-CP-45/09, 2 July 2009,
Consultation Paper No. 45
1.
Introduction
2.
Advice - Proportionality
3.
Proportionality Assessment – A three step process
4.
Simplified Methods
5.
Reinsurance Recoverables
6.
Annex A: Gross-to-net Techniques
New:
Solvency ii and Captives, CEIOPS Level 2 measures
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