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Personal Finance Insurance. The SCR, as well as the minimum capital requirement MCR , are based on an accounting formula that must be re-computed each year. Compare Investment Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Terms How Capital Requirements Keep Your Savings Account Safe Capital requirements are standardized regulations for banks and other depository institutions that determine how much liquid capital that is, easily sold assets they must hold for a certain level of assets.
The ratio uses tier 1 capital to judge how leveraged a bank is in relation to its consolidated assets. How Contingent Convertibles — CoCos Work and the Risks Contingent convertibles CoCos are similar to traditional convertible bonds in that there is a strike price, which is the cost of the stock when the bond converts into stock.
Solvency II Own Funds – The Economics of Market Consistent Valuation
What Is Tier 3 Capital? Tier 3 capital is tertiary capital, which many banks hold to support their market risk, commodities risk, and foreign currency risk. Voluntary Reserve Voluntary Reserve is a monetary sum held by insurance companies over and above the requirements set by government regulators. Stress Testing Stress testing is a computer-driven simulation technique for evaluating banks and asset portfolios on how they might react in various situations.
Ignoring outwards reinsurance, the calculation of the undiscounted element of the claims provision is similar to the undiscounted claims reserve already estimated by re insurers on a regular basis to fulfil existing regulatory requirements. The key changes are the removal of any implicit or explicit margins for prudence and consideration of ENID.
This is likely to continue in the immediate future. Although stochastic techniques are possible, they have not as yet gained widespread use for this purpose.
This may change over time as the techniques develop further, become better understood, more flexible, available in commercially available reserving products and as the link between reserving and internal models develops. Assumptions and methods must be chosen on a best estimate basis excluding any margin for prudence. For example, allowance should be made for negative incurred but not reported IBNR where it is expected that future profit will emerge from existing case reserves.
The removal of any explicit margins for prudence in existing earned reserves may be relatively straightforward.
Ensuring the removal of implicit margins is more complex insofar as these are based on actuarial judgements and embedded within calculations. This is discussed further in section 3. The present values of the cash flows can be calculated by applying a payment pattern to the undiscounted reserves to generate future cash flows, which are then discounted at EIOPA-prescribed rates for specific currencies and summed. Assessment of the appropriate payment pattern is likely to be based on historic payments where sufficient credible data is available.
Further discussion on payment patterns and cohorts of claims accident year AY versus underwriting year UY is included in section 3. One may think that this is not a problem in that Solvency II does not require the elements of the claims and premium provisions to be calculated separately. However, under the current proposal for reporting, re insurers will need to split out expenses, so this will need to be allowed for, explicitly or approximately, for reporting purposes.
Also, the practitioner must take care not to either double count or omit allowance for all expenses. This is the expected present value of future cash flows relating to future claims events on existing policies. Many re insurers are calculating this element of the premium provision using a loss ratio approach: applying a loss ratio to an unearned premium to come up with an estimation of the total undiscounted claims, then applying a payment pattern to generate future cash flows that can be discounted and summed to generate a present value.
How one chooses a loss ratio assumption will vary between re insurers.
Strictly speaking, a loss ratio derived from a robust unexpired risk reserve URR calculation is the correct approach, but, in practice, many re insurers do not carry out detailed URR calculations unless they expect that the premiums for a class of business are insufficient. It may be sufficient to use alternative, more readily available approaches such as pricing loss ratios, plan loss ratios or a burning cost method, but care needs to be taken to ensure that the approach used is appropriate.
Pricing loss ratios are based on estimates of likely future experience and thus may be suitable as a base for premium provision loss ratios. However, pricing loss ratios may not be appropriate for several reasons. For example, the period of exposure for the pricing loss ratio may be very different from the period of exposure covered by the premium provision. For annual contracts, written uniformly over the calendar year CY , the exposure for the premium provision will be weighted towards the first few months.
Current pricing loss ratios are likely to assume a longer exposure period and thus if there are significant trends in claim costs, the pricing loss ratios may overstate trends for the premium provision. Plan loss ratios may be suitable for the premium provision, provided they have been estimated on a best estimate basis and either cover the same period of exposure covered by the premium provision, or trends in claims costs over time are insignificant.
However, they are not suitable if:. The projection underlying URR loss ratios and for a premium provision loss ratio, would typically start with an analysis of recent loss experience, most likely using the projected ultimate losses for recent AYs taken from the claims provision. Adjustments are required to adjust the historic experience to the future exposure period covered by the unearned premium.
Such adjustments may take account of, for example, changes in:. Attritional and large losses should be considered separately if such an analysis is warranted by the nature of the risks, availability of data and proportionality. If the book is exposed to natural catastrophes these may need to be projected separately. Some natural catastrophes are seasonal.
It may not be necessary or indeed practical to adjust for all of the above factors, particularly as many may have already been considered as part of the original loss projection used as a starting point. URR loss ratios are often updated less frequently than the technical provisions, so, if they are to be used for the premium provision, will require careful consideration and possible adjustment when not recent. Care needs to be taken to ensure that URR loss ratios calculated, say, 6 months earlier, are still applicable.
Changes in the balance of risks written over the period may mean that the URR loss ratios at the year-end are not suitable at, say, the half-year, because the nature of the portfolio is changing. An alternative to using loss ratios is to project burning costs based on a suitable exposure measure e. These burning costs are then multiplied by a projection of the exposure. An advantage of this approach is that it considers the claim cost independently of the premium charged and rating actions, which do not always have a proportional impact on claims costs.
This method does, however, require additional considerations:. This involves altering the average cost per policy to reflect any changes in the profile of policies written. The natural link to premium inflation is lost when using burning costs. A loss payment profile assumption will be needed.
Ideally, this should represent the timing of losses relating to the future exposure. The materiality of this assumption to the premium provision depends on the term of the liabilities and prevailing yields. In recent years, yields have been very low, so payment pattern assumptions have been less of a concern than they otherwise would be. If the reserving approach uses AY data cohorts one could first project incidence by underwriting period and then apply corresponding accident period payment patterns, or model inception patterns and losses based on time since inception.
If the reserving approach uses UY cohorts the situation is a little more complex. As the premium provision relates to future exposure, an exposure period payment pattern will be required. If this cannot be calculated directly a transform will be required to obtain a suitable accident period payment pattern from the underwriting period payment pattern. This pattern can then be applied to the projected incidence by underwriting period as above.
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In either case, a simple lag may suffice provided the simplification does not have a material impact. Allocated and unallocated claim management as well as other expenses are discussed in detail in section 5. This information should be known as part of the credit control process and as it is required to construct the asset side of the balance sheet.
The potential for confusion between Finance and Actuarial is significant in many organisations. Typical complications include. It is important that Finance and Reserving functions reach a common understanding as to what falls into technical provisions and what will remain in other parts of the balance sheet. Without this there is a risk of double counting or omission. Ideally, re insurers should be looking to collect the data at the level required for the technical provisions. Further issues may arise if there is a need to split the future premiums receivable between the earned and unearned element.
Though this approach is appealing, as it reinforces the concept of future and past exposure in the respective provisions, it increases the complexity of the calculation if rigorously applied. For many re insurers, the amount of future premium attributable to past exposure is likely to be low, and immaterial, so, on the grounds of proportionality, those re insurers may choose to allocate all future premium to the premium provision.
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We note that this should not have any effect on the overall best estimate and thus should take lower priority than issues that may affect the surplus assets when deciding on the approach and level of effort to expend. This is determined on a legal obligations basis. A contract should be recognised as an existing when the re insurer becomes a party of the contract.
A contract should be de-recognised as an existing contact when the obligation specified in the contract is discharged or expires. If such rights relate only to a part of the contract this part should be excluded from the existing contract. In particular, future premiums and any resulting cash out-flows should be included if their payment by the policyholder is legally enforceable. The assessment of boundary conditions should, in principle, be made on a per contract basis.
However, where this approach is not practical, a higher level of granularity can be applied if this does not lead to a material difference to a per contract assessment. One of the impacts of allowing for boundary conditions is that the premium provision may need to include cash flows relating to policies with a commencement date falling after the valuation date.
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Such policies may include:. Under a binding or delegated authority binder a re insurer agrees to underwrite future business that may be introduced by a third party under specified conditions. Binding or delegated authorities may also be known as partnership agreements. The key question, from a contract boundary perspective, is that if the insurer is legally bound to accept future business that could be introduced, should future insurance contracts that may be introduced under the binder be allowed for in the premium provision?
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