Valerio Scacco Presentation

Capital Modelling in a
A member of
Solvency II Framework
Capital Modelling in a Solvency II Framework
For a complete understanding of the topics covered, the content of

this presentation requires the author’s comment.
New York - May 7th, 2015
New York - May 7th, 2015 Annual 2015 URS User Group Forum
Agenda
Solvency II - Introduction
• Why Solvency II
• The 3 Pillars of Solvency II
Pillar 1 – Regulatory Requirements

• Possible Approaches to SCR calculation
• How many are using internal model for Pillar 1?
• The overall structure of SCR
• Premium & Reserve Risk according to the Standard Formula
• SCR with an Internal Model: Value at Risk approach
• Premium Risk: St. Formula vs Internal Model – Example
The Role of Reinsurance in Solvency II
Pillar 2 – The ORSA Framework

• Risk Management System and ORSA
• Forward Looking Assessment of Own Risks (FLAOR)
• FLAOR: Standard Formula vs Internal Model – Example
• FLAOR: Company’s Risk Profile – Example
New York - May 7th, 2015 Annual 2015 URS User Group Forum 2
Why Solvency II?

Capital Requirement under Solvency I
𝑴𝒅𝑺 = 𝜶 𝑴𝒂𝒙[𝑴𝑷, 𝑴𝑺]
𝑆𝑜𝑙𝑣𝑒𝑛𝑐𝑦 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝛼 max 𝑃𝑀; 𝐿𝑀
18% 61.300.000 + 16%(𝑃 − 61.300.000) 𝑃 > 61.300.000
𝑀𝑃 =
𝑃𝑀 = 18% min 𝑃; 18%
61.3𝑚
𝑃 + 16% max 𝑃 − 61.3𝑚; 0
𝑃 ≤ 61.300.000
𝐿𝑀 = 26% min 𝐿; 42.9𝑚 + 23% max 𝐿 − 61.3𝑚; 0

S > 42.900.000
26% 42.900.000 + 23%(𝑆 − 42.900.000) 𝑃
𝑀𝑆 =
26% 𝑆 S ≤ 42.900.000
𝑃
𝐿𝑁𝑒𝑡
𝛼 = 𝑟𝑒𝑡𝑒𝑛𝑡𝑖𝑜𝑛 𝑙𝑒𝑣𝑒𝑙 = max 50%; 𝐺𝑟𝑜𝑠𝑠
𝑆 𝑛𝑒𝑡𝑡𝑜 𝑟𝑖𝑎𝑠
𝐿
𝛼 = 𝐺𝑟𝑎𝑑𝑜 𝑑𝑖 𝐶𝑜𝑛𝑠𝑒𝑟𝑣𝑎𝑧𝑖𝑜𝑛𝑒 = 𝑀𝑎𝑥 50% ;
𝑆
S
O
L
Market, V
Charge Factors Counterparty and Approximate
not-dependant on Operational Risks
E
treatment of
LoBs’ riskiness explicitly not Reinsurance N
taken into account C
Y
II
The 3 Pillars of Solvency II
Solvency II
Pillar 1 Pillar 2 Pillar 3

Economic Capital
which the undertaking • Valuation of Assets • Supervisory review • Detailed public
must set aside in order • Valuation of and intervention disclosure
to keep its default
Liabilities • Effective Risk requirements.
probability below
Management System • Regulatory reporting
0.5%, on a 1-year time • Regulatory Capital
horizon, and taking • Internal Control requirements
into account every
(Solvency Capital
quantifiable risk. Requirement): • Own Risk & Solvency
• Standard Formula Assessment (ORSA)
• Internal Model
• Tiering of Eligible
Own Funds
Possible approaches to SCR calculation
Undertakings select their approach

to SCR calculation following the
principle of proportionality,
reasonably evaluating the nature,
materiality and complexity of the
risks to which they are exposed Full Internal
Partial Model
Internal
Undertaking Model
Specific
Parameters
Standard (USP)
Formula
Standard Formula
with Simplifications
How many are using internal model for Pillar 1?
The overall structure of the SCR
Modules
Sub-Modules
Premium & Reserve Risk according to the Standard Formula
SCR for Premium and Reserve Risk is determined as follows:

Volume Measure representing expected earned premium
SCRPrem&Res = 3 • s • V and outstanding claims reserves
s A Measure resulting from the aggregation of volatility coefficients (i.e. risk factors),
which are different for Premium & Reserve Risk, and for each Line of Business (LoB)
EIOPA provides Market Wide values of volatility coefficients:
• sRes, LoB (to be taken as already net of possible reinsurance)

• sPrem, LoB:
Gross of Reinsurance: Grosss
Prem, LoB
Net of Reinsurance: Nets = Grosss • NPLob

Prem, LoB Prem, LoB
• NPLob is a factor provided in order to take account (if present) of non-proportional

reinsurance. However, it is a fixed 0.8 factor, regardless of the contract terms, and it can
be used only in premium risk for LoB MVL, Fire, GL.
SCR with an Internal Model: Value at Risk approach
In the Solvency II concept, a stochastic model should be able to answer the

question:
In a 1-year time, where could I be in the 1 in 200 worst case scenario?
So we want to obtain the probability distribution of our Net Asset Value (𝑁𝐴𝑉) a
time t = 1 (𝑁𝐴𝑉 = 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠)
0.5 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒
𝑆𝐶𝑅 = 𝑁𝐴𝑉0 − 𝑁𝐴𝑉1
For 𝑁𝐴𝑉0 we only need the For 𝑁𝐴𝑉1 we want the 0.5-
expected value. In theory, percentile, so we need a
this can be calculated with stochastic model to
deterministic methods produce the pdf
SCR with an Internal Model: Value at Risk approach
𝑆𝐶𝑅 = 𝑁𝐴𝑉0 − 𝑁𝐴𝑉1
For 𝑁𝐴𝑉0 we only need the For 𝑁𝐴𝑉1 we want the 0.5-
expected value. In theory, percentile, so we need a
this can be calculated with stochastic model to
deterministic methods produce the pdf
DNAV=SCR
Balance Sheet at Balance Sheet at 0.5 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒

𝑁𝐴𝑉0 𝑁𝐴𝑉1
time t=0 time t=1
Expected Value Scenario 1 in 200
Premium Risk: St. Formula vs Internal Model – Example

12%
SCR (SF) NAV t = 0

9%
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
E[NAV t = 1]
SCR (SF)
9%
NAV t = 0
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
NAV t = 1
SCR (SF)
E[NAV t = 1]
9%
NAV t = 0
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
NAV t = 1
SCR (SF) 0.5 - Perc. Gross

9%
E[NAV t = 1]
NAV t = 0
SCR (PIM)
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
NAV t = 1
SCR (SF) 0.5 - Perc. Gross

9%
SCR Budget ↑ (SF) NAV t = 0
SCR (PIM)
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
NAV t = 1
NAV t = 1, Bud.↑
SCR (SF)
0.5 - Perc. Gross
9%
SCR Budget ↑ (SF) 0.5 - Perc. Net
NAV t = 0
SCR (PIM)
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
NAV t = 1
NAV t = 1, Bud.↑
SCR (SF)
9% 0.5 - Perc. Gross
SCR Budget ↑ (SF)
0.5 - Perc. Net
NAV t = 0
SCR (PIM)
6%
SCR Budget ↑ (PIM)
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25
The Role of Reinsurance in Solvency II

 Typical effectcs of reinsurance on Solvency II Balance Sheet are:
• reduction of Net Asset Value
• reduction of Solvency Capital Requirement
• reduction of Risk Margin
• (usually) increase of Solvency Ratio
Example of the structure of a Solvency II Balance Sheet

Struttura del Bilancio Solvency II - Lordo Riassicurazione Struttura del Bilancio Solvency II - Netto Riassicurazione
Gross of Reinsurance Net of Reinsurance
70 Free Surplus 70
Other Assets
Milioni
Milioni
Net Asset Other Assets Free Surplus
60 SCR 60 Net Asset
Value Reinsurance Value SCR
Risk Margin Recoverables
50 50 Risk Margin
Other Liabilities Other Liabilities
40 40
Cash and
Invested
30 Assets 30 Cash and
Best Estimate Invested Best Estimate
20 Technical 20 Assets Technical
Provisions Provisions
10 10
0 0
Assets Liabilities Assets Liabilities
Prem. Risk and Reinsurance: St.Form. vs Int.Mod. – Example

12%
SCR (SF) NAV t = 0

9%
6%
3%
0%
-25 -20 -15 -10 -5 0 5 10 15 20 25

12%
SCR - Gross (SF)

9% NAV t = 0
6%
3%
0%
-10 -8 -6 -4 -2 0 2 4 6 8 10

12%
NAV t = 1 - Gross
SCR - Gross (SF)

NAV t = 0
SCR - Gross (PIM)
6%
3%
0%
-10 -8 -6 -4 -2 0 2 4 6 8 10

12%
NAV t = 1 - Gross
SCR - Gross (SF)

SCR - Net (SF)
NAV t = 0
SCR - Gross (PIM)
6%
3%
0%
-10 -8 -6 -4 -2 0 2 4 6 8 10

12%
NAV t = 1 - Gross
NAV t = 1 - Net
SCR - Gross (SF)
SCR - Net (SF)
0.5 - Perc. Net
NAV t = 0
SCR - Gross (PIM)
6%
SCR - Net (PIM)
3%
0%
-10 -8 -6 -4 -2 0 2 4 6 8 10
Pillar 2: Risk Management System and ORSA
RISK RISK
REGISTER APPETITE
ORSA
FRAMEWORK
RISK
FLAOR
POLICY
Forward Looking Assessment of Own Risks (FLAOR)
Local Gaap
Business Plan
(min. 3 years)
Capital Solvency II
Management Plan Business Plan
(according to
Risk Appetite) (TP.Reins,DT,OF)
FLAOR
Forward Looking
Assessment of Own Risks
Regulatory
Stress Test, Requirements
Scenario Analysis e
Reverse Stress Test (like Pillar 1, but with
multi-year projection)
Overall Solvency
Needs
(entity-specific
risk profile)
FLAOR: Standard Formula vs Internal Model – Example
Nav Gross - 2014
OSN Gross (PIM)- 2013
SCR Gross (SF) - 2013
-30 -20 -10 0 10 20 30 40
Nav Gross - 2014
𝑆𝐶𝑅𝑡 = 𝑁𝐴𝑉𝑡 − 𝑁𝐴𝑉𝑡+1
-30 -20 -10 0 10 20 30 40
Nav Gross - 2014
Nav Gross - 2015

SCR Gross (SF)- 2014
-30 -20 -10 0 10 20 30 40
Nav Gross - 2014

OSN Gross (PIM) - 2015
Nav Gross - 2015
SCR Gross (SF) - 2015 Nav Gross - 2016

SCR Gross (SF)- 2014
-30 -20 -10 0 10 20 30 40
OSN Net - 2015 Nav Net - 2014
Nav Net - 2015

SCR Net (SF) - 2015
Nav Net - 2016
OSN Net - 2014

SCR Net (SF) - 2014 𝑆𝐶𝑅𝑡 = 𝑁𝐴𝑉𝑡 − 𝑁𝐴𝑉𝑡+1
OSN Net - 2013
SCR Net (SF) - 2013
-30 -20 -10 0 10 20 30 40
FLAOR: Company’s Risk Profile – Example
FLAOR: Company’s Risk Profile – Example
A member of
00187 Roma 20145 Milano

Via Toscana, 42 Via Ariosto, 2
Tel. +39.06.45435061/2 Tel. +39.02.89074319
Fax +39.06.45435890 Fax +39.02.8907592
info@res-company.it www.res-company.it
Flavio Fidani +39.335.8399811 - f.fidani@res-company.it

Francesco Cuzzucrea +39.338.6044959 - f.cuzzucrea@res-company.it
New York - May 7th, 2015 Annual 2015 URS User Group Forum

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Capital Modelling in a

Capital Modelling in a Solvency II Framework

For a complete understanding of the topics covered, the content of

Pillar 1 – Regulatory Requirements

The Role of Reinsurance in Solvency II

Pillar 2 – The ORSA Framework

Why Solvency II?

𝐿𝑀 = 26% min 𝐿; 42.9𝑚 + 23% max 𝐿 − 61.3𝑚; 0

The 3 Pillars of Solvency II

Pillar 1 Pillar 2 Pillar 3

Possible approaches to SCR calculation

Undertakings select their approach

How many are using internal model for Pillar 1?

The overall structure of the SCR

Premium & Reserve Risk according to the Standard Formula

SCR for Premium and Reserve Risk is determined as follows:

EIOPA provides Market Wide values of volatility coefficients:

• sRes, LoB (to be taken as already net of possible reinsurance)

Net of Reinsurance: Nets = Grosss • NPLob

• NPLob is a factor provided in order to take account (if present) of non-proportional

SCR with an Internal Model: Value at Risk approach

In the Solvency II concept, a stochastic model should be able to answer the

In a 1-year time, where could I be in the 1 in 200 worst case scenario?

SCR with an Internal Model: Value at Risk approach

Balance Sheet at Balance Sheet at 0.5 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑖𝑙𝑒

Premium Risk: St. Formula vs Internal Model – Example

SCR (SF) NAV t = 0

Premium Risk: St. Formula vs Internal Model – Example

Premium Risk: St. Formula vs Internal Model – Example

Premium Risk: St. Formula vs Internal Model – Example

SCR (SF) 0.5 - Perc. Gross

Premium Risk: St. Formula vs Internal Model – Example

SCR (SF) 0.5 - Perc. Gross

Premium Risk: St. Formula vs Internal Model – Example

Premium Risk: St. Formula vs Internal Model – Example

SCR Budget ↑ (PIM)

The Role of Reinsurance in Solvency II

Example of the structure of a Solvency II Balance Sheet

Prem. Risk and Reinsurance: St.Form. vs Int.Mod. – Example

SCR (SF) NAV t = 0

Prem. Risk and Reinsurance: St.Form. vs Int.Mod. – Example

SCR - Gross (SF)

Prem. Risk and Reinsurance: St.Form. vs Int.Mod. – Example

SCR - Gross (SF)

Prem. Risk and Reinsurance: St.Form. vs Int.Mod. – Example

SCR - Gross (SF)

Prem. Risk and Reinsurance: St.Form. vs Int.Mod. – Example

SCR - Net (PIM)

Pillar 2: Risk Management System and ORSA

Forward Looking Assessment of Own Risks (FLAOR)

FLAOR: Standard Formula vs Internal Model – Example

Nav Gross - 2014

OSN Gross (PIM)- 2013

SCR Gross (SF) - 2013

-30 -20 -10 0 10 20 30 40

FLAOR: Standard Formula vs Internal Model – Example

Nav Gross - 2014

OSN Gross (PIM)- 2013

SCR Gross (SF) - 2013

-30 -20 -10 0 10 20 30 40

FLAOR: Standard Formula vs Internal Model – Example

Nav Gross - 2014

Nav Gross - 2015