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Market Risk Calibration March 2010

The CRO Forum welcomes the opportunity to contribute to the calibration of the standard formula through this paper on market risks. This document is a follow-up to our position papers published respectively last May: ‘Calibration Principles for the Solvency II Standard Formula”; and last December: ‘Calibration recommendation for the correlations in the Solvency II standard formula’.

Carbon nano tubes

The Emerging Risks Initiative releases today three papers on risks emerging in the insurance industry, namely: Environmental liabilities & biodiversity losses; Carbon nano tubes (CNT); and Workplace related stress. The papers identify elements of the changing risk landscape that may create new challenges for stakeholders such as public authorities as well as financial institutions like insurance providers.

The CRO Forum keeps its finger on the pulse…

In addition to its commitment to the Solvency II project, the CRO Forum maintains its focus on the promotion of best risk management practices by unraveling potential threats to the industry.

CRO Forum responses Wave 3 Consultation

There is need for an appropriate balance between controlling risk, ensuring practicability for issuers of these products and also respecting the principle of “freedom of investment” (priority: medium) The advice in this paper should be balanced between 2 important Principles in the Directive: “Prudent Person” (Art 132) and also “Freedom of Investment” (Art 133).

Solvency II Calibration

This document is a follow-up to our position paper published last May: ‘Calibration Principles for the Solvency II Standard Formula”. The paper provides our recommendation on the methodology to calibrate market risk correlation factors as well as a counterproposal for the correlation matrix as suggested by CEIOPS in its Consultation Paper n°74. The final chapter of this document also briefly addresses the correlations for non-market risk.

Internal Model Myths

For a long time, many (re)insurance companies have realized the need for risk-based valuations and solvency capital measurement and have started developing internal economic capital models which suit their needs. This is without prompting from regulators and rating agencies. Why? Such models provide a common measurement basis across all risks (e.g. same methodology, time horizon, risk measure, level of confidence, etc.) and are a powerful tool for strategic decision-making, for example in capital allocation and pricing.

Solvency II: all models are internal…but some

Under Solvency II, (re)insurance companies have the option to elect the Standard Model as defined under Solvency II or apply for approval to use Internal Models. Regulatory authorities have spent a lot of time and attention on the admissibility requirements for granting Internal Model approval.

Press release on Solvency II

The Forum strongly believes the directive represents an important step toward implementing an advanced supervisory and solvency framework which will help strengthen the European insurance industry. The Forum now urges the European Commission to introduce clear and effective implementing measures that will deliver the directive's basic principles.

Internal Model Admissibility

Internal models should reflect the nature, scale and complexity of the underlying businesses; they should be proportional in sophistication to the materiality of the risks they cover. Materiality levels should be determined by stakeholders based on the model's purpose. Practical considerations for models include usability, reliability, timeliness, process effectiveness, systems and cost efficiency. There should be an acceptable tradeoff between accuracy and the various practical constraints.

Operational Risk Management

Further, European supervisors considered the causes of failures (and near-failures) of a number of insurers and their analysis showed that the causes were mostly associated with inappropriate risk decisions resulting from underlying internal failures rather than inadequate capitalisation per se.

Calibration Principles

The Solvency II standard formula to calculate a company's Solvency Capital Requirement should present a balancing act between various targets such as simplicity, risk sensitivity and robustness. The CRO Forum believes the main principles of the current standard formula, namely to asses the sensitivity with respect to all material risk factors and to aggregate capital requirements allowing for diversification, are appropriate for this purpose and moreover set incentives towards risk mitigation strategies.

Internal models benchmark study

This presentation is based on research (Internal Models Benchmarking Study 2008) carried out on behalf of the Chief Risk Officer Forum by Oliver Wyman.

Addressing the pro-cyclical nature of Solvency II

Risk capital charges in the Solvency II context reflect the 99.5% quantile on a 1-year horizon. The consistent application of risk capital charges in Solvency II to all sources of risk is imperative. Inconsistent application of risk charges creates perverse incentives for certain asset classes or insurance products.

Public risk discl. under Solvency II

as a basis for discussion on the implementing measures for articles 50-55 of the EU Solvency II Draft Directive. The CRO Forum advocates a principles-based approach: Section B of this paper establishes five main principles for public risk disclosure which should be adhered to by all undertakings.

CRO Forum QIS4 Benchmark Study

The CRO Forum companies have developed internal capital models, which they expect to be approved by the regulators as a basis for setting the level of target capital ('SCR'). The CRO Forum companies have also participated in QIS4.

Liquidity Risk Management

This paper is part of a series of work by the CRO Forum under their Best Risk Management Practices initiative.The paper outlines important principles and considerations that should be part of best risk management practice for the management of liquidity risk within an insurance company. The primary focus of this paper is the management of liquidity risk where the company bears the risk, as opposed to the policyholder.

CRO Forum response on the credit crisis

Financial Crisis strongly reinforces the case for Solvency II. EU should not water down the Solvency II directive or postpone the legislative process New CRO Forum publication comments on the consequences of the financial crisis forEnterprise Risk Management and regulation in the insurance industry

Market Value of Liabilities for Insurance Firms

Over the past 3-4 years a tremendous amount of positive energy and resource has been expended in the name of improving the efficiency and effectiveness of the oversight of insurance entities, globally, by regulatory and supervisory bodies, industry associations and commentators alike. The CRO Forum is pleased at the pace and direction of the changes under consideration. However it has also become clear that in the course of the wider dialogue, confusion has sometimes arisen about the intended meaning about certain principles and elements of suggested implementation frameworks. Moreover, parallel discussions in the field of financial accounting have meant some terminology has dual meanings.

European harmonization of reporting formats

Thank you for your letter dated 3 June 2008 asking for our views on the European harmonisation of reporting formats. I am pleased to provide you with the CRO Forum answers on your specific questions. Concerning your first question; we agree that the suggested timetable should be in line with the Solvency II project. There are many good reasons for this. Firstly, the current framework differs across jurisdictions and the underlying data is not consistent as Members States apply different valuation bases. Therefore, using the current fragmented supervisory landscape as a starting point for a European wide reporting format would not be appropriate and we need the harmonization of principles that Solvency II brings.

Comments on QIS4 Draft Technical Specification

It is obvious that the Standard Formula does not exhibit full risk sensitivity at every individual company level, as the sensitivity to risks is individually set e.g. through risk mitigation measures the company might have chosen. We welcome the steps taken in the framework directive to promote good risk management and want to encourage the Commission to appropriately reflect the diversity in risk exposure and risk profiles existing in the insurance industry. Solvency II should make use of data and expertise in the industry to the largest extent possible