Standard formula

[Viki2010]

Hi, just a couple of questions on the topic:

1. How is the 99.5% calibration performed? Is that the last stage of scr calculation after obtaining an scr figure from standard formula?

2. Concentration risk in market risk - is that the same as contagion risk? Does it apply to sa2 products?

 

[Lindsay Smitherman]

The stress tests that the company has to perform under the standard formula are calibrated to the 1 in 200 year (99.5%) event level, so once you have performed them you have already taken into account the appropriate confidence level.

I tend to think of concentration risk as being related to lack of diversification within a portfolio (so higher volatility of outcomes) and contagion risk as being about the more systematic risk which spreads an economic shock from one part of the financial services sector to another, or one part of the economy to another, or one country to another (or whatever). Any company with assets and investments is potentially exposed to either type.

 

[Mbotha]

I tend to think of concentration risk as being related to lack of diversification within a portfolio (so higher volatility of outcomes)

So if most of the company's assets are invested in corporate bonds (say), the concentration risk SCR would be much higher than under a scenario where it's asset portfolio is well-diversified, right? Would the company even need to hold this SCR if it's portfolio is well-diversified?

 

[Lindsay Smitherman]

So if most of the company's assets are invested in corporate bonds (say), the concentration risk SCR would be much higher than under a scenario where it's asset portfolio is well-diversified, right?

Not necessarily, if they are well-diversified within the corporate bond portfolio.

Would the company even need to hold this SCR if it's portfolio is well-diversified?

Possibly not: it depends on whether any individual counterparty exposure exceeds the limits set out by EIOPA. The concentration risk sub-module of the SCR standard formula basically applies stress factors to the excess of a single counterparty exposure over stated thresholds. However, you are not required to know about the detail of this approach as it is not covered in the Core Reading.