SCR Calculation Equity Risk

[Shifali Sarkar]

Hello Everyone

I have a doubt in one of the solvency capital requirement questions. April 2019 Qtn 1, part iii.

When there is an increase in value of equities, then the SCR will increase. This is because there is an increase in the amount of assets stressed under equity submodule within SCR.
Now please refer to Sep 2021, Q1, part ii. It says adverse movement for the company in respect of equity risk is the downward stress. But downward movement will lower the solvency capital requirements. This is because the assets will be reduced.

I am getting confused between these two things. As per my understanding, anything that leads to higher capital requirements for the company puts a strain on it. Then why is the adverse direction for equity stress is down. Request to please help on this topic. I have not worked in UK market, hence a bit detailed explanation will be very helpful.

 

[Lindsay Smitherman]

Don't worry, you don't have to work in the UK market to understand this.
The two questions are asking quite distinct things, hence the apparent confusion.
April 2019 Q1(iii) is basically asking: what is the impact on the SCR if a specified event happens to the company, such as an increase in the value of assets.
Sept 2021 Q1(ii) is asking about doing the SCR calculation itself, ie which direction of stress is likely to be worse.

A fall in equity values is likely to make the basic balance sheet position (assets - liabilities) worse; an increase in equity values is likely to improve the basic balance sheet position. So the downward stress is used to calculate the SCR. That's the Sept 2021 question.

Then what might happen to the SCR if equity values increased? If the calculation were redone immediately after an increase in the value of equities, the equity component of the SCR would be higher, as the company would now lose more if equity values fell (as per the SCR stress calculation described in the previous paragraph). That's the April 2019 question.

It is really important to appreciate and understand the distinction between questions asking about the impact on the balance sheet if a particular event or scenario happened, and questions asking about which stresses are used to calculate the SCR.

 

[Shifali Sarkar]

Don't worry, you don't have to work in the UK market to understand this.
The two questions are asking quite distinct things, hence the apparent confusion.
April 2019 Q1(iii) is basically asking: what is the impact on the SCR if a specified event happens to the company, such as an increase in the value of assets.
Sept 2021 Q1(ii) is asking about doing the SCR calculation itself, ie which direction of stress is likely to be worse.

A fall in equity values is likely to make the basic balance sheet position (assets - liabilities) worse; an increase in equity values is likely to improve the basic balance sheet position. So the downward stress is used to calculate the SCR. That's the Sept 2021 question.

Then what might happen to the SCR if equity values increased? If the calculation were redone immediately after an increase in the value of equities, the equity component of the SCR would be higher, as the company would now lose more if equity values fell (as per the SCR stress calculation described in the previous paragraph). That's the April 2019 question.

It is really important to appreciate and understand the distinction between questions asking about the impact on the balance sheet if a particular event or scenario happened, and questions asking about which stresses are used to calculate the SCR.

Many thanks this is helpful.