Free surplus under SII

[person]

I'm getting a little confused about some aspects of SII . In particular, what counts as free surplus for the purpose of potential transfers to the shareholder fund?

pre SII, the free surplus is basically Admissible assets - reserves - CRR.

All of which I understand can legally be transferred to the SHF (assume NP business).

On the SII balance sheet, the free capital is just Assets - TP - SCR (ignoring the other smaller bits)

Does this mean that a firm is legally able to transfer this amount to the SHF? Or is the SII balance sheet just a tool for determining the SCR, which then must be held in excess of traditional mathematical reserves, so free surplus is actually:

Assets (admissible?) - SCR - Reserves.

this is probably a very silly question but I can't seem to find it explicitly stated anywhere.

 

[mugono]

Hi

I'll give it a go

An immediate point I'll make is that the concept of admissible assets exists only under pillar 1 peak 1 (solvency 1).

Hence there is no such admissible asset constraint under solvency 2. Free assets held in the non profit fund (for clarity in excess of any required capital) will be owned by the shareholders and so I don't see why they couldn't legally transfer it to the SHF.

Free assets held in the with profit fund doesn't entirely belong to the shareholders and so cannot be transferred legally without a reattribution of the estate.

Hope that helps, any questions are welcome

 

[person]

Thanks for your response. Does this mean that when solvency 2 is implemented, the concept of prudent mathematical reserves completely disappears? So for a given policy, firms just need to hold the technical provisions and SCR?

 

[cjno1]

Thanks for your response. Does this mean that when solvency 2 is implemented, the concept of prudent mathematical reserves completely disappears? So for a given policy, firms just need to hold the technical provisions and SCR?

The overall effect of S2 is still to hold prudent reserves, but the composition is a much more transparent way of achieving this, by breaking the calculation down into best estimate and then an allowance for cost of capital and prudence on top.

 

[person]

The overall effect of S2 is still to hold prudent reserves, but the composition is a much more transparent way of achieving this, by breaking the calculation down into best estimate and then an allowance for cost of capital and prudence on top.

Where the allowance for prudence you talk about is the SCR?

I am also worrying about pricing under SII....

under solvency 1, because the total capital requirement is weighted towards the reserves rather than the solvency capital, I imagine it is easier to allow for the required capital on a policy since a prudent reserve on a single policy is easy to calculate, as well as how this moves over the life of a policy. So if you were pricing using a cashflow method, you can simply add in the cashflows for build up and release of capital requirements.

How can the capital requirements under solvency 2 be allowed for in pricing properly? For example on cashflow pricing, I can imagine it is easy to add in cashflows associated with building up and releasing technical provisions, but what about the SCR? Wouldn't you need to know the incremental impact the policy has over its lifetime on the companies total SCR? This would be very difficult to know with any accuracy unless you have some very sophisticated models for calculating the SCR.

 

[mugono]

Under solvency 2, the idea is for the liabilities to be market-consistent. Where risks are hedgeable, this can be taken directly from market prices. Non hedge able risks are determined from best estimate assumptions with a risk margin added.

Regarding your follow on comments, many companies will likely use their pillar 2/ica capital for pricing currently so I would imagine is less of a step change than you suggest... How would they have projected this??

Whilst taking a % of reserves for capital is simple it doesnt adequately capture the risk profile of the contract and at best will be a very rough approximation.

I suspect how insurers allow for capital will vary between companies but I don't see why it would be difficult to allow for capital if an approach different from a % of reserves were adopted.

It may be worthwhile referring to qis 5, which gives further details for projecting the scr (albeit for deriving the risk margin)