Risk Margin vs SCR

Hi

Could you please suggest, in practical world, why there is a requirement to hold both risk margin as well as solvency capital requirements under SII?

Since both of them are required by regulator for future adverse experience, why we cannot hold just one of them rather than both?

Are the risks covered under each one of them different?

Please help on the above concern.

Regards
Yogesh

 

Hi Yogesh

My understanding is as follows:
- SCR is set held to protect insurer against future adverse events.
- Risk margin represents what an insurer would have to pay to the market to take on the best estimate liabilities. When the market takes on your best estimate liabilities, they will have to set aside capital to cover the SCR. This has a cost as the insurer buying your best estimate liabilities cannot use the capital backing the SCR for alternative profit generating activities (e.g. writing more new business). Therefore holding the SCR incurs a cost. The risk margin represents this cost.

Hope that helps
Amit

 

Hi, in which circumstances the risk margin is or can be released?

 

Yet, another question on the Risk Margin please.

Which market risks would be non-hedgeable (included in RM) vs. hedgeable (excluded from RM).

Based on Mock C q2 iii B, I am deducing that the spread risk would be one of those hedgeable risks which are not impacting the RM. I just don't have a clear division/ distinction in my mind to quickly sort things out under the exam conditions.....

Part iii c of the solution mentions how the "reinsurer's credit default" would be accounted for in RM.....(credit default would be non-hedgeable?)

 

Hi

The relevant bits of the regulations are found in article 38, paragraph 1(h&i) of the delegated regulations.

Part (h) explains that when calculating the SCR for the purpose of calculating risk margin, you can assume you can trade all your assets, without cost, to minimise all market risks. In practice, most small and simple insurers can assume that these actions will lead to all market risks being completely removed - i.e. all market risks are hedgeable for them. Larger or more complex insurers may need to do further analysis before they can justify this, but any residual risk is likely to be very small.

Part (i) explains that credit risk with respect to reinsurance contracts (what I assume is meant by the mock paper by "reinsurer's credit default") must be captured in the SCR that is used to calculate risk margin.

Thanks and best wishes
Amit

 

Thanks very much Amit.

What would be examples of non-hedgeable market risks?

 

Every insurer I have worked with (albeit they have all been on the smaller side), have treated all market risks as hedgeable. I suspect you can make this approximation in the exams as well.

I am completely hypothesising and do not know for certain, but I suspect larger firms may need to consider some market risks as non-hedgeable if, for example, there might not be enough capacity in the market to completely remove that risk.

 

Thank you. I've seen one calculation of risk margin with non headeable risks but just cant remember what those were.

 

Let me know if you do remember - I am interested to read and find out more about it.

 

And is your company using Risk Drivers? I'd be interested is some good examples....