Volatility adjustment

Discussion in 'SA2' started by GauravT, Feb 24, 2018.

  1. GauravT

    GauravT Member

    Can anyone help me with the use of volatility adjustment?
    I am confused about whether insurance companies are allowed to add volatility adjustment only in times of general economic stress or are they always allowed this adjustment even in normal/stable economic environment?
     
  2. ActuaryLad

    ActuaryLad Active Member

    Hi

    Firms must meet certain criteria to use the volatility adjustment (VA)

    Firms must apply and get supervisory approval to use the (VA).

    Once approved firms will use the VA regardless of the state of the wider economy so long as they believe they continue to meet the criteria for using the VA.

    Firms should be monitoring the ongoing appropriateness of using the VA as a part of their ORSA. The firms I’ve worked with have typically carried out this reassessment annually.

    Hope this helps
    Amit
     
  3. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    Thanks Amit!

    Just to add: companies with VA approval will use a separate set of risk-free rates that have the VA added into them, as published by EIOPA. In times of good market liquidity, the VA addition made by EIOPA will be very small. However, during a significant illiquidity event, the VA included in the discount rates will become much larger.
     
  4. GauravT

    GauravT Member

    Thanks Amit and Lindsay!!
     
  5. Sponge

    Sponge Member

    Tha is for the above ....
    There is mention in the notes about how a firm must have a liquidity plan and sneitivity analysis on top of everything else in order to use the VA.

    What will be in the liquidity plan? Credit derivatives, Cash, Deposits securities, Overdraft arrangements, liquidity risk management framework?
     
  6. ActuaryLad

    ActuaryLad Active Member

    The underlying intent of the VA is to reduce pro-cyclic behaviour.

    A liquidity plan should contain projected incoming and outgoing cashflows in normal and in stressed conditions. The plan should demonstrate that the firm has sufficient liquidity to meet its claims without being forced to sell any illiquid assets (even in stressed conditions).

    Where the cashflow analysis shows a shortfall, the plan should outline how the shortfall will be met. Most plans I have seen involve using cash reserves or selling gilts. I imagine your suggestions would be ok as well. The main thing that firms aren't allowed to do is to engage in pro-cyclic behaviour and sell illiquid assets.
     
    Sponge likes this.
  7. Sponge

    Sponge Member

    Thanks
     
  8. Edward chong

    Edward chong Member

    Hi,
    What types of business are eligible to use VA? Is it only restricted to annuities?
     
  9. ActuaryLad

    ActuaryLad Active Member

    Application of VA (and MA) is associated with products with "long term guarantees". Unhelpfully, the Solvency II regulatory framework does not include a legal definition of "long-term guarantees".

    In practice the first waves of VA applications were for annuity portfolios that were too difficult to get an MA approval for. I have heard noises from some firms looking to get VA approval for other types of business, such as the guaranteed element of with-profits business. However, as of now, I am unsure as to whether these applications have been submitted and/or whether they have been successful.
     
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  10. Sponge

    Sponge Member

    Won't Whole of Life products qualify too
     

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