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SP9 October 2020 Q2(iii)

D

Dar_Shan0209

Ton up Member
Hi Anna/David,
Regarding the above-mentioned subject,
Given credit spreads have decreased, it is my understanding that narrowing spreads will lead to a fall in credit risk. Can you please explain why the opposite is being reflected in the examiners’ report? Perhaps I am missing something.
Also, regarding expense risk, does it fall part of the underwriting risk component in the SCR, for example, increasing u/w cost and/or managing and administering policies due to inflationary effects?
Thanks.
 
Hi Darshan

Your understanding is correct - but there's another factor at play, which is not obvious at first sight.

If credit spreads narrow, eg if corporate bond yields fall, the price of corporate bonds rises. So we may go from having a corporate bond portfolio with value $100m to one with value $120m say. Therefore, the exposure to a potential loss has increased. So when you do your credit risk stress on the portfolio, the absolute amount of the loss that is thought to occur with a 99.5% probability will increase and so the SCR increases.

I think I remember that the question gives you a description of what's happened over the last quarter? In which case, based on a short period of good past experience, we are unlikely to change the parameters / assumptions in the model to reflect lower credit risk going forwards, ie the stress itself is unlikely to change ... but the exposure has increased!

Is this ok?
Anna
 
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