April 2019 Q1d

Hi

You are correct that this is not explicitly stated in the SA2 course, and you would not be expected to know details of how all of the risks are stressed. However, the point that is being made in this part of the solution (that the standard formula SCR would not change under an increase in the risk of default of reinsurance counterparties, unless the reinsurers have their credit ratings downgraded) can be derived from having a basic understanding of the standard formula.

As stated in the SA2 course, the standard formula uses prescribed stress tests and factors. In other words, specified parameters are applied as stress tests for each risk that has to be considered. In terms of reinsurance default, it wouldn’t seem sensible to apply the same % loss of value to every reinsurer. Therefore different %s are likely to be applied to reinsurers with different probabilities of default. Their credit rating would seem to be a reasonable way in which to quantify this for the purposes of the standard formula, given that it is an objective measure. (And you will note that the SA2 Core Reading does mention ratings in the brief content on the counterparty risk module within Chapter 11 and in Chapter 22 under credit risk.) So it would be reasonable to assume that the standard formula states a different level of stress for reinsurers of different credit ratings.


If there is an increased risk of default of a particular reinsurer, then if that reinsurer’s credit rating isn’t changed there wouldn’t be any difference under the standard formula SCR: the same parameter would be used for the value at risk calculation. The only reason why it would change would be if EIOPA changed the parameter value in the standard formula. But it wouldn’t be practical (either for the supervisors or the insurance companies) to keep changing the high volume of parameters on a real-time basis – such changes would be expected to be infrequent. On the other hand, if the increased risk of default did translate itself into a ratings downgrade for the reinsurer, then a different standard formula parameter would have to be used, resulting in a higher loss impact and thus a higher SCR.

Don’t worry if you didn’t make this connection, you would still have been able to score highly even without having appreciated this.

Thanks

 

If the increased expense leads to an increase in best estimate expense assumptions, the SF expense stress would then be applied to a higher expense assumption. Resulting in an increase in the SCR and risk margin. The BEL would also increase due to the higher expense assumption under normal conditions.
You don't need to know any more detail than this.
Thanks