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Chapter 20 - Supervisory reserves

C

CHUN LEONG LEE

Keen member
Hi ActEd team, I have a question please.

Under page 10, para 2.2 (Interplay between reserves and solvency capital requirements), it mentions that solvency capital requirements cannot be looked in isolation and has to be considered with adequacy of reserves set up. It also mentions that the balance between the 2 depends on the local regulations.

I would like to ask apart from what's mentioned, could you provide some further insights or explanations on why the two components (SCR + Reserves) cannot be looked in isolation? E.g. what will go wrong, what could be missing, or what consequences will there be, if each component is considered in isolation?

This is just for my own techincal understanding on its importance.

Thank you.
 
Hi Chun

A numerical example might help.

In some countries the reserves are calculated on a best estimate basis, let's say these reserves are 100. The SCR would then be quite large, say 50. So in total the insurer needs assets of at least 150 to be solvent.

In other countries the reserves are calculated using a prudent basis, say 130. The SCR is designed to give further protection to policyholders, but the reserves are already quite strong, so a smaller SCR of 20 might be sufficient. So in total the insurer again needs assets of at least 150 to be solvent.

In either case the policyholders have the same level of protection because the insurer holds assets of 150 for liabilities that we only expect to cost 100.

We can see that it is important to look at the two components (reserve and SCR) together, as it is their total that determines the assets the insurer will hold. If the insurer held best estimate reserves of 100 and a small SCR of 20, then the insurer only needs to hold assets of 120 which doesn't give much protection against things going wrong. On the other hand, if prudent reserves of 130 and a large SCR of 50 were required, then the insurer would need to hold assets of at least 180 - this might be excessive, the insurer might charge the policyholder more for the cost of capital or might even be forced to stop selling insurance.

I hope these examples help.

Best wishes

Mark
 
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