Hi Is cost of guarantees for declared or future bonuses or any guarantees like no MVR or surrender penalty etc. a part of economic capital requirements/SCR? or is it part of Technical provisions? i.e. if I have to state the economic capital or SCR of any company, should it be inclusive of cost of guarantees? My understanding was it is part of technical provisions and its reduction will lead to increase in available capital but will have no impact on economic capital required/SCR but In April 2016 question 1 (iii) solution, it is argued both ways? Please help in clarifying. Thanks
The cost of guarantees determined on a market-consistent basis (ie effectively the amount that someone "in the market" would require in order to take those guarantees on) is part of the BEL and therefore technical provisions. The existence of guarantees also increases the SCR (or, equivalently, required capital on an economic basis) because the cost of guarantees will increase significantly under whatever stress scenario results in the guarantees moving into the money. For example, the guarantee relating to the payment of the sum assured and declared bonuses at maturity of a with-profits contract will have a significantly greater cost under the equity stress scenario (assuming equities backing asset shares).
Thank you. So if I am understanding correctly, the Cost of guarantee which is part of BEL will increase in stress scenario and hence SCR since it is calculated as Change in assets over change in BEL, it will lead to SCR. And if this is correct, I have one question that from practicality perspective, will any company which is using standard formula, recalculate the cost of guarantees under stress scenario? To derive the actual BEL under that scennario or will it go with same cost of guarantees as base case in all scenarios?
Yes, that's right. Yes, the cost of guarantees will be recalculated under the stress scenario whether using the standard formula or using an internal model. The difference is that under the standard formula the stress scenario is prescribed by EIOPA rather than determined by the company itself.
Thanks. Just one more thing, for the prescribed stress under standard formula, can companies get scenarios around that prescribed stressed value to calculated cost of guarantees as it has to be determined stochastically? I am talking about scenarios from ESG like B&H etc.
Hi The stress event would happen now (or over the one year time period of the SCR VaR calculation). The stochastic simulations needed for the remaining projection term to the guarantee date then just need to be the standard market-consistent calibration (ie with expected return based on risk-free rates and volatilities around that).
