CMP, Chapter 16 Page 26 (Securitisation): "The introduction of Solvency II, which does allow credit to be taken for expected future profits (albeit with some restrictions), has meant that such arrangements are no longer effective, and other types of capital raising have become more attractive." Hoes does Solvency II allow for expected future profits? Is it in the assets or is it just that insurers now only need to hold BEL instead of prudent mathematical reserves?
Hi Solvency II's BEL allows for all expected future cashflows so will recognise when future income is greater than future outgo. The BEL is based on best estimate assumptions and so there is no longer the release of the prudential margins in the future. This implies that previous capital raising arrangements such as Securitisation and Financial Reinsurance become less effective. Thanks Em
Thanks! I've got two follow up questions: 1. CMP Chapter 13 Page 12 on Risk Margin: "It represents the theoretical compensation for risk of the future experience being worse than the best estimate assumptions, and for the cost of holding regulatory capital against this." From this sentence, it sounds like the Risk Margin includes two components - some sort of margin of prudence (experience worse than BE assumptions) AND the cost of holding that margin. However, later on in the more detailed description on the calculation of the RM, it sounds like RM is only the cost of holding that margin ("The product of the cost of capital rate and the capital requirement at each future projection point is then discounted, using risk-free discount rates, to give the overall risk margin."). So is RM: A) margin + cost, or B) cost? 2. If the answer to the above question is A), then wouldn't that margin be like prudent margins under Solvency I? And if so, could you securitise that?
Hi The RM is the cost of holding the SCR capital for the non-hedgeable risks and is added to the BEL to equal the amount that would have to be paid to another insurance company in order for them to take on this best estimate liability. The cost of capital is the shareholder required return and the actual return on the SCR. Unlike the situation where there is a risk that prudential margins are not released in future under Solvency I, there is no risk transfer involved in securitising the RM and so I can’t see how securitising would help. Plus the regulator requires companies to hold the RM and so will unlikely be happy with reducing this via securitisation. Hope this helps Thanks Em
