When calculating the premium and reserve risk SCR under SII it is optional to allow for geographical diversification depending on if risks are situated in different geographical locations. Qn: How does one allow for geographical diversification for Marine, Aircraft and Transportation? Is this based on where the vessel or aircraft is registered or the geographical limitations specified in the policy?
I' m not a GI expert so I may be wrong. However, if I was faced with this dilemna in an exam question, Id try to think about this logically. In reserving you are reserving against future liabilities. As you point out, with 'vehicles' in this wide sense, they may actually be at risk of having a claim anywhere that is covered in the geographical limits of the policy. So to me its the policy term limits that should dictate. With this argument Id be comfortable applying some diversification benefit - after all above you say it is 'optional' so it isn't obligatory and you should be able to do it if you feel its justified.
It's likely to be a mixture of actuarial judgement and analysis of data. It should be possible to test the correlations present in past data, and combine that with known information about the routes travelled. It sounds like you're describing the S2 standard formula, which allows up to 25% diversification. For an internal model of course, an insurer can choose its level of diversification, so long as it can convince the regulator that its methods are reasonable.
Correct, am looking at it from a SII SF perspective. What is not clear to me is if the insurer was to allow for geographical diversification for MAT line of business is this based on: a) where the aircraft or ship is registered? b) based on geographical regions "visited" by the aircraft or vessel (say 60% UK and 40% N America)? or c) a mix of a and b?
There is no hard and fast formula. It is up to the actuary to decide what is best for their company and feel that they are able to justify the methodology they are adopting. So, they think about the relative risk and time spent in each. As I said before, to me, we are looking at risk so its exposure to area of risk that's significant. If all 'vehicles' spend time in the same area of risk, then there is no diversification benefit to be had. You have to realise at the SA level you have to be able to discuss judgement and not rely on formula.
