Impact of matching adjustment on SF SCR - April 2017 Q1(iv)

Discussion in 'SA2' started by VCSUC, Apr 8, 2018.

  1. VCSUC

    VCSUC Member

    The Examiner's Report says " The main impact will be on the market risk module. This is because the company can change the risk-free discount rate... ".
    I would thought the main impact to market risk module was mainly due to that some assets that are held to maturity, so the shocks applied on market risk scenarios could be less significant and thus assets side would have less reduction?
    The change in risk-free discount rate would have a similar impact on other risk modules as well (increase risk free rate and reduce the BEL) so liabilities reduced under all scenarios/modules, not more significant in market risk? or because the shock to risk free rate is less significant in market risk module due to the application of MA?

    For the market risk module, any adverse movement in the market (eg. equity/bond prices drop) would decrease the assets, also the investment income in BEL, and increase/decrease risk free discount rate? Please correct me if I'm wrong.

    Thank you.    ​
     
    VCSUC, Apr 8, 2018
    #1
  2. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    Being able to use a matching adjustment (MA) doesn't have any impact on the asset side of the balance sheet. Under the SCR stresses the value of assets will still fall by as much as they would if the matching adjustment wasn't there. Assets are just valued at market (fair) value.

    The MA only impacts the BEL calculation. The main benefit within the SCR will be in the spread widening component of the market risk model. If the spreads widen due to an increased liquidity margin, the MA will increase correspondingly. Hence the BEL under the stress will fall, possibly significantly, thus reducing the SCR in relation to that stress (since SCR for stress = {assets - BEL} with no stress - {assets - BEL} with stress).

    For the other stresses, the values of BEL with and without the stresses will be slightly lower due to the normal level of MA being in place, but these differences will largely offset in the SCR calculation. There will be some second order impact, but not as significantly as for the liquidity spread widening stress, where the BEL-with-stress is likely to reduce materially (because the MA will increase).
     
    Lindsay Smitherman, Apr 9, 2018
    #2
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  3. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    The risk-free discount rate (and expected risk-free investment return assumptions in the BEL) will only change if swap rates change.

    When testing other market risk factors in the standard formula SCR (eg equity price falls) they are considered on a standalone basis (without interest rates changing) and then the separate stresses are combined using correlation factors, to allow for the inherent relationships.
     
    Lindsay Smitherman, Apr 9, 2018
    #3
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  4. VCSUC

    VCSUC Member

    Thank you Lindsay.
     
    VCSUC, Apr 11, 2018
    #4
  5. User 1234

    User 1234 Active Member

    Hi Lindsay,
    You mentioned that "If the spreads widen due to an increased liquidity margin, the MA will increase correspondingly. " Can I please check if this is only applicable under Internal Model as MA/VA is not stressed/changed under standard formula for the spread widen SCR?

    Thank you!
     
    User 1234, Mar 26, 2022
    #5
  6. Lindsay Smitherman

    Lindsay Smitherman ActEd Tutor Staff Member

    Hi - my understanding is that what I wrote is true for the MA whether standard formula or internal model, but that you are correct for the VA, which is only changed under the internal model.

    Having said that, there have been suggestions that EIOPA would also introduce a dynamic VA for the standard formula - I know there have been recentish consultations on that. Perhaps someone working in Solvency II could update on that?
     
    Lindsay Smitherman, Mar 28, 2022
    #6
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