I would like to understand how to determine the impact of various movements on the undiversified SCR, with some basic reasoning. Say: 1. Fall in property value over the year 2. Fall in govt bond interest rates 3. Fall in corporate bond interest rates 4. Lower new business volumes in general, what should be kept in mind when assessing these impacts? For instance, a drop in property rates, I thought would trigger an increase in property risk capital, however it’s actually the other way I think. Thanks!
A fall in the market value of property would mean a total lower amount of property assets held on the insurer's balance sheet. Therefore, the Solvency II SCR shock will now be applied to a smaller market value, and therefore the new undiversified property risk SCR will be lower. All of the shocks listed above can be approximated as linear stresses i.e., an x% increase/ decrease stress (whichever is biting) will result in a solvency capital requirement of y (note that their direction would depend on the product type). This should be a helpful guide, it is also important to remember that the shock being applied to the base value, is agnostic of what has happened in the past. In your question above you refer to a 'fall in property rates'; this does not directly affect the SCR calculation, however its effect should be considered via its impact on the assets and/or liabilities.
Thanks, I get this. But on the other hand if I think of it more, say the value property drops so the assets drop. Surely, the stress applied to calculate SCR reduces because the base value has reduced however, now that there are less valued assets backing the liabilities, would that trigger the need of more valuable assets to cover the SCR? Like I find a bit hard to interpret the overall picture. Property drop -> Asset drop -> Less surplus -> lower SCR but there's a higher risk because there aren't enough assets to back liabilities or capital. Separate question, is economic risk capital same as SCR under SII?
Yes, you are correct in your understanding of requiring assets to replace the 'lost value' from the property fall. However, insurers will not typically hold assets only to back 100% of the SCR, in fact the total assets will need to be much higher than this so as to avoid a situation of regulatory intervention (i.e., the ladder of intervention). The type of assets required to back the SCR are discussed in Chapter 11. The question you referred to only asked about the undiversified property SCR, and not the total SCR. To consider the impact on the overall SCR, you would need to consider the aggregate of all movements and this would not be straightforward to deduce if you talk about multiple stresses simultaneously. Economic risk capital from my understanding would be as defined by the insurer, so it would depend on whether the assumptions used by the insurer are the same as those being used under Solvency II. Where these are not the same, the capital requirements will vary e.g., use of a different risk discount rate.
