Please explain!

[tommo]

A group’s solvency capital requirement may be based on a target percentile in
the tail of the underlying aggregate loss distribution. But we may allocate the
diversified capital down to individual classes of business or products for a
company in the group with reference to a lower percentile or with reference to
various percentile-defined layers to prevent over-allocation to catastrophe-type
business.

Cheers,

Alun.

 

[MorningtonCrescent]

This is saying that just because we use a 99.5% VaR to calculate the total SCR, we needn't use a 99.5% VaR to allocate capital down to individual classes.

Imagine we did use the 99.5% to allocate capital. Well, for very positively skewed risks, like catastrophe business, the 99.5th percentile will be much further away from the mean than if we were considering nice stable non-cat business. So we'd end up allocating a lot of capital to the cat business and relatively little to the nice stable non-cat business.

To reduce this problem, we might decide to use a different risk measure, say 85% VaR or something.

 

[tommo]

This is saying that just because we use a 99.5% VaR to calculate the total SCR, we needn't use a 99.5% VaR to allocate capital down to individual classes.

Imagine we did use the 99.5% to allocate capital. Well, for very positively skewed risks, like catastrophe business, the 99.5th percentile will be much further away from the mean than if we were considering nice stable non-cat business. So we'd end up allocating a lot of capital to the cat business and relatively little to the nice stable non-cat business.

To reduce this problem, we might decide to use a different risk measure, say 85% VaR or something.

Cheers!