SCR questions

[Mbotha]

I have a few questions I'm hoping to get some help on....

Longevity swaps:
How do longevity swaps impact the BEL and the SCR (e.g. for annuity business)? My thinking is that the BEL is still modelled using best estimate mortality assumptions (the cashflows from the longevity swap aren't modelled). On the asset side, assets are reduced by the PV of the fixed payment leg and increased by the PV of the floating leg (similarly to how reinsurance premiums and recoveries would be accounted for). Any collateral payments would also be modelled as part of the assets. The longevity SCR would be impacted as follows: the lighter mortality (claims for longer durations) resulting from the stress mean stressed assets would be higher (assuming the gap between the floating and fix payment legs widens at the tails). The counterparty default SCR would also increase. Is that right?

Would this differ if the longevity swap was structured as a derivative rather than a reinsurance arrangement?

Mortality vs longevity SCR:
How does the SCR for the mortality risk SCR differ to that of the longevity risk SCR? Is the latter only calculated for business with longevity risk (e.g. annuities)? The stresses would also be different right (e.g. x% reduction in mortality rates rather than an increase)?

Yes: the market risk stresses for equities tend to be higher than for property (and will be lower still for bonds and cash).

Is it the interest rate sub-module that would be impacted by higher/lower cash holdings?

 

[Lindsay Smitherman]

Re longevity swaps: Yes I think that is right (although not an expert!): the BEL remains the same, assets would reduce by the cost of the transaction, and the SCR reduces as a result of lower longevity risk (offset to some extent by higher counterparty default risk). The risk margin should also reduce correspondingly, since the insurance risk component is part of the SCR subset on which the risk margin calculation is based. [I believe that there are some issues relating to how such transactions are allowed for in the balance sheet if structured as derivatives, but you would not be expected to know any of that.]

Re mortality vs longevity: Yes, what you have said is correct.

 

[Lindsay Smitherman]

Is it the interest rate sub-module that would be impacted by higher/lower cash holdings?

Yes, if the "cash" is in the form of fixed interest short-term money market instruments such as bills then there will be interest rate risk. [For basic cash deposits, there would be no impact on market value of a change in interest rates.] There may also be currency risk.

Also, need to consider counterparty default risk (separate risk module).

 

[Viki2010]

Re longevity swaps: Yes I think that is right (although not an expert!): the BEL remains the same, assets would reduce by the cost of the transaction, and the SCR reduces as a result of lower longevity risk (offset to some extent by higher counterparty default risk). The risk margin should also reduce correspondingly, since the insurance risk component is part of the SCR subset on which the risk margin calculation is based. [I believe that there are some issues relating to how such transactions are allowed for in the balance sheet if structured as derivatives, but you would not be expected to know any of that.]

Re mortality vs longevity: Yes, what you have said is correct.

Lindsay, wouldn't we expect some longevity risk for Whole Life products? The policyholder may live longer than expected when pricing the product.

 

[Lindsay Smitherman]

Lindsay, wouldn't we expect some longevity risk for Whole Life products? The policyholder may live longer than expected when pricing the product.

Would the whole life assurance policyholder living longer than expected be a bad thing for the insurance company? if it is a without-profits policy with a fixed benefit, the longer the term to death the more time the company has to take premiums and earn investment return. If it is a with-profits or unit-linked policy, the company has a longer time to take charges/receive shareholder transfers.

 

[prachi]

Hi,

que 1
I have few questions on longevity swap.
a) How Collateral is calculated at beginning of the contract?
I understand that it is PV of floating payment minus PV of fixed.
Where,
Fixed payments reflects counterparty B best estimate plus the risk margins
But how PV of floating payments is estimated? Like on which assumptions ? Does it use counterparty A assumptions to mortality ?

b) Run off of Collateral.
If the fixed and floating payments gets released as expected then Collateral value will change in the assumed pattern throughout the policy term.

But in reality, future is uncertain. So how Collateral amount can be changed during the policy period (eg after few years) compared to assumed collateral value at each time period ?
We know that Collateral is calculated on the prospective basis, and fixed payments are set at outset. So only changes in future expected floating payments can impact the collateral value during middle of the term, right?
Lets assume the floating payments are based on some assumptions of counterparty A and those assumptions get revised in middle of annuity policy duration (in light of experience emerging) , then Collateral will be changed , right?

Que 2. What is the impact of deposit back on SII balance sheet?
I am confused specially after reading solution to Q1, April 2015, part 7

 

[Lindsay Smitherman]

Re longevity swaps: the basis on which the collateral is calculated would have to be agreed between the two parties.
The actual amount of collateral held will vary over time according to the actual experience of the portfolio and in line with interest rate changes (used for the discount rate).

 

[Lindsay Smitherman]

Re deposit back: the reinsurer deposits money back with the insurer (typically equivalent to the reinsured reserves), but this is effectively still the reinsurer's money. The arrangement basically allows the insurer to capitalise the expected future reinsurance recoveries within its balance sheet. So an insurer with a deposit back arrangement in place would have to be careful not to double count those recoveries.