comparison qis5 and parallel run -...

© 2012 Towers Watson. All rights reserv ed.

Comparison QIS5 and Parallel Run

Overview of similarities and differences

Towers Watson Netherlands - Risk Consulting & Software

May 2012

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© 2012 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

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Contents

Introduction

Main conclusions

Technical Provisions

Solvency Capital Requirement (SCR)

Market Risk

Life Risk

Non-Life Risk

Health Risk

Operational / Intangible Asset / Default Risk

Other

Limitations

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Introduction

The objective is to give a brief overview of the main similarities and differences

between QIS5 and the Parallel Run.

Sources:

QIS 5: QIS5-technical_specifications_20100706.pdf

Parallel Run: Solvency II_Parallel Run over 2011_Handleiding en technische

specificaties_tcm50-225969.pdf

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Main conclusions

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Change in basis risk free interest rates. Last liquid point is only 20 years. After

20 years risk free rates converge in next 40 years to Ultimate Forward Rate of

4.2%.

Introduction of countercyclical premium based on 75% of QIS5 proxy method

without bucketing. Slight run-off countercyclical premium after 20 years, but

remains substantial for longer tenors.

Whole impact Countercyclical premium part of SCR Market risk module with

correlation 0 with other market risks.

Symmetric adjustment for the equity shock decreased from 9% to 5%.

Lapse stress changed for Life, non-Life and Health.

Some Non-Life and Health parameters for premium and reserve risk have

been changed.

Additional reporting disclosures such as net present values of different

incoming and outgoing cash flows and surrender values.

The range of application of scenarios for Catastrophe risk has been changed.

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Technical Provisions

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QIS 5 Parallel Run

Valuation

Risk-free rate Liabilities should be discounted with the risk-free rate plus an illiquidity premium.

As risk-free rate should be used the Swap-

curve - 10 basis points for the first 30 years. Between 30 and 60 years forward converges to

the ultimate forward rate of 4.2%.

See page 50 and annex E

The risk-free interest rate is based on the swap curve adjusted for 10bps for credit risk.

The last liquid point is assumed to be 20 years.

After 20 years the rates converge in 40 years according the Smith-Wilson model to the Ultimate

Forward Rate (UFR) of 4.2%.

See page 66

Illiquidity premium /

Countercyclical premium

50%, 75% or 100% illiquidity premium, depending on type of liability.

See page 50

Countercyclical premium of 75% of the proxy method from QIS5 for first 20 years. No bucketing.

After 20 years countercyclical premium decreases slowly, but remains significant.

Matching premium out of scope.

Insurers are allowed to make an extra valuation with a 100% countercyclical premium.

See page 67

Risk Margin Risk Margin Part of TP in order to ensure that the value is equivalent to the amount that (re)insurance undertakings would be expected to require in

order to take over and meet the (re)insurance obligations.

See page 54-55

This is calculated as the present value of 6% (CoC) of the future SCR’s (discounted with the

appropriate rate).

See page 58

No changes in calculation. The discount rates should be basis risk free rate without the countercyclical premium.

See page 26

(1) We note the latest proposal of the ECON commission of the European Parliament includes a risk -f ree rate based on the Swap-curv e – 10 basis points until 20 y ears. Then the curv e

will be extrapolated to the ultimate f orward rate of 4,2% in 10 y ears.

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Solvency Capital Requirement (SCR)

*

* Illiquidity under QIS5, Countercyclical premium in Parallel Run

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SCR - Market Risk

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QIS 5 Parallel Run

Interest Shift of whole curve up and down.

See page 110-111

Shift of whole curve up and down. Changed shocks after 20 years. Shock for each term is minimum 100 basis points for up and down shocks.

See page 68

Equity Stress: on two different types of equity, stresses take account of (9%) symmetric adjustment.

See page 112-115

Stress: on two different types of equity, stresses take account of (5%) symmetric adjustment.

See page 15

Duration based equity approach is not allowed.

See page 17

Property Stress: instant 25% decrease in real estate investments.

See page 116-117

No changes.

See page 30

Currency Stress up: instant 25% rise of currency.

Stress down: instant 25% fall of currency.

See page 117-119

No changes.

See page 52

Spread The spread is split up in:

Bonds

Structured credit products

Credit derivatives

Required capital is computed as the decrease in spread, based on

credit rating. See page 119-127

No spread risk on European Economic Area (EEA) government bonds See page 123

Spreads changed with different segmentation of durations which leads to smoother transfer of capital requirements from short to long durations of corporate bonds.

See appendix D page 69-74

Residential mortgages are part of counterparty default risk.

See page 17

For credit derivatives used for risk mitigation no capital requirement when the underlying assets are owned and no other material exposure is present.

See page 73-74

Concentration Maximum exposure per counterparty depends on credit rating. See page 127-132

For unrated (re)insurers no reference can be made to SII ratio, capital requirement will be based on poorest credit rating.

See page 88-89

Illiquidity /

Countercyclical premium

Stress: instant 65% fall in value of illiquidity premium with a correlation of -0.5 with spread risk.

See page 109, 132-133

Stress: instant 100% decrease of the countercyclical premium with correlation 0 with other market risks. Whole impact countercyclical premium part of SCR Market Risk module.

See page 13

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SCR – Life Risk

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QIS 5 Parallel Run

Mortality Stress: 15% increase in mortality rates.

See page 149-150

No changes.

See page 30

Longevity Stress: 20% decrease in mortality rates.

See page 151-152

No changes.

See page 30

Disability Stress: 35% increase in next year disability rates, thereafter 25% permanent increase and a permanent 20% decrease in recovery rates.

See page 152-155

No changes.

See page 54

Lapse The maximum of an: up, down and mass-lapse stress.

See page 155-159

Mass-lapse stress up from 30% to 40% for Retail (Individual) business.

See page 18

DNB explicitly mentioned the extended lapse definition including paid up.

See page 17

Expense Stress: 10% increase in future expenses and 1% per annum increase of the expense inflation rate.

See page 159-160

No changes.

See page 30

Revision Stress: 3% increase in the annual amount payable for annuities exposed to revision risk. See page 160-161

No changes. No details provided in specifications.

Catastrophe Stress: 15 basispoints increase in mortality rates over next year.

See page 161-163

No changes. No details provided in specifications.

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SCR – Non-Life Risk

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QIS 5 Parallel Run

Premium and Reserve Function of st.dev. times Volume:

Approx 3 * st.dev. * Vol

St.Dev. and Volume are split in 12 LoB’s

St.Dev. is given per LoB and Volume is computed from written and earned premium per LoB (premium risk) and claims outstanding (reserve risk).

See page 196-203

3 * st.dev. * Vol

Lob’s are replaced by segments.

Calculation of premium volume is adapted. Parameters now only include earned premiums (no written premiums). Premium

volume now also includes the value of expected premiums for policies with start date after calculation date.

Parameters for premium and reserve risk are altered. Only one estimation method for entity specific parameters is allowed. ρ is

set to 3.

See pages 20, 75, 90

Lapse Same as in Life (without non-retail).

See page 203-205

Changed from Life. The discontinuance of 40% of both the insurance and reinsurance policies for which this discontinuance results in a higher best estimate. For outgoing

reinsurance contracts related to future contracts: a decrease of 40% of the expected number of future policies.

See pages 18, 55

Catastrophe Compute via standardized scenarios and factor based methods and aggregate using zero correlation.

See page 206-243

Changes in cat risk for motor liability and credit and suretyship. The scenario for a man-made motor liability catastrophe depends on the number of insured vehicles grouped by the

maximum claim size. Solvency capital for the credit and suretyship catastrophe risk consists of a default and a

recession component. For each component an altered scenario is prescribed.

See pages 21, 79-80

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SCR – Health Risk

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QIS 5 Parallel Run

SLT

(Similar to Life

Techniques)

Mortality Same as in Life.

See page 168-169

No changes.

See pages 30, 56

Longevity Same as in Life.

See page 169

No changes.

See pages 30, 56

Disability/

morbidity

Sum of Medical and Income

Medical expense insurance, max of claim shock up and claim shock down

Income protection insurance, same as in Life.

See page 169-173

No changes.

See page 56

Lapse Same as in Life, except with 20% instead of 50% for up and down stress.

See page 174

For increased and decreased discontinuance: same as in Life. For mass lapse, same as in Non-Life (or Life without non-retail).

See page 19

Expense Same as in Life

See page 173

No changes.

See pages 30, 57

Revision Same as in Life, but with 4% stress instead of 3% (with a possibility of USPs).

See page 173-174

No changes.

See page 57

Non-SLT Premium &

Reserve

Same as in Non-Life, but with 4 LoB’s .

See page 174-180

Same changes as in Non-Life. The reduction of the parameters due to HRES have changed.

See pages 20, 75, 90

Lapse Same as in Life (without non-retail).

See page 180-183

Same as in Non-Life.

See pages 19, 57

Catastrophe Split in 3 uncorrelated events:

Arena (Mass), Concentration and Pandemic.

For medical expenses Arena and Pandemic do not apply. See page 186-195

The range of application of the scenarios has changed.

Where in QIS5 only concentration risk was applicable for medical expenses, in the Parallel Run the concentration risk is the only

risk that is not applicable for medical expenses.

Furthermore, Arena is replaced by mass accident risk. Pandemic risk is adapted to include medical costs. Risk

Equalisation Fund should be considered when determining solvency requirement for pandemic for basic health insurance. See pages 79-83

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SCR – Operational / Intangible Asset / Default Risk

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QIS 5 Parallel Run

Operational SCR = min(0.3⋅BSCR;Op) + 0.25⋅Exp.

Where Op is based on premiums and provisions.

See page 102-104

Slight change in factor from 1.1 to 1.2 in formula of Oppremiums.

See page 58

Intangible Asset 80% of Value Intangible Assets.

See page 105

No changes.

See page 51

Counterparty default Split in type 1 and type 2 exposure, with 75% correlation. Type 1 are exposures which may not be diversified and where the counterparty is likely

to be rated.

Type 2 are exposures which are usually diversified

and where the counterparty is likely to be unrated.

SCR is based on Loss-Given-Default per counterparty.

See page 134-146

Split in type 1 and type 2 exposure. Residential mortgages are part of counterparty default risk under type 2.

See page 17

Use of simplified methods from QIS5 is allowed.

See page 87

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Other

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QIS 5 Parallel Run

Contract boundaries Annex D of the QIS5 specifications sets out examples of contract boundaries

See page 27-28 and annex D

DNB made further clarifications. The implications of the ‘en-bloc clausules’ are still left to the judgment of the insurer.

See page 61-65

Employee benefits IFRS treatment recommended. Valuation based on Solvency II principles are allowed with sufficient documentation.

See page 19

IFRS, BW valuation and other valuation techniques allowed which lead to market value.

See page 13

Insurer may choose to stress, but treatment should be disclosed. Stress is not mandatory.

See page 14

Loss absorbency of technical

provisions and deferred tax

Two approaches were tested:

•Equivalent scenario

•Modular approach

See 97-101

Only modular approach should be used.

See page 14

Net approach for deferred tax assets is allowed when covered

by future profits in foreseeable future. Starting point is the shocked position.

See page 84-85

Undertaking-specific

parameters

Undertakings are encouraged to calculate undertaking-specific parameters. USPs can be applied for premium and reserve risk and for

revision risk

See page 244-260

Only one method based on lognormal distribution is allowed for standard deviation of premium and reserve risk.

See page 21

Additional Disclosures No additional disclosure needed of net present values of cash flows or surrender values.

Additional disclosure needed of net present value of incoming and outgoing cash flows and surrender values.

See page 40 and 47

Expected loss separately disclosed in reporting tool.

See page 29

MCR Minimum Capital Requirement

See page 287-294

No changes.

See page 31

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Limitations

The information in this publication has been prepared for general purposes only

and does not purport to be and is not a substitute for specific professional advice.

While the matters identified are believed to be generally correct, before any

specific action is taken, specific advice on the circumstances in question should

be obtained.

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Comparison QIS5 and Parallel Run

Towers Watson Netherlands – Risk Consulting & Software For more details and questions please contact:

Gerard Pater, Dennis Bank or Suzanne Overberg

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