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Representatives of the insurance industry have been involved in lengthy discussions with European policy-makers over the treatment of catastrophe risk by the standard formula. But while some changes have been secured by insurers, a satisfactory agreement has yet to be reached on all of the industry's concerns. Some in the industry now feel there is little chance of further changes being made before Solvency II comes into force.
A central focus of the discussions has been the ‘country factors' and the inclusion of undertaking specific parameters (USPs), which enable the standard formula to be adjusted for certain risk factors.
The standard formula for non-life catastrophe risk is calibrated by using average industry risk portfolio by country, but insurers say the number of data sources used to calculate this currently makes it difficult for insurers to determine what counts as the ‘average' exposure. This failure means the standard formula may not be appropriate for non-standard portfolios with a large element of non-European economic area (EEA) catastrophe risk or with large original deductibles, says David Simmons, managing director of analytics at reinsurance broker Willis Re in London. In such cases, the risk profile of the company will be too different from the one assumed under the standard formula calibration.
For insurers with these non-standard portfolios, using a partial internal model for catastrophe risk is the only alternative, as the efforts by the insurance industry to enable companies to use USPs for catastrophe risk have been rejected by the European Insurance and Occupational Pensions Authority (EIOPA), according to Simmons.
But pushing insurers to use a partial internal model has been criticised as being an excessive and costly requirement, particularly for small companies, as is EIOPA's rejection of the use of USPs. "This attitude is very strange, as by definition, USPs are meant to be much more aligned to the true risk profile of the company and therefore result in much more accurate capital requirements", says Amélie Deleurence, Brussels-based policy adviser on prudential regulation at Insurance Europe.
Progress has been made in other key areas of the sub-module, including the allowance for regional diversification and the calculation of reinsurance benefit. "Some allowance for geographical diversification has been added for non-EEA territories, along the lines of region-based diversification allowed for non-cat premium risk in QIS 5", says Willis Re's Simmons.
The catastrophe calibrations are likely to be examined in 2018, when the European Commission (EC) is scheduled to review some of the existing parameters.
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