Question ID: 1867
Regulation Reference: (EU) No 2015/35 - supplementing Dir 2009/138/EC - taking up & pursuit of the business of Insurance and Reinsurance (SII)
Topic: Solvency Capital Requirement (SCR)
Article: 176
Status: Final
Date of submission: 26 Feb 2019
Question
I am seeking clarification on Solvency II standard formula spread risk charges on defaulted and non-performing loans.
1) What is the spread risk capital requirement on a defaulted loan with issuer rating D (CQS 6) after the loan due date? would this loan be treated as Type II equity exposure?
2) Would spread risk capital requirement on a defaulted loan with issuer rating D (CQS 6) still be calculated based on duration and rating as prescribed by Article 176?
3) Would a non-performing loan carry a higher capital requirement under Solvency II standard formula approach than an equivalent performing loan, assuming both loans are to obligors with the same CQS and have the same duration?
EIOPA answer
The following is based on the assumption that the defaulted loan is assigned a credit quality step of 6 in accordance with Articles 4 and 5 of the Commission Delegated Regulation (EU) 2015/35 and the mapping set out in the implementing technical standards with regard to the mapping of credit assessments of external credit assessment institutions for credit risk („Mapping ITS").
1.The defaulted due loan should be included in the calculation of the capital requirement for spread risks on bonds and loans and not in the calculation of the capital requirement for equity risk. Based on Article 176 (2) of the Commission Delegated Regulation (EU) 2015/35 the modified duration for the due loan should be set to one year. In accordance with paragraph 3 of this Article the risk factor stress should be set to 7.5 %.
2.See answer to 1.
3.The treatment of a loan in the spread risk sub-module depends only on the modified duration and the credit quality step. Whether the loans of defaulted and non-defaulted obligors are assigned to the same credit quality step depends on the rules set out in Article 4 and 5 of the Commission Delegated Regulation (EU) 2015/35 and in the mapping ITS.
Regarding the maturity: The contractual clauses governing the loan may set out that the loan becomes immediately due in case of a default. Please be also aware of the „floor" of one year for the modified duration set out in Article 176(2).
Please be also aware of the following:
1.The valuation of the loan for the purpose of calculating the regulatory own funds and solvency requirements should be in line with Article 75 of Directive 2009/138/EC (Solvency II).
2.According to Article 45(1)(c) Directive 2009/138/EC (Solvency II) the undertaking needs to demonstrate in its ORSA the significance with which the risk profile of the undertaking deviates from the assumptions underlying the Solvency Capital Requirement.
In addition and according to Article 45(1)(a) Directive 2009/138/EC (Solvency II) the undertaking is required to take into account the undertaking's specific risk profile when assessing its overall solvency needs.
The ORSA assessment of the overall solvency needs is therefore not subject to how risks are estimated by the standard formula.
Please note that EIOPA proposed in December 2020 a different treatment for defaulted loans (see paragraphs 5.22 and 5.23 in the “Opinion on the 2020 review of Solvency II").