Question ID: 3091
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: 121 to 125
Status: Final
Date of submission: 15 May 2024
Question
Refer to Articles 121 to 125 of the Commission Delegated Regulation (EU) 2015/35 containing the natural catastrophe risk sub-modules of SII, which specifies two events (scenarios A and B) each for Windstorm/Flood/Hail and one event for Earthquake & Subsidence perils. Article 126, Interpretation of catastrophe scenarios states that the two consecutive events (scenarios A and B) for Windstorm/Flood/Hail perils are independent. Separately, the explanatory text underlying the Guidelines on Application of outwards reinsurance arrangements to the non-life underwriting risk sub-module, Page 230, EIOPA-CP-14-036_GL-Pillar_1.pdf (europa.eu) states that “2.13. The catastrophe sub-modules specify a 1 in 200 year gross loss for each sub-module after diversification”. Assuming that an EU insurer which insures UK property (e.g. through a branch) writing only direct business (i.e. no non-proportional risks) has three catastrophe excess of loss reinsurance arrangements with one reinstatement available on all layers and Layer 1 has an aggregate limit. As UK direct property is exposed to Windstorm and Flood perils, a total of 4 events to be considered in the natural catastrophe risk sub-modules. Can you please confirm whether the aggregate limit should be applied as per Approach (1) or (2) below? Approach 1: Part 1 (based on Delegated Acts) a) Calculate the gross WS scenario loss b) Calculate the net WS scenario loss (i.e. the greater of the A/B sub-scenarios, including reinstatement costs.) c) Calculate the gross FL scenario loss d) Calculate the net FL scenario loss (i.e. the greater of the A/B sub-scenarios, including reinstatement costs.) e) Calculate the combined gross WS & FL loss from (a) and (c) using the peril correlation matrix f) Calculate the combined net WS & FL loss from (b) and (d) using the peril correlation matrix Part 2 (based on Guideline 15, para 1.35) “Undertakings should ensure that the total recovery from risk mitigation methods that is allowed for in their calculation of net losses does not exceed the total amount possible under the terms of their risk transfer programme.” g) Calculate the benefit taken for reinsurance (e) minus (f) h) Calculate the maximum recoverable from the Cat XL, (i.e. aggregate limit less reinstatement cost) i) If (g) is less than (h) then capital requirement for cat = (f) otherwise, capital requirement for cat = (e) minus (h) Approach 2 based on the above and Q&A 2349 - European Union (europa.eu): (i) Calculate the gross Windstorm (WS) scenario loss (A and B) (ii) Calculate the gross Flood (FL) scenario loss (A and B) (iii) Calculate the net undiversified SCR after applying risk mitigation for each of the combination of WS-A FL-A, WS-A FL-B, WS-B FL-A and WS-B FL-B considering one reinstatement and aggregate limit available on Layer 1 including any reinstatement costs (iv) Identify the combination of events that produce the maximum net undiversified SCR (v) Calculate the combined gross and net WS & FL loss as per (iv) above using the peril correlation matrix Separately, the net diversified SCR per Approach 2 could result in a prudent risk charge than the intended “The catastrophe sub-modules specify a 1 in 200 year gross loss for each sub-module after diversification”. Could you please clarify whether this has been intended for the standard formula approach?
EIOPA answer
As mentioned in the Guidelines on application of outwards reinsurance arrangements to the non-life underwriting risk sub-module – Guideline 6 “Where a number of 1 in 200 year catastrophe events can be defined, undertakings should derive events which are consistent with their risk profile and select the event which results in a highest catastrophe charge after the application of the risk mitigation techniques."
In the example submitted with the question, it might be necessary (1) to calculate the diversified gross natcat SCR up to level 3 (see Flowchart for the non-life underwriting Risk p.248), and (2) then disaggregate this number to find the scenario combination which results in the largest catastrophe loss after the application of the risk mitigation. Here, it concerns the combination of a windstorm scenario (of type A or B) and flood scenario (of type A or B), where the events happen in the most disadvantageous order.
(3) According to Guideline 15, finally it needs to be assessed, whether while determining the net loss according to step (2), the maximum recoverable from the reinsurance contract was not exceeded. Thus it needs to be checked if the risk mitigation from reinsurance calculated as the difference between the gross loss and the net loss, i.e. (1)-(2), is lower than the maximum recoverable. (4) If this is the case, the net loss according to step (2) is the NatCat SCR. Otherwise, the net loss calculation under step (2) needs to be adjusted and the net loss needs to be increased appropriately such that the risk mitigation does not exceed the maximum recoverable from the reinsurance treaty.