While Article 199(3) DR specifies that we can use the Solvency Ratio of an entity subject to Solvency II to deduce a Probability of Default for the Counterparty Default Risk module, it is not mentioned that this can also be applied when calculating the adjustment for reinsurance default on the ceded Best Estimate of Technical Provisions in Article 42 DR. Therefore, it creates the inconsistency of having a reinsurer being considered as unrated in the adjustment on ceded Best Estimate of Technical Provisions (i.e. PD = 4.2%), while it may have a SII solvency ratio of 300% meaning the counterparty default risk module will consider a PD of 0.01%. 

Article 42(3) DR specifies that the calculation of the counterparty default adjustment (CDA) should take into account possible default events over the lifetime of any exposure, and whether and how the probability of default varies over time. 

The potential for the probability of default to vary over time is not present in the calibration of the standard formula component of counterparty default risk. Moreover, the SCR calculation is based on a time horizon of one year. Accordingly, and in context of the setting described in the question, the parameter PD referred to in Article 199(3) DR denotes the probability of default of the reinsurer during the following 12 months. In contrast, according to Article 42(3) DR the probability of default used in the CDA shall take into account possible default events over the entire lifetime of the reinsurance contract. The assessment of the probability of default for the purposes of the CDA calculation should therefore take into account the fact that this cumulative probability increases with the time horizon of the assessment. For example, the probability that the counterparty defaults during the next two years is higher than the probability of default during the next year, i.e. the 12 months-time-horizon of the SCR. However, the Level 1 text is clear setting out as an overarching principle that the assessment of assets and liabilities should lead to market consistent estimates. Markets base their operations and modelling at this respect on transition matrices, which at the end likely derive in variable probabilities of default. This does of course not preclude the use of appropriate simplifications.

Given the difference between the instruction in Article 42(3) DR and the calibration choices underpinning Article 199(3) DR, it cannot be said that the probability of default used in the standard formula will always be suitable for use in calculating the CDA. Instead, undertakings are required to perform their own analysis to arrive at an approach that is assessed to be in line with the requirements in Article 42 DR.