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name: solvency-ii description: Solvency II framework — three pillars, SCR, MCR, ORSA.
Pillar 1 — Quantitative Requirements:
Pillar 2 — Qualitative Requirements (Governance):
Pillar 3 — Reporting and Disclosure:
Technical Provisions = Best Estimate Liabilities (BEL) + Risk Margin
Best Estimate Liabilities:
= Probability-weighted average of future cash flows
= PV of expected future claim payments + expenses - future premiums
Discounted at risk-free rate (EIOPA publishes term structures)
Adjustments to risk-free rate:
- Volatility Adjustment (VA): Correction for credit spread volatility
- Matching Adjustment (MA): For portfolios of illiquid liabilities matched with assets
- Transitional measures: Phased introduction for legacy portfolios
Risk Margin:
= Cost of capital required to run off the insurance liabilities
= Cost-of-Capital rate (6%) x PV of future SCR over run-off period
Represents the amount a third party would require above BEL to take over the liabilities
Standard Formula — modular structure:
SCR = BSCR + Adj + SCR_op
BSCR (Basic SCR) — aggregated using correlation matrices:
Market Default Life Health Non-Life
Market risk 1.00
Counterparty def. 0.25 1.00
Life underwriting 0.25 0.25 1.00
Health UW 0.25 0.25 0.25 1.00
Non-life UW 0.25 0.50 0.00 0.00 1.00
BSCR = sqrt(Sum_ij Corr_ij x SCR_i x SCR_j) + SCR_intangibles
Adj = Adjustment for loss-absorbing capacity of technical provisions and deferred taxes
SCR_op = Operational risk capital charge
SCR risk modules:
| Module | Sub-modules | Key Risk |
|---|---|---|
| Market risk | Interest rate, equity, property, spread, concentration, currency | Asset value changes |
| Counterparty default | Type 1 (reinsurance, derivatives), Type 2 (receivables) | Counterparty failure |
| Life underwriting | Mortality, longevity, disability, lapse, expense, revision, catastrophe | Insurance risk (life) |
| Health underwriting | SLT health, non-SLT health, catastrophe | Insurance risk (health) |
| Non-life underwriting | Premium & reserve, lapse, catastrophe (natural, man-made) | Insurance risk (non-life) |
| Operational risk | Based on premiums and technical provisions | Operational failures |
SCR calculation method:
Each sub-module applies a prescribed stress:
- Equity risk: 39% + symmetric adjustment (type 1) or 49% (type 2) instantaneous fall
- Interest rate risk: Prescribed up/down shifts to yield curve
- Spread risk: Instantaneous widening based on rating and duration
- Property risk: 25% instantaneous fall
- Longevity risk: 20% permanent decrease in mortality rates
- Lapse risk: Max of mass lapse (40%), permanent increase (50%), permanent decrease (50%)
- Non-life CAT: Scenario-based (natural catastrophe models by peril and region)
SCR for each module = Change in net asset value (own funds) under the stress
MCR = Max(MCR_linear, 25% x SCR)
MCR = Min(MCR, 45% x SCR)
MCR = Max(MCR, Absolute Floor)
Absolute floors:
Life: EUR 3.7M
Non-life: EUR 2.5M
Composite: EUR 3.7M
Reinsurance: EUR 3.6M
MCR_linear: Based on technical provisions and premiums written
(simpler calculation than SCR — provides an absolute minimum)
Breaching MCR triggers ultimate supervisory intervention (license withdrawal)
Breaching SCR triggers recovery plan and supervisory escalation
Classification into tiers based on quality:
| Tier | Characteristics | Examples | SCR Coverage Limit | MCR Coverage Limit |
|---|---|---|---|---|
| Tier 1 (unrestricted) | Permanent, fully loss-absorbing, subordinated | Paid-up ordinary share capital, retained earnings, reconciliation reserve | Unlimited | Unlimited (min 80% of MCR) |
| Tier 1 (restricted) | Permanent, loss-absorbing, call after 5+ years | Perpetual subordinated instruments | Max 20% of Tier 1 | Max 20% of Tier 1 |
| Tier 2 | Subordinated, minimum 10-year maturity | Dated subordinated debt, unpaid called-up capital | Max 50% of SCR | Max 20% of MCR |
| Tier 3 | Subordinated, minimum 5-year maturity | Short-dated subordinated debt, net DTA | Max 15% of SCR | Not eligible |
Solvency ratio:
Solvency Ratio = Eligible Own Funds / SCR x 100%
Target: > 100% (absolute minimum)
Comfortable: > 150-180% (most insurers target this range)
Strong: > 200%
Below 100%: Recovery plan required, supervisor intensifies oversight
Below MCR: Finance scheme required, ultimate intervention possible
Purpose: Forward-looking self-assessment of the undertaking's overall solvency needs considering its specific risk profile, risk tolerance, and business strategy.
ORSA requirements:
ORSA process:
1. Risk identification and assessment
- Quantifiable risks (market, underwriting, credit, operational)
- Non-quantifiable risks (strategic, reputational, regulatory)
- Emerging risks
2. Stress testing and scenario analysis
- Regulatory stress scenarios
- Reverse stress tests (what breaks the business?)
- Company-specific scenarios (key risk concentrations)
3. Capital projection
- Base case: SCR and own funds over planning period
- Adverse scenario: Impact on solvency ratio
- Management actions: Planned responses to solvency deterioration
4. Board sign-off
- ORSA report presented to and approved by the board
- Integration with business strategy and capital planning
- Documented decision-making process
| Feature | Standard Formula | Internal Model |
|---|---|---|
| Complexity | Prescribed calculations | Company-specific model |
| Calibration | Regulatory parameters | Own data and assumptions |
| Risk sensitivity | Moderate | High (reflects actual risk profile) |
| Approval | Automatic | Requires supervisory approval (pre-application, documentation, validation) |
| Diversification | Prescribed correlation matrices | Company-specific correlations |
| Cost | Low | High (build, validation, ongoing maintenance) |
| Typical users | Small-mid insurers | Large insurers, complex risk profiles |
=== SOLVENCY II POSITION ===
Amount (EUR M)
Own Funds:
Tier 1 unrestricted __________
Tier 1 restricted __________
Tier 2 __________
Tier 3 __________
Total own funds __________
Eligible own funds (after limits) __________
SCR Components:
Market risk __________
Counterparty default risk __________
Life underwriting risk __________
Health underwriting risk __________
Non-life underwriting risk __________
Diversification benefit (__________)
BSCR __________
Operational risk __________
Adj (loss-absorbing capacity) (__________)
SCR __________
MCR __________
Solvency Ratio (Own Funds / SCR): ____%
MCR Coverage (Own Funds / MCR): ____%
Status: [ ] Compliant [ ] Recovery Plan [ ] Finance Scheme
=== FORWARD-LOOKING SOLVENCY PROJECTION ===
Year 0 Year 1 Year 2 Year 3
(Actual) (Projected) (Projected) (Projected)
Own funds ________ ________ ________ ________
SCR ________ ________ ________ ________
Solvency ratio ____% ____% ____% ____%
Stress scenario (equity -30%, spread +100bp):
Own funds ________ ________ ________ ________
SCR ________ ________ ________ ________
Solvency ratio ____% ____% ____% ____%
Management actions:
Dividend restriction: Trigger at ____% solvency ratio
De-risking: Trigger at ____% solvency ratio
Capital raise: Trigger at ____% solvency ratio