Solvency ii - Best Estimate
from the Solvency ii Association,
the largest Association
of Solvency ii Professionals in the world
Who is responsible
for the calculation of the best estimate?
The coordination of
the best estimate is assigned to the Actuarial Function (Article 47 of
the Directive, follows)
What is the best
estimate?
According to
Article 76 (follows),
the value of technical provisions shall be equal to the sum of a
best estimate and a risk margin.
The
best estimate shall correspond to the
probability-weighted
average of future cash-flows, taking account of the time value of
money (expected present value of future cash-flows), using the
relevant risk-free interest rate term structure.
The
calculation of the best estimate shall be based upon
up-to-date
and credible information and realistic assumptions and be performed
using adequate, applicable and relevant actuarial and statistical
methods.
The cash-flow projection used in
the calculation of the best
estimate shall take account of all the cash in- and out-flows
required to settle the insurance and reinsurance obligations over
the lifetime thereof.
The best estimate shall be calculated gross, without deduction of
the amounts recoverable from reinsurance contracts and special
purpose vehicles. Those amounts shall be calculated separately, in
accordance with Article 80.
Are
there any challenges?
Many.
-
Accounting practices across Europe are
diverse and do not produce consistent best estimates.
-
There are
differences in the interpretation of
what constitutes a discounted best estimate
(first among supervisors, and second among firms).
-
The
calculation of the best estimate shall be based upon
"up-to-date
and credible information" (very difficult) and
"realistic assumptions" (almost an oxymoron) and
"be performed
using adequate, applicable and relevant actuarial and statistical
methods" (nice words but not very specific ... everybody can do
whatever he/she likes, provided the supervisors do not understand on
pretend they do not understand to give to the country a competitive
advantage).
-
The
"up-to-date
and credible information"
is usually a
combination of
market and entity specific information (that can be
selected to become higher or lower).
-
Will firms
communicate the uncertainty to
senior management and the board of directors?
From the European Parliament
legislative resolution of 22 April 2009 on the
amended proposal for a directive of the European Parliament and of
the Council on the taking-up and pursuit of the business of
Insurance and Reinsurance (recast)
Article 47
Actuarial function
1. Insurance and reinsurance undertakings shall provide for an
effective actuarial function to undertake the following:
(a)
to coordinate the calculation of technical provisions;
(b) to ensure the appropriateness of the methodologies and
underlying models used as well as the assumptions made in the
calculation of technical provisions;
(c) to assess the sufficiency and quality of the data used in the
calculation of technical provisions;
(d) to compare
best estimates against experience;
(e) to inform the administrative or management body of the
reliability and adequacy of the calculation of technical provisions;
(f) to oversee the calculation of technical provisions in the cases
set out in Article 81;
(g) to express an opinion on the overall underwriting policy;
(h) to express an opinion on the adequacy of reinsurance
arrangements;
(i) to contribute to the effective implementation of the risk
management system referred to in Article 43, in particular with
respect to the risk modelling underlying the calculation of the
capital requirements set out in Chapter VI, Sections 4 and 5 and the
assessment referred to in Article 44.
Article 76
Calculation of technical provisions
1. The value of technical provisions shall be equal to
the sum of a
best estimate and a risk margin as set out in paragraphs 2 and 3.
2. The
best estimate shall correspond to the
probability-weighted
average of future cash-flows, taking account of the time value of
money (expected present value of future cash-flows), using the
relevant risk-free interest rate term structure.
The calculation of the best estimate shall be based upon
up-to-date
and credible information and realistic assumptions and be performed
using adequate, applicable and relevant actuarial and statistical
methods.
The cash-flow projection used in
the calculation of the best
estimate shall take account of all the cash in- and out-flows
required to settle the insurance and reinsurance obligations over
the lifetime thereof.
The best estimate shall be calculated gross, without deduction of
the amounts recoverable from reinsurance contracts and special
purpose vehicles. Those amounts shall be calculated separately, in
accordance with Article 80.
3. The risk margin shall be such as to ensure that the value of the
technical provisions is equivalent to the amount insurance and
reinsurance undertakings would be expected to require in order to
take over and meet the insurance and reinsurance obligations.
4. Insurance and reinsurance undertakings
shall value the best
estimate and the risk margin separately
However, where future cash flows associated with insurance or
reinsurance obligations can be replicated reliably using financial
instruments for which a reliable market value is observable, the
value of technical provisions associated with those future cash
flows shall be determined on the basis of the market value of those
financial instruments.
In this case, separate calculations of
the
best estimate and the risk margin shall not be required.
5. Where insurance and reinsurance undertakings value the
best
estimate and the risk margin separately, the risk margin shall be
calculated
by determining the cost of providing an amount of
eligible own funds equal to the Solvency Capital Requirement
necessary to support the insurance and reinsurance obligations over
the lifetime thereof.
The rate used in the determination of the cost of providing that
amount of eligible own funds
(Cost-of-Capital rate)
shall be the
same for all insurance and reinsurance undertakings and shall be
reviewed periodically.
The
Cost-of-Capital rate
used shall be equal to the additional rate, above the relevant
risk-free interest rate, that an insurance or reinsurance
undertaking would incur holding an amount of eligible own funds, as
set out in Section 3, equal to the Solvency Capital Requirement
necessary to support the insurance and reinsurance obligation over
the lifetime of that obligation.
Article 81
Data quality and application of approximations, including
case-by-case approaches, for technical provisions
Member States shall ensure that insurance and reinsurance
undertakings have internal processes and procedures in place to
ensure the appropriateness, completeness and accuracy of the data
used in the calculation of their technical provisions.
Where, in specific circumstances, insurance and reinsurance
undertakings have insufficient data of appropriate quality to apply
a reliable actuarial method to a set or subset of their insurance
and reinsurance obligations, or amounts recoverable from reinsurance
contracts and special purpose vehicles, appropriate approximations,
including case-by-case approaches, may be used in the calculation of
the
best
estimate.
Article 82
Comparison against experience
Insurance and reinsurance undertakings shall have processes and
procedures in place to ensure that
best estimates, and the
assumptions underlying the calculation of
best estimates, are
regularly compared against experience.
Where the comparison identifies systematic deviation between
experience and the
best
estimate
calculations of insurance or reinsurance undertakings, the
undertaking concerned shall make
appropriate adjustments
to the actuarial methods being used or the assumptions being made.
Article 85
Implementing measures
The Commission shall adopt implementing measures laying down the
following:
(a) actuarial and statistical methodologies to calculate the
best
estimate referred to in Article 76(2);
(b) the relevant risk-free interest rate term structure to be used
to calculate the
best estimate referred to in Article 76(2);
(c) the circumstances in which technical provisions shall be
calculated as a whole, or as a sum of a
best estimate and a risk
margin, and the methods to be used in the case where technical
provisions are calculated as a whole;
(d) the methods and assumptions to be used in the calculation of the
risk margin including the determination of the amount of eligible
own funds necessary to support the insurance and reinsurance
obligations and the calibration of the Cost-of-Capital rate;
(e) the lines of business on the basis of which insurance and
reinsurance obligations are to be segmented in order to calculate
technical provisions;
(f) the standards to be met with respect to ensuring the
appropriateness, completeness and accuracy of the data used in the
calculation of technical provisions, and the specific circumstances
in which it would be appropriate to use approximations, including
case-by-case approaches, to calculate the
best estimate;
(g) the methodologies to be used when calculating the counterparty
default adjustment referred to in Article 80 designed to capture
expected losses due to default of the counterparty;
(h) where necessary, simplified methods and techniques to calculate
technical provisions, in order to ensure the actuarial and
statistical methodologies referred to in points (a) and (d) are
proportionate to the nature, scale and complexity of the risks
supported by insurance and reinsurance undertakings including
captive insurance and reinsurance undertakings.
Those measures designed to amend non-essential elements of this
Directive, by supplementing it, shall be adopted in accordance with
the regulatory procedure with scrutiny referred to in of Article
304(3).
Consultation Paper No. 26
Draft CEIOPS Advice for
Level 2 Implementing Measures on Solvency II:
Technical provisions - Elements of actuarial and statistical
methodologies for the calculation of the best estimate
Solvency
ii Best Estimate - CEIOPS Consultation Paper No.
26
Consultation Paper No. 41
Draft CEIOPS’
Advice for Level 2 Implementing Measures on Solvency II:
Technical
Provisions - Article 85 c, Circumstances in which technical
provisions shall be calculated as a whole
CEIOPS Consultation Paper No. 41 - Level 2, Circumstances in which
technical provisions shall be calculated as a whole
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