Under Solvency II, insurers have a choice of which methods they use to assess risk and capital. While some insurers will opt for the Standard Formula as the basis for an economic view of their businesses, they should be aware of its limitations. The latest Swiss Re report, “Solvency II Standard Formula: Consideration of non-life reinsurance”, shows how the Standard Formula deals with non-proportional reinsurance.
The Solvency II framework is based on an economic assessment of insurers’ risk and capital. This will oblige insurers to apply economic principles when calculating their required and available regulatory capital. An economic principle-based approach means using market-consistent values for the assessment of the asset and liability side of an insurer’s balance sheet.
Based on their individual situation, each (re)insurance company must answer the question of whether to use the Solvency II Standard Formula or, alternatively, a partial internal model or a full internal model for this calculation. It is anticipated that some companies will rely on the Standard Formula once the Solvency II framework is implemented.
This focus report shows how the Standard Formula deals with reinsurance and points to a shortcoming in the Standard Formula. On the basis of illustrative calculations, the report shows that the Standard Formula only provides limited capital relief in contrast to the internal model for non-proportional reinsurance. For the reader interested in the technical background, some guidance on the examples is provided. Finally, the report suggests two possible ways of how to improve the Standard Formula in order to allow for a more adequate consideration of non-proportional reinsurance.
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