The Standard Formula (SF) aims to capture the risk that an average European (re)insurance company is exposed to. The SF may not be appropriate for all (re)insurance companies, but the majority of European insurers currently uses it. In this article, Milliman’s Steven Hooghwerff, Sinéad Clarke, and Roel van der Kamp provide a short overview of the SF’s structure. They also present a suggested framework and worked examples, and discusses challenges and pitfalls to be considered.
The assessment of the appropriateness of the standard formula is a key part of the Own Risk and Solvency Assessment (ORSA) process under Solvency II. As part of this assessment, (re)insurers must identify any material deviations in risk profile compared with the assumptions underlying the standard formula. This briefing note by Milliman’s Andrew Kay and Sinéad Clarke outlines what is expected under this assessment, including the key challenges such as the treatment of risks that are not reflected in the standard formula, the qualitative assessment, and what is required if a material deviation is identified.
We previously published the results of our survey looking at how prepared Irish companies are in relation to assessing the appropriateness of the Solvency II Standard Formula for their risk profiles. One interesting finding was that almost half of high/medium-high companies in the survey, as assessed under the Central Bank of Ireland’s risk rating system, the Probability Risk and Impact SysteM (PRISM), said they were not intending to include an assessment of the appropriateness of the Standard Formula parameters in their 2015 Own Risk and Solvency Assessments (ORSAs) or Forward-Looking Assessments of Risk (FLAORs) as the ORSA is known during the preparatory phase in lead up to Solvency II.
The European Insurance and Occupational Pensions Authority (EIOPA) paper on the background to the calibration of the Standard Formula is of particular interest in making such an assessment. Key calibration assumptions include:
• The equity portfolio is well diversified and there is no adverse exposure to a rise in equities
• The portfolio of liability benefits is well diversified in terms of applying the underwriting risk stresses
• There is no inflation risk on insured benefits
• Concentration risk doesn’t capture geographic or sector diversification