Shortfalls exist in Solvency II standard capital assessment formula

Non-proportional (re)insurers can improve capital assessment by using a partial internal calculation formula under Solvency II, Swiss Re said.
Under Solvency II, in order for insurers to calculate how much capital they need to support the business they write, assets and liabilities have to be valued using a market consistent view, Swiss Re said.
Based on its own circumstances, each (re)insurance company must decide which approach to use for its calculation (the Solvency II Standard Formula, a partial internal model or a full-internal model).
Under the Standard Formula, companies’ risks are assessed based on pre-determined market parameters, and entity-specific parameters are only partially taken into account, the release explained.
Quantitative impact studies show that proportional reinsurance contracts are fully reflected in the Standard Formula. But for non-proportional, non-life reinsurance (excess-of-loss and stop-loss treaties, for example), the Standard Formula typically fails to recognise the economic benefits of these structures, Swiss Re said.
“As a result, non-proportional, non-life reinsurance is not afforded the appropriate capital benefit under Solvency II,” Swiss Re said.
“A better alternative for insurers could be to use partial or full internal models to produce a more accurate estimate of the required capital.”
An internal model is based on the company’s own risk landscape. However, it requires a major effort to develop.
“As a pragmatic alternative, a partial internal model, combining aspects of both the Standard Formula and the internal model, may improve the assessment based on the Standard Formula in a cost-efficient manner.”