EIOPA Study Examines Internal Model Market and Credit Risks Under SII
EIOPA published a report presenting the results of its yearly study on the internal modeling of market and credit risks under the Solvency II Directive, also known as SII. This year's study includes new elements in the form of sustainability considerations, analysis of dependency structures, and effects of COVID-19 crisis on the modeling of market and credit risks. The overall results continue to show significant variations in asset model outputs, which could be partly attributable to model and business specificities already known by the relevant national competent authorities, but also indicate a certain need for further supervisory scrutiny.
The report summarizes key findings from the market and credit risk comparative study, or MCRCS, undertaken in 2020 based on year-end 2019 data and provides an insight into the supervisory initiatives being taken following the conclusions of this study. Market and credit risks contribute significantly to the solvency capital requirement of insurance undertakings and are of material importance for the majority of internal model undertakings. The 21 participants from 8 different member states cover nearly 100% of the EUR investments held by all undertakings with an approved internal model covering market and credit risks in the European Economic Area (excluding UK). The study based on simplified asset-liability-portfolios also puts focus on the analysis of interest rate "down" movements, more relevant for liabilities. Furthermore, to achieve a more holistic picture, effects from the undertakings’ approach to the volatility adjustment (VA) are taken into account in the analysis of the portfolios. The study results, tools, and experience will be feeding into the Supervisory Review Process on internal models and vice versa.
The results of the analysis show that credit risk charges for sovereign bonds across groups of modeling approaches show relatively low variation for bonds issued by Germany, Netherlands, Austria, Belgium, and France. The variation is greater for the bonds issued by Ireland, Portugal Spain, and Italy. These results are influenced by firms which show zero or low credit risk shocks across the instruments. Additionally, credit risk charges for corporate bonds are generally higher for bonds with lower credit ratings and the variation increases materially with worsening credit quality. The variation becomes substantial for BB-rated bonds. This demonstrates the variety of modeling assumptions being made by firms, particularly for low-rated bonds. With respect to equity risk, undertakings show less variation in the risk charges for major equity indices compared to risk charges applied to the strategic equity participations. Risk charges applied to the five real estate benchmark investments vary to a larger extent compared to equity. Additionally, for the real estate category, model calibrations tend to emphasize more the risk profile of the undertakings’ actual investment portfolio and less on publicly available indices.
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Keywords: Europe, EU, Insurance, Market Study, Credit Risk, Solvency II, Supervisory Review Process, COVID-19, SCR, Internal Controls, Solvency Capital Requirements, EIOPA
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