On 28th July 2014 the European Commission circulated an updated draft of the Solvency II Delegated Acts to Member States. The latest draft of the Delegated Acts includes a change to the standard formula operational risk module for unit linked products. As in previous drafts, the operational risk capital for unit linked business under the standard formula had been set at 25% of unit linked expenses. However, the definition of unit linked expenses in the latest draft Delegated Acts is:
• “Amount of expenses incurred during the previous 12 months in respect of life insurance contracts where the investment risk is borne by policyholders.”
This compares with the definition of unit linked expenses in the technical specification released by EIOPA in April 2014 for the purpose of completing stress tests which was:
• “Amount of expenses incurred during the previous 12 months in respect of life insurance where the investment risk is borne by the policyholders, excluding acquisition expenses.”
So, based on the latest draft Delegated Acts, companies writing unit linked business will now be required to include related acquisition expenses (including initial commission) in the operational risk capital calculation when using the standard formula. This change may result in a significant increase to the operational risk capital and thus the SCR for certain companies.
Acquisition expenses are defined in EIOPA Consultation paper on the proposal for Guidelines on Solvency II relating to Pillar 1 requirements dated 2 June 2014 as:
“2.52 Acquisition expenses include expenses which can be identified at the level of individual insurance contract and have been incurred because the undertaking has issued that particular contract. These are commission costs, costs of selling, underwriting and initiating an insurance contract that has been issued.”
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