There is little doubt that Solvency II will have a significant impact on many aspects of how insurance companies operate in the future. Much has been written already about this and it remains fertile ground for discussion as debate continues over many details of the regulation.
This report brings some of the implications of Solvency II alive by:
• Creating a simplified but realistic UK ‘Model Life Company’ (MLC)
• Imagining a world where Solvency II had been implemented before the global financial crisis (GFC)
This report combines modelling techniques refined in industries outside the financial sector with significant advances in computing technology to gain insights that would previously have been out of reach. This report offers an illustration of how advanced modelling approaches can expand the body of actionable information to support management decision-making.
Milliman’s Elliot Varnell, Jeremy Kent, Russell Ward, Russell Osman, and Andrew Gilchrist published a new paper on InsuranceERM.com assessing the implementation of management actions (subscription) to reduce technical provisions and capital charges by firms as well as their desire to carry over credit previously taken for these actions into Solvency II.
Here is an excerpt from the paper discussing the modelling of management actions:
In order to take credit for management actions, the actions need to be reflected in the model used to calculate the best estimate. This can be challenging where actions depend on the solvency of the insurer, creating a circular logic in the calculations which need sophisticated techniques to solve or model simplifications to remove the circularity.
There may be a number of actions available and the action, or actions, taken will depend upon the circumstances applying at the time. Some modelled management actions may not be undertaken in circumstances where the model assumes they will be taken. In this case, the board will need to consider whether it remains appropriate to take credit for that action and regulators may well seek justification from firms wishing to continue to take credit for such actions.
There may also be some non-modelled actions which will be available to the insurer in adverse circumstances. For example, a mutual insurer will need to reduce, or remove, discretionary policyholder benefits in significantly adverse circumstances to meet minimum benefits guaranteed to all policyholders. If the mutual is currently well capitalised, then it is unlikely to be modelling such an action, because the consequential reduction in liabilities and capital would be small. That is, the implicit margin included in the reserves by not modelling that action would be small. However, if capital becomes constrained, then the implicit margin would increase and it is likely the model would be enhanced to include that action.
For more insight about management actions and how they provide a crucial link between Pillar I and Pillar II of Solvency II, read this research paper on dynamic management actions.