Home Uncategorized Aon Benfield recommends internal models to boost reinsurance value under Solvency II

Aon Benfield recommends internal models to boost reinsurance value under Solvency II

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Aon Benfield, the world’s premier reinsurance intermediary and capital advisor, today launches a new report that examines the many different facets of the Solvency II framework ahead of the scheduled 2012 inception of the protocol.

The 63-page study, Solvency II for Reinsurance Mangers, provides a comprehensive overview of the European Union regime from a variety of perspectives – including those of rating agencies and captives – that will help reinsurance managers in their business preparations for Solvency II.

The study reveals how Solvency II will boost the importance of reinsurance by proving its value as an efficient form of capital, which can be demonstrated through a partial internal model. As the regulation puts further pressure on capital, buying reinsurance should no longer be a budget matter, but be based on sound risk and capital considerations. A partial internal model, for example using Aon Benfield’s ReMetrica and S2Metrica software, can increase the benefit of reinsurance within the non-life capital requirement by 25% and even more in certain cases.

Key themes and recommendations for reinsurance managers include:

• A partial internal model is crucial to obtain a more accurate picture of premium risk. The Standard Formula does not provide adequate credit for non-proportional reinsurance on casualty lines. In particular, the existing proposal in QIS 5 penalises larger insurers by providing no noticeable benefit from purchasing non-proportional reinsurance while an internal model would provide that advantage;

• Catastrophe risk will become a main driver for capital with the benchmark to withstand a 1 in 200 year event. However the methodology for the standardised scenarios for catastrophe modelling overlooks key data features like location granularity, occupancy (residential versus commercial versus industrial), limits or deductibles;

• For insurers with a well-diversified portfolio of reinsurers, counterparty default capital requirement – which accounts for approximately 5-10% of total required capital – can be 40% lower than a portfolio of less diversified counterparties.

Marc Beckers, head of EMEA Analytics at Aon Benfield, said: “In a Solvency II world, reinsurance is the most obvious place to start with an internal model. Under the current proposal, the benefit of an internal model compared to the Standard Formula is largest for reinsurance, particularly for non-proportional property cat and casualty reinsurance. Rather than looking to raise capital to fund any shortfall in net assets, companies may consider reinsurance options to reduce their capital requirement. Furthermore, volatility of earnings will increase as a result of fair value accounting (Solvency II and IFRS Phase II) and reinsurance is the cheapest and most efficient way to reduce this volatility.”