On December 4, the European Insurance and Occupational Pensions Authority (EIOPA) unveiled the long-awaited findings of its extensive comparative study on non-life underwriting risk in internal models. Spanning the years 2016 to 2020, the report provides a comprehensive overview of how internal models address this critical component.
Non-life underwriting risk plays a significant role in setting the Solvency Capital Ratio (SCR) of insurance undertakings and the study enables EIOPA to understand different approaches taken across the insurance sector. This wider analysis of internal models provides valuable insight into the European non-life insurance sector. Insurers should be encouraged to look into the findings in detailed – whether internal model users or not – and compare these to their own models and processes. Aside from this, the report also delves deeper into the specifics of internal model usage within the Credit & Suretyship line of business. This is our primary interest here and is discussed in more detail below.
Methodology and Collaboration
The report’s focus spans critical areas, including capital intensity, measures for premium risk, comparison with the standard formula approach, and the impact of factors like inflation and diversification. Despite differing approaches, the findings reveal no discernible drift toward high or low capital intensities for different elements of internal models, indicating a degree of consistency within the non-life insurance industry.
EIOPA’s analysis looks closely at the relationship between Internal Models and the Standard Formula. Those who have followed the ongoing Solvency II review will know that ICISA has raised the value of the internal model as a priority issue with decision makers. This is in response to efforts to get internal model users to refer more closely to the standard formula and includes provisions to require internal model firms to also report standard formula SCR calculations to supervisors periodically.
ICISA has highlighted that the internal model is the most appropriate measure of the risk an undertaking is exposed to, and its integrity must be maintained. Internal models are particularly beneficial for non-standard (re)insurers and are approved for use by the relevant national supervisor. The internal model is by definition a better reflection of a Group’s specific risks than the standard formula can be, and this is a foundational element within the Solvency II framework in Europe. Reports such as this one looking at the appropriateness of the internal model or specific elements within it, are important to demonstrate that they remain fit for purpose.
Credit and Suretyship Deep Dive
Part of the study is dedicated to the C&S sector, driven by its unique characteristics. EIOPA proactively sought to understand whether the SCR for this sector is sufficient and whether a level playing field exists across the sector. This proactive approach contributes to a better overall understanding of the C&S sector, assuring regulators and stakeholders of the regulator’s commitment to comprehensively assessing specific sectors within the insurance industry.
EIOPA’s findings indicate that there are no major differences in capital requirements for C&S internal model insurers. Any observed variations are attributed to differences in risk profiles, raising no expressed concerns about regulatory fairness or appropriateness. Despite different definitions for key elements, such as premium and reserve risk, across the C&S industry, outcomes of the models remain consistent.
EIOPA’s report also sheds light on the impact of catastrophe risk on the C&S sector, emphasizing insurers’ proactive management of exposures by adjusting levels of cover based on the economic performance of buyers. Key to understanding EIOPA’s view on this topic lies in the comment, “If credit insurers were not to reduce cover in the event of a pending crisis, they might incur losses that they could find difficult to absorb.” This may seem obvious to those within the sector, but this element is not well understood outside the sector. It is both important and beneficial to our sector that regulators gain a better understanding of these kinds of normal risk management mechanisms used in our sector.
This has historically been an area where misunderstanding has arisen and can lead to distrust of the sector. This also relates to ongoing discussions about the impact of decisions to reduce or withdraw cover on the performance of the real economy and policymakers efforts to address this. As a result, opportunities such as this report, which build greater understanding among policymakers and regulators about our sector are to be welcomed. By examining this question from the perspective of internal models, EIOPA contributes to a nuanced understanding of how C&S insurers address changes in risk and the potential impact on capital requirements.
Looking to the future
EIOPA’s comprehensive report significantly contributes to our understanding of internal models within the C&S lines and the non-life insurance sector as a whole. With no major disparities identified in capital requirements, the report serves as a valuable resource for internal model users, standard formula undertakings, as well as stakeholders outside the sector. However, it is also important that our industry understands the perspective of regulators and policymakers. This includes helping to build awareness about the ways in which the industry makes decisions about risk and addressing changes to cover levels. This is a conversation that ICISA has engaged in during the last number of years and will continue to do so in 2024.
These insights pave the way for informed discussions and collaborative efforts to enhance industry understanding and regulatory effectiveness. As the insurance landscape evolves, the regulator’s proactive approach to sector-specific studies ensures ongoing scrutiny and adaptation to changing dynamics, fostering a resilient and well-regulated insurance market.