In this series, we apply the magnifying glass to how the standard formulae for selected SCR sub-modules were calibrated. We investigate the history behind the calibration, the risks that were excluded from the calibration, and potential shortcomings as a result.
In PART I we covered mortality risk1, PART II considers retrenchment risk. Look out for future articles in this series on other sub-modules.
Currently, retrenchment risk is calculated by permanently increasing retrenchment rates by 50% relative to best estimate assumptions. This calibration was however done at a very high and pragmatic level. It is suggested that insurers with significant exposure to retrenchment risk, should evaluate whether the standard formula gives an adequate estimate of retrenchment risk. This can be done using internal models as part of the ORSA process. Some limitations of the current calibration are that it neither reflects the cyclical nature of retrenchment, nor does it make allowance for catastrophic events.
Conclusion: The current standard formula may underestimate retrenchment risk. This is because no allowance is made for catastrophe risk or the cyclical nature of retrenchments. These limitations may have substantial short-term impacts. Insurers that are more exposed to retrenchment risks should consider evaluating its retrenchment risk via internal modelling and include a consideration for this in the ORSA.
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1 PART I of the series can be assessed here: Mortality Risk Calibration, Shortcomings & Risks Not Considered.