After the first South African Quantitative Impact Study (SA QIS1), a need was identified to have a separate sub-module for Retrenchment risk within the Solvency Capital Requirement (SCR).  As a result, a retrenchment rate shock equal to a permanent 50% increase in retrenchment inception rates relative to best estimate assumptions, was included from SA QIS2 onwards.

The calibration for this stress was done at a very high and pragmatic level. This was given the relatively small exposure in the SA insurance industry to Retrenchment risk overall, and the relatively small part of the industry risk capital represented by the retrenchment risk sub-module. At the time of the SA QIS 2 report, retrenchment risk represented less than 5% of the SCR for the insurers who completed the retrenchment risk calculation. In addition, not a lot of statistically credible data on South African retrenchment claims was available at the time of calibration.

Although retrenchment risk is not one of the larger risks across the industry as a whole, it may be significant for some insurers. However, the QIS2 and QIS3 task groups recommended retaining Retrenchment risk as a separate sub-module. It is included in the SCR standard formula at the original calibration of a permanent 50% increase in retrenchment inception rates relative to best estimate assumptions. Importantly, the Solvency Asset and Management (SAM) Steering Committee task group noted that those insurers for whom retrenchment is a significant risk should address this via a partial internal model or the Own Risk and Solvency Assessment (ORSA).

As part of its SAM Phase II subcommittee work, the Actuarial Society of South Africa is currently focusing on retrenchment risk. The existence of a task group dedicated to this, indicates the need to relook the original calibration.

The current calibration is limited in that it does not reflect the cyclical nature of retrenchment and does not allow for catastrophic events (resulting from a concentration of risk). These limitations could result in retrenchment risk being understated within the SCR.

Concentration & Catastrophe

The current SCR for retrenchment risk captures the risk of long-term retrenchment assumptions being too low, but it does not capture a short-term catastrophe (‘CAT’) type event (similar to the CAT risk that is calculated for mortality and morbidity risks). This is particularly relevant to products with shorter contract boundaries.

Allowing for CAT risk is important because retrenchment events tend to be catastrophe-like – every few years retrenchment rates spike for some reason or another. These increases may be concentrated in some areas (geographical or industry) more than others, leaving some insurers more vulnerable than others.

Consider the COVID-19 pandemic as an example. While a lot of attention was on mortality risk, we have seen short-term retrenchment rates increase substantially for a number of our clients. The changing landscape from ESG initiatives may also result in industry specific retrenchments. This suggests the need for a retrenchment CAT risk component in the standard formula, to capture these ad hoc, possibly short term, increases in retrenchment risk going forward.

Cyclicality

The current calculation does not reflect the cyclicality of retrenchment risk. Following QIS2, some insurers were of the opinion that the 50% increase is not onerous enough. The view was that the increase might well be higher, but for a shorter period only (i.e. not a permanent increase as is currently being assumed in the retrenchment risk calculation).