The COVID-19 pandemic brought renewed attention to the appropriateness of the SCR standard formula. This is an excellent time to apply the magnifying glass to how the standard formulae for the various risks were calibrated.
In this series, we will investigate selected SCR sub-modules including the history behind the calibration, the risks that were excluded from the calibration, and potential shortcomings as a result. PART I covers mortality risk. Look out for future articles in this series on other sub-modules.
The current Prudential Authority (PA) Financial Soundness for Insurers (FSI) solvency capital requirement (SCR) formula for mortality risk does not allow for mortality fluctuation risk and variation of the stress by the number of lives assured. Potential diversification benefits on larger volumes of business, or lack of diversification benefits on smaller volumes of business, are therefore not taken account of when the mortality stress (15% increase in the long-term mortality assumptions) is applied. It should also be kept in mind that the 15% was adopted from the UK Solvency II calibration and not calibrated to the South African market specifically.
In evaluating the appropriateness of the mortality risk standard formula, insurers should be aware that the current standard formula does not allow for mortality fluctuation risk. This is particularly relevant for smaller insurers where fluctuation is typically more significant than for larger insurers. The SCR may therefore be understated for smaller insurers, especially those without reinsurance agreements in place.
Reference & further reading: This article uses information from the SAM steering committee Position Paper 66 – Life SCR - Mortality Risk (fsca.co.za)
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