QIS4: significant improvements, but the main risk for life insurance is not taken into account in the standard formula

In its response to the CEIOPS consultation on the preliminary technical specifications for the fourth quantitative impact survey (QIS4), EDHEC argues that the main risk faced by life insurance companies is not taken into account in the standard formula.

Author(s):

Samuel Sender

Research Associate with the EDHEC Risk and Asset Management Research Centre

This risk is that following market (or other significant) losses, a wave of surrenders leaves shareholders bearing the entirety of losses. This is the phenomenon that led to such bankruptcies as that of Executive Life, where losses made public by rating agencies and the media triggered a wave of surrenders and bankruptcy-even though the losses alone were thought bearable for some time. In this paper, we argue that such a combined risk can be taken into account only in a scenario in which high levels of surrenders are combined with market losses, and that market losses alone merely added to surrenders alone may not suggest any need for shareholder capital. We also argue that QIS4 has resulted in substantial practical improvements to the standard formula-in particular, guidelines as well as proxies that will allow the participation of smaller companies or of less strategic lines of business. These improvements are in line with our past recommendations for clear guidelines, as in previous works we pointed out that diverging interpretations of the necessary calculations could lead to significant differences in capital requirements as well as to an inability to compare results across insurance companies and countries. The recognition of geographical diversification within life and non-life lines of business is likewise a great improvement.

Type: Position paper
Date: le 19/02/2008
Research Cluster : Finance

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