Where a company purchases an Adverse Development Cover ADC ie a reinsurance

Where a company purchases an adverse development

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Where a company purchases an Adverse Development Cover (“ADC”) – i.e. a reinsurance treaty that limits the deterioration of its reserves – it is not allowed to take credit for this risk mitigation in the Standard Formula. (This point has been argued at length with national supervisory authorities and EIOPA; although it has not been officially communicated and there may be some companies out there still taking credit for ADCs within the Premium and reserve Risk module of the Standard Formula.) It is a very straightforward exercise to calculate the 1-in-200 reserve risk shock and apply the terms of the ADC to calculate the ADC recovery in this scenario, effectively capping reserve risk, before aggregating with Premium Risk, so there is no reason why not to be able to take full credit for these RMTs. Likewise, where a company has an Aggregate Stop Loss which protects against poor performance of the book as a whole – effectively capping the loss ratio – it may not be allowed to take full credit for this risk mitigation in the Premium and Reserve Risk module of the Standard Formula. While some NSAs advise and/or require Companies to have these risk mitigation techniques, some others deter them from having them altogether. These are two very important points; companies are being deterred from buying these important risk mitigation tools because they may not get adequate recognition of solvency relief. They are important risk mitigation tools and help preserve the stability of the sector. Moreover, it is mainly Companies under the Template comments 9/66
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Comments Template on Discussion Paper on the review of specific items in the Solvency II Delegated Regulation Deadline 3 March 2017 23:59 CET standard formula who would benefit most by these instruments and therefore implementing a (partial) internal model is not a solution. Q4.2 Definition of the RMT with respect to rolling FX hedges: The RMT is usually defined as a long term strategy to mitigate the FX exposure with a time horizon which is typically longer than 12 months (e.g. « no unhedged FX exposure »). The instruments used for the implementation of the RMT are typically short term (1-3 Month) FX forward contracts, which are regularly adjusted and rolled in line with the corresponding long term strategy. Typically, the maturity of the instruments used and the frequency of the hedge adjustments are shorter than 3 months to ensure proper hedge efficiency and to minimize the hedge error / basis risk. This RMT is widely used throughout Europe by insurance companies and asset managers. If the term « risk mitigation techniques » is not interpreted as strategy (for example « no unhedged FX exposure ») but as the instruments used for the implementation of a given strategy (e.g. short term FX forward contracts), then the requirements of Article 209 §3b would not be met. According to this article, the replacement of the RMT should not be more often than every 3 months, and the replacement frequency and the maturity / remaining lifetime of the instruments would necessarily be at least 3 months when acquired.
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