UK life insurers report major changes in how they are having to assess and measure longevity risk within Solvency II internal models, according to research by Towers Watson. In its annual study of risk calibration methodologies*, which received responses from the majority of UK life insurers seeking internal model approval, Towers Watson found that six firms strengthened their longevity risk calibrations by at least 20% |
Tim Wilkins, a senior consultant at Towers Watson, said: “The approval process for Solvency II has been very painful for insurers and the survey results show some have had to make major changes to their models, but the next step for those who do get across the line in January 2016 will be just as critical as they begin to embed and apply their internal models.”
Together with longevity risk, credit risk is seen as presenting the biggest modelling and validation challenges. For credit risk, one notable change observed since last year’s survey is a reduction in the number of firms reporting separate stresses for spread risk and default and migration risk.
Tim Wilkins commented: “This indicates a trend towards creating integrated credit models for these components, but after speaking to a number of firms we see some also considering how to extend credit models to cover illiquid assets without creating excessive complexity. We have also seen some strengthening of models since the survey was completed.”
Almost 60% of firms in the survey said they intend to use a matching adjustment (MA) when valuing their annuity businesses.
Corporate bonds dominate MA portfolios, although some firms have significant allocations to more illiquid assets, including equity release mortgages and various types of loan. These firms appear to be gaining a MA benefit from the higher yields that are typical for these assets, although the corresponding capital requirements have to be considered.
The changes in methodologies and calibration of risk models seen since the previous year’s survey show how much work has been required by UK life insurers going through internal model approval processes (IMAP). This year, only half of the firms responding to the study are currently in IMAP as some applications have been deferred until 2016 or beyond.
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