Group Level SST
Philipp Keller, Federal Office of Private Insurance
Basle, 19 May 2006
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Contents
• Group Solvency Requirements in Switzerland
• The Reason for the Choice of the Swiss Approach
• Discussion of the Swiss Approach
• Summary and Challenges
2
Group Requirements in Switzerland
• As of 1 January 2006, all supervised groups and conglomerates
in Switzerland need to satisfy risk based capital requirements
 group level SST
• For the group level SST, groups and conglomerates need to use
internal models satisfying SST principles
• Groups and conglomerates have to have internal models
approved by FOPI by 2008 to determine group level SST for
year 2008
• FOPI supervises approx. 10 groups and 70 subsidiaries of
insurance groups
• During 2006 and 2007, FOPI will meet monthly with all groups
involved in order to achieve market wide consistency in
implementation of SST requirements
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The Importance of Being Consistent
con·sis·tent (k&n-'sis-t&nt): marked by harmony, regularity,
or steady continuity : free from variation or contradiction
Merriam-Webster Online Dictionary
For FOPI, consistency between the requirements on a group and
on a subsidiary of a group is key
Without consistency,
Further objectives of FOPI:
• If requirements for groups and legal entities are
inconsistent, then in case of a parent company
owning subsidiaries it will experience the situation
of having two contradictory capital requirements:
One for the group and one for solo solvency
• groups will have to develop different models for
group level solvency requirements and for solo
level requirements for the different subsidiaries.
Different models will make embedding within
companies questionable
• a layer of economically irrelevant arbitrage
instruments will be developed to exploit
regulatory inconsistencies
• Assessing the risk situation of the
investment in major legal entities
(respectively sub-groups) of a
group is essential for competent
capital and risk management
• Future risk based capital
requirements in different
jurisdiction will necessitate either
the development of many standalong capital models or – preferably
– a group model able to capture
capital requirements of solo entities
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FOPI’s Approach: CRTI
A group is defined not only by its legal structure but also by its web of
intra-group capital and risk transfer instruments
CRTI: Capital and Risk
Transfer Instruments
CRTI Approach: Explicit
modeling of all relevant
CRTIs and taking into
account the legally
limited liability structure
Intra-group retrocession, contingent
capital issued and received, etc.
Fungible capital
Legal Entity 3
Parent Company
Market Value Margin
Legal Entity 1
Intra-Group Capital and Risk
Transfer Instruments:
• Intra-group
Retrocession
• Guarantees
• Participations
• Dividends
• Loans
Legal Entity 2
Group
• securitization of
future cash
flows / earnings
• Issuance of
• sale / liquidation
surplus notes
of a business
Intra Group Capital and Risk
Transfer Instruments can only
be considered if they are
legally binding and accepted
by the regulators involved
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Contents
• Group Solvency Requirements in Switzerland
• The Reason for the Choice of the Swiss Approach
• Discussion of the Swiss Approach
• Summary and Challenges
6
The Consolidated Approach
Group Test: Assumes unrestricted capital
transfer between the legal entities of the
group even if no formal capital and risk
transfer instruments are in place 
consolidated calculation
• For the solo test of a subsidiary of
a group to be consistent with a
group level consolidated
approach, capital flows to and
from the group need to be taken
into account, even if there are no
formal CRTI in place
• Group level diversification can
only be allocated exogenously to
the subsidiary
Solo Test: Assumes unrestricted capital
transfer in case of financial problems in the rest
of the group even if no formal capital and risk
transfer instruments are in place  group risk
• The consolidated approach might
be realistic if the economic
situation of a group is good.
However, in case of financial
distress, the assumptions likely
break down
Formal capital and risk transfer instruments
Assumed unrestricted capital transfer
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The CRTI Approach
Group Test: Assumes capital
transfer only via formal capital and
risk transfer instruments
• The CRTI approach for groups is
consistent with FOPI‘s solo solvency
test: Only formal CRTI are considered,
promises by the group to support a
subsidiary are not quantified within
the solo SST
• The CRTI approach requires modeling
of (major) legal entities, thereby
giving incentives for appropriate
capital management according to legal
entities economic capital needs
Solo Test: Assume capital transfer
only via formal capital and risk
transfer instruments
• The CRTI approach better captures
the options and strategy of a group in
case of financial distress than the
consolidated model
FOPI decided to choose the CRTI
approach for the group solvency test
Formal capital and risk transfer instruments
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Contents
• Group Solvency Requirements in Switzerland
• The Reason for the Choice of the Swiss Approach
• Discussion of the Swiss Approach
• Summary and Challenges
9
The CRTI Approach in a Nutshell 1
• The CRTI approach is methodologically consistent between the solo
and the group level solvency test
• For a parent company, the group level solvency requirement equals
the solo solvency requirement
• Owning a subsidiary is an asset
• The value of a subsidiary for the parent company is the economic
value (independent of regulatory or accounting conventions the
subsidiary is domiciled in)
• All relevant formal capital and risk transfer instruments have to be
modeled
• The risk of a subsidiary for the parent is defined as the potential
change of the economic value of the subsidiary within one year
• The option of a parent company to let a subsidiary go into run-off is
taken into account ( the value of a subsidiary for the parent
company is never less than 0 if there are no CRTI)
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The CRTI Approach in a Nutshell 2
• The parent company is assumed to be able to unlock economic value
of a subsidiary by selling it for its economic value
• However, remaining fungibility restrictions and liquidity need to be
modeled
• The group level model needs to be able to quantify the risk of the
different legal entities
• Simplifications can be acceptable (e.g. sub-consolidation instead
of modeling of all legal entities individually)
• But the group model needs to be able to map the major subgroups/legal entities
• Calculation of available funds with a view on double-gearing
• A parent company benefits endogenously from group level
diversification by taking into account the dependency structure
between the risks in its subsidiaries and the risks of the parent
company
• A subsidiary can benefit from group level diversification via taking
into account CRTIs between the subsidiary and other legal entities of
the group
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CRTI Approach Properties: Diversification
Capital and Risk Transfer Instruments allow downstreaming of group
level diversification to subsidiaries
With a guarantee from the
parent to the subsidiary
Without CRTI
SCR of the subsidiary is
reduced due to the
guarantee of the parent
RBC
SCR
Subsidiary
RBC
SCR
Parent
Risk bearing capital of the subsidiary is
unchanged since the economic value of the
guarantee is offset with the transaction cost
RBC
SCR
Subsidiary
SCR of the parent is increased
due to the risk that the
guarantee issued will be invoked
RBC
SCR
Parent
RBC of the parent is unchanged since the fee for
the guarantee paid by the subsidiary compensates
for the economic cost of the guarantee issued
The ‚allocation‘ of group level diversification to subsidiaries is not achieved via an
arbitrary, exogenous allocation method but endogenously via CRTI. This however only
works if CRTI are accepted across jurisdictions.
CRTIs are also the responsibility of the subsidiary, and the subsidiary needs to have
strategy for dealing with the situation if the CRTIs are revoked by the parent
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CRTI Approach Properties: Group’s Put Option
Subsidiary
A
L
Parent
A
Subsidiary
A
L
L
Parent
A
L
Adverse event
impacting the
subsidiary’s
balance sheet
Economic value
of subsidiary
Economic value of the
parent = Economic
value of own business +
economic value of
subsidiary
The economic
value of the
subsidiary is
negative
If no CRTI exist
between the parent
and the subsidiary, the
parent can exercise the
put option to let the
subsidiary go into
default
The CRTI approach takes into account the legally limited liability structure: The
model assumes that in case of financial distress, the group will not support a
subsidiary if no CRTI are in place
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CRTI Approach Properties: Risks
The risk of a subsidiary for the parent company is emanating from the change in
economic value of the subsidiary and – potentially – from CRTI which will be
invoked during a time horizon of one year
Adverse event impacting the
subsidiary’s balance sheet,
subsidiary is insolvent
Subsidiary
A
L
Subsidiary
A
L
Parent
A
L
Parent
A
No CRTI in place: The
subsidiary is in default, the
economic value of the subsidiary
for the parent is zero
L
A
L
Economic value of
subsidiary as asset
of the parent
Missing capital of subsidiary
is replenished with assets
from the parent
A
L
An insolvency protection
guarantee from the parent to
the subsidiary is in place:
The subsidiary is in run-off, the
value of the subsidiary for the
parent is zero and capital is
further depleted due to payout
of guarantee
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Contents
• Group Solvency Requirements in Switzerland
• The Reason for the Choice of the Swiss Approach
• Discussion of the Swiss Approach
• Summary and Challenges
15
CRTI Approach: Pros and Cons
Advantages of the CRTI Approach
Disadvantages of the Approach
• Group level model can (theoretically) be used for
different legal entities
• Existing groups’ internal models
often follow a full consolidation
approach
• Realistic assumptions
• Consistency between legal entity and group level
requirements
• Risks within different legal entities are captured
• The model can be changed easily to fullconsolidation assumptions (by adding unlimited
guarantees between the legal entities of the
group)
• The model can be implemented gradually, using
initially simplified approaches (e.g. subconsolidations). Then it can be gradually
enhanced to take explicitly those subsidiaries into
account where regulators require risk-based
solvency calculation
• Not as close to the Solvency 1
approach for groups as the
consolidated model
• More complex to model than
consolidated approach, more
expensive since group internal
capital and risk transfer instruments
do not cancel; legal entities need to
be mapped within the model
• CRTIs need to be formally accepted
across jurisdictions
• Allocation of diversification is endogenous within
the model (via capital and risk transfer
instruments) rather than exogenous as in the
consolidated approach)
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Restriction of Capital Mobility
Subsidiary
A
L
Parent
A
Subsidiary
A
L
L
Parent
A
L
Adverse event
impacting the
subsidiary’s
balance sheet
Assume that the local supervisor of the parent company restricts
capital mobility. This causes the default of the subsidiary although
the group as a whole could survive without problem if the parent
were allowed to inject capital in the subsidiary.
The acceptance of CRTI across jurisdictions is key to allow
subsidiaries to benefit potentially from being part of a group.
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Restriction of Capital Mobility
[Nationalism] is the last refuge of the scoundrel
Samuel Johnson
For FOPI, one of the main question for group supervision will be the
treatment of the policy holders in different jurisdictions in case of
financial distress of a group
• If local regulators consider only their own policy holders and restrict capital
fungibility in case of financial problems within a group, group diversification is
limited and policy holders in other jurisdictions might suffer
disproportionately  this situation leads to high premiums and inefficiencies
and might even lead to insolvent run-offs of distressed legal entities while
other legal entities of the group are still solvent
• If local regulators agree on capital flows also in case of financial distress, all
policy holders suffer (potentially) equally  this approach allows policy
holders to benefit from group diversification and more efficient allocation of
capital
FOPI strongly supports a harmonized treatment of policy
holders, irrespective of their nationality and a harmonization of
requirements of regulators
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