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The Actuary The magazine of the Institute & Faculty of Actuaries

Solvency II: standard formula will fit most UK firms but should not be default option

The standard formula should be a “good fit” for most UK insurance firms when complying with Solvency II, but firms still need to assess whether it is appropriate, an actuary has warned.


Stacks of banknotes © iStock
There are a number of risks to consider whether the standard formula is suitable to calculate solvency capital requirements. © iStock

Philip Simpson, principal at Milliman, said: “The emphasis is on the firm to demonstrate why the standard formula is suitable for risk exposures. It’s not simply an automatic default option.”

He said the Prudential Regulatory Authority (PRA) considered the standard formula the right option when calculating solvency capital requirements (SCR) under Solvency II, but there were cases where the standard formula might not be suitable. 

Speaking at a webinar Solvency II: The Final Frontier, organised by The Actuary, Simpson outlined a number of considerations to be considered when judging the appropriateness of the standard formula.

He said life firms should consider factors such as longevity risk and the firm’s own pension scheme risk and credit risk, including whether their assets are “significantly different from the typical portfolio of corporate bonds”. 

In addition, he said life firms needed to consider equity risk if they had a different equity portfolio with a different concentration risk from that assumed in the standard formula.

Simpson said non-life firms had to consider non-life underwriting risk “if the deviations are significant from the standard formula assumptions”. Catastrophe risk also needed to be taken into account.

He outlined a number of options if firms felt the standard formula was not suitable. 

He said firms should have regular dialogue with their PRA supervisor, including a review of their ORSA [Own Risk and Solvency Assessment], while considering future ORSAs and developing action plans.

“Will the difference between ORSA and the standard formula continue? For example, can the business model be made more standard formula-friendly?” he said.

In the longer term, Simpson said firms could consider implementing a partial internal model or “undertaking specific parameters”. 

Simpson said capital add-ons could be used as a temporary measure to generate an SCR, but “firms will be encouraged to consider a partial or a full internal model”.