The Pfandbrief 2011 | 2012

Quo vadis? The regulatory treatment of Pfandbriefe under Solvency II
The calculation of capital requirements under Solvency II
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Under the regulations, the Solvency Capital Requirement (SCR) is the amount of capital that
undertakings will be required to hold in order to carry out regulated operations. The Minimum
Capital Requirement (MCR) defines the lowest level at which a business may maintain operations.
If capital falls below this level, the undertaking may not be allowed to take on new business.
If necessary, an undertaking’s authorisation to operate may also be revoked. A ladder
of supervisory intervention exists between the SCR and MCR which establishes supervisory
powers on the basis of an insurer’s solvency situation. The ladder of supervisory intervention
is intended to ensure that insurers receive equal treatment. This catalogue of measures also
makes it possible for insurers to predict what action will be taken by the supervisory authorities.
The further an insurer falls below the SCR, the more far-reaching the supervisory authority’s
powers become.
The regulatory capital requirements under the first pillar are calculated using a riskoriented
approach. Specifically, this means that insurers must include in the calculation all
relevant risks to which they are exposed by their operations. The assumption for all types of
risk is that the assumed loss will not exceed a probability of 99.5%. The risks calculated are
then combined using a correlation matrix. Since it is correctly assumed that there is not a
positive linear relationship between the various risks, the correlation coefficients are lower
than 100%. In other words, the risks will not materialise in full at the same time.
In addition to the technical risks in the life, health and non-life segments, insurers must
also include the market and counterparty risks in the calculation. Market risk consists, in turn,
of six sub-risks: interest rate risk, equity risk, property risk, spread risk, foreign exchange risk
and concentration risk 1) . An insurer’s assets must be allocated to the corresponding sub-risks.
The interest rate risk, spread risk and concentration risk are of particular significance for
Pfandbriefe and covered bonds.
Interest rate risk
The interest rate risk reflects the risk that the risk-free market interest rate will change and
thus lead to a decrease or an increase in the market values of fixed-income assets on both
sides of the balance sheet. The greater the difference in duration between the interest-bearing
assets on the asset side and the liabilities on the liabilities side, the greater the insurer’s interest
rate risk. For this reason there is no fixed capital requirement for Pfandbriefe or other
fixed-income securities resulting from the interest rate risk. If the duration on the asset and
liabilities sides is exactly the same, the capital requirement resulting from the interest rate risk
may even in principal be eliminated. It is particularly important for life insurers to close this
duration gap as they typically have relatively long-term liabilities in their portfolios.
1)
In QIS5, an illiquidity premium risk also had to be included in the calculation. This risk related exclusively to an insurer’s
liabilities. At the time of going to press, it was not certain whether the illiquidity premium risk would actually be established
as part of the standard model.