A guide to the requirement.

Solvency II is a comprehensive programme of regulatory requirements for insurers. One of the two financial requirements of Solvency II is the Solvency Capital Requirement (SCR).

The SCR is widely thought to have been implemented as a reaction to the $142bn bailout of American International Group, better known as AIG, which had gambled on selling credit default swaps on collateralised debt obligations (CDOs) and lost that bet in 2008. The EU Solvency II rules, which were eventually introduced on 1 January 2016, were set akin to the regulation of a bank and based on short-term liquidity requirements (banks take short-term deposits and lend over the long-term). The SCR calculation is therefore rather at odds with the position of a typical life insurer with long-term liabilities (annuities) that they match with long-term assets. 

The SCR is the amount of funds that insurance and reinsurance companies are required to hold under the European Union’s Solvency II directive in order to have 99.5% confidence they could survive the most extreme expected losses over the course of a year. The SCR charge for property was set to 25%, which was based on the fall in UK capital values in 2008 (-25.9%). However, the liabilities of life insurers have much longer durations than one year, so what would happen if we undertook the analysis over five years?

The standard deviation of annual capital growth on the MSCI UK Index (1981-2021) is 8.8%. A 25% fall in the index therefore constitutes 3.3 standard deviations, which has a likelihood of 0.05% (assuming that the series is normally distributed). Over a 5-year period, the volatility would be expected to be 3.9% (8.8%*SQRT[1/5]). The fall of -26.6% from 2007 to 2012, equivalent to -6.0% pa, therefore constitutes 2.2 standard deviations, which has a likelihood of 1.44%.

Changing the measurement period from one to five years would not therefore materially affect the SCR and may even increase it slightly.