
ANALYSIS

Introduction
The SCR coverage ratio is considered to be the new measure of an insurer’s capital strength under Solvency II. Like all headline metrics it serves a useful purpose, but does not tell the whole story. Understanding the underlying assumptions and drivers of the ratio can help to assess both the strength of an insurer’s capital and the reliability of the measure as a whole.Capital cover
Regulators expect firms to have at least as much capital as their Solvency Capital Requirement (SCR). The SCR represents the maximum loss over the next year at a confidence level of 99.5% (or 1-in-200 years). This means that for a firm with an SCR of £100m, there is a 99.5% chance that the loss over the next year will not be more than the SCR. The SCR coverage ratio is the ratio of capital that insurers have available to support their SCR (the “eligible own funds”) to the SCR. It provides a measure of the buffers a firm has in place to withstand balance sheet volatility while still holding enough capital to comply with the regulatory requirement. The following graph shows the 20 least well-capitalised firms out of 100 of the top non-life insurers across the UK and Ireland[1]. [caption id="attachment_1587734" align="aligncenter" width="1449"]
Impact of an MCR loss
The MCR is calculated using a simple formula linked to the amount and type of business written. It is intended to represent the maximum loss over the next year at a confidence of 85% (or 1-in-6.67 years). The formula for calculating the MCR differs from the SCR calculation in a number of ways:- it is much less complex than the SCR calculation;
- it makes no allowance for any diversification; and
- it is retrospective (based on prior year measures), whereas the SCR is prospective.

- material exposures to catastrophe risks or non-insurance risks (which increase the SCR but are not considered in the MCR calculation); and/or
- writing fewer lines of business – which results in less diversification benefit (diversification reduces the SCR but is not allowed for in the MCR).
Conclusion
The market continues to explore the Solvency II metrics and in particular the SCR coverage ratio as the key headline figure of an insurer’s capital strength. Gaining a better understanding of the robustness of this metric is crucial to make sense of Solvency II and the usefulness of the Solvency II public disclosures. — The author is a Partner at LCP’s Insurance Consulting practice. Views expressed are the author’s own. The article is based on analysis conducted by LCP. The report, Solvency ll reporting 2017, can be accessed here. Notes: [1] Note that Exeter Friendly Society’s Eligible Own Funds are limited to the value of their SCR due to the Solvency II rules for ring-fenced funds. ** The name of the specific entity used for each group is listed in the report. — Find out more about Solvency II Wire Data and the information available to premium subscribers here: Solvency II Wire Data.