EIOPA has advised updating the natural catastrophe risk parameters in Solvency II every three to five years for climate change adaptation. In 2021, a methodological paper1 outlined the inclusion of climate impacts in these parameters, emphasising the need for regular reassessment. The process for integrating these changes remains in development, aiming for periodic updates. The 2023/2024 (re)assessment presents a public consultation on reassessing natural catastrophe risks in the standard formula.
Background
The European Insurance and Occupational Pensions Authority (EIOPA) has carried out a review and update of the standard formula's natural catastrophe (Nat Cat) parameters. EIOPA will consider the feedback received to the 2023/2024 (re)assessment of natural catastrophe risk in the standard formula (SF) and shall submit an opinion on natural catastrophe risk to the Commission by end 2024. The Commission will consider the opinion for a potential (re)calibration of the SF parameters.
The (re)assessment of natural catastrophe risk in the SF by EIOPA involved evaluating current models and, if significant, suggesting adjustments. In this process, EIOPA has prioritised the use of Nat Cat models that incorporate climate change2. It is assessing the inclusion of data from new countries and monitoring emerging risks. Additionally, it is utilising the best available data, including open-source models. The purpose behind seeking external input was to ensure that these Nat Cat parameters are still serving their intended purpose because some have not been revisited since 2010. This step is to reflect updates in risk modelling and to account for climate change, building on discussions from EIOPA's 2021 methodological paper for a comprehensive reassessment in 2023/2024.
In this briefing note we also include a case study of the impact of the changes in Solvency II natural catastrophe risk in the standard formula of the Netherlands.
The following areas are covered in this briefing note:
- Methodology.
- Reassessment and recalibration of risks: Earthquake, windstorm, flood, hail and subsidence.
- Granularity and monitoring of emerging risks: Droughts, wildfires and coastal floods.
- Impact assessment: Internal models, EU-wide and in the Netherlands.
Methodology
The methodology for reassessing the Solvency II natural catastrophe risk parameters combines quantitative modelling and expert consensus via the Delphi method. The Delphi method involves running models for specific scenarios, using expert judgement when models are unavailable, anonymising the results and then gathering iterative feedback from experts to refine the estimates and reach a consensus. The (re)assessment process has the following steps:
- Selection criteria
- Data collection
- (Re)assessment of country factors
- Decision of (re)calibration
- Decision of reassessment risk zones and aggregation matrices
- (Re)assessment of risk zone weights, country correlations and aggregation matrices
- Monitoring of emerging perils
These steps ensure that the natural catastrophe risk parameters are evaluated and updated where necessary. During the calibration EIOPA takes into consideration the public-private scheme plans and insurance specificities by country.
(Re)assessment and (re)calibration of risks
The capital requirement for natural catastrophe risk SCRnatCAT under Solvency II is expressed as:
where i encompasses the sub-modules for earthquake, windstorm, flood, hail and subsidence.
Earthquake
During the 2023/2024 earthquake risk assessment for the Solvency II framework, recalibration was considered for several European countries, with Romania revising its 2010 country factor. Details of the reassessment of earthquake risk in the SF are given in the table in Figure 1.
Figure 1: Reassessment of earthquake risk in the SF
| EARTHQUAKE | Old country factor | New country factor | Risk zones changes | Details |
|---|---|---|---|---|
| Romania | 1.7% | 1.0% | From 41 NUTS3 to 47 CRESTA zones | Recalibration due to Natural Disaster Insurance Pool3 (PAID) scheme, excluding non-PAID insured risks like industrial and commercial properties. |
Windstorm
In the 2023/2024 Solvency II windstorm risk reassessment, the Technical Expert Network on Catastrophe Risks determined new country factors based on the Delphi method. Details of the reassessment of windstorm risk in the SF are given in the table in Figure 2.
Figure 2: Reassessment of windstorm risk in the SF
| WINDSTORM | Old country factor | New country factor | Details |
|---|---|---|---|
| Poland | 0.04% | 0.03% | Reduction based on model suggestions and Delphi method consensus. |
| Guadeloupe | 2.74% | 6% | Increase due to the impact of hurricane Irma and model data. |
| Martinique | 3.19% | 5% | Increase due to the impact of hurricane Irma and model data. |
| St-Martin | 5.16% | 10% | Significant increase influenced by the impact of hurricane Irma and model data. |
| Iceland | 0.03% | 0.06% | No models available for Iceland. The factor is determined by comparing the 99.5th percentile to the 98th in typical modelled curves for windstorm losses. |
Flood
The Solvency II standard formula's 2023/2024 reassessment resulted in proposed updates to flood risk country factors for European nations. reflecting significant impacts from climate change on this peril. The flood risk update involves the largest number of countries compared to other perils, underscoring the need to revise modeling assumptions accordingly. If a country is newly included in the assessment, the risk zones and aggregation matrices are also updated, in line with the methodology. Details of the (re)assessment of flood risk in the SF are given in the table in Figure 3. Note that separate models are used per country.
Figure 3: (Re)assessment of flood risk in the SF
| FLOOD | Old country factor | New country factor | Details |
|---|---|---|---|
| Romania | 0.3% | 0.13% | Recalibration excluding the PAID scheme. |
| Czechia | 0.3% | 0.25% | Reduction aligning with new model insights. |
| Belgium | 0.1% | 0.12% | Nudged up based on updated modelling data. |
| Ireland | - | 0.17% | New inclusion. Set considering expert opinion and model results. |
| Luxembourg | - | 0.13% | New inclusion. Based on a single model and expert consensus. |
| Norway | - | 0.05% | New inclusion. Tailored factor based on expert judgement. |
| Sweden | - | 0.045%4 | New inclusion. Set based on loss histories and expert judgement. |
| Finland | - | 0.04% | New inclusion. Considering flood control measures and expert judgement. |
| Denmark | - | 0.04% | New inclusion. Considering cloudburst events and national flood defence schemes. |
| Netherlands | - | 0.035% | New inclusion. Excluding primary flooding. The correlations between the Netherlands, Belgium and Germany are set at 25% |
Hail
In the 2023/2024 exercise, the hail risk assessment was updated for several European countries. Furthermore, note that, if a country is a new inclusion, then the risk zones and aggregation matrices are also updated in line with the methodology. Details of the (re)assessment of hail risk in the SF is given in the table in Figure 4.
Figure 4: (Re)assessment of hail risk in the SF
| HAIL | Old country factor | New country factor | Details |
|---|---|---|---|
| Netherlands | 0.02% | 0.03% | Increase to align with nearby countries like Belgium and France, despite no significant hail events since last calibration. |
| Belgium | 0.03% | 0.035% | Rise based on expert consensus and observed trends in severe weather events. |
| France | 0.01% | 0.02% | Increase reflecting expert consensus and observed trends in severe weather events. |
| Germany | 0.02% | 0.03% | Increase reflecting expert consensus and observed trends in severe weather events. |
| Luxembourg | 0.03% | 0.10% | Significant recalibration based on the latest model data. |
| Poland | - | 0.02% | Newly established factor based on recent assessments. |
In addition to these updates, the factor to reflect the increased vulnerability of motor insurance to hail has been recalibrated as well. The current hail damage factor for motor insurance of five times the sum insured was deemed too low. The recalibrated factor across all countries is proposed to be 10, determined as a middle ground considering the average model results suggests a factor of 15 and the current hail damage factor of five. This change is reflected by:
The motor factor is defined as:
This uniform factor adjustment follows an expert Delphi process and aims to better balance between observed data variances and prior assessments.
Subsidence
During the 2023/2024 reassessment exercise for the Solvency II standard formula, Belgium was included for the first time alongside France for subsidence risk, reflecting a heightened awareness of this peril. Details of the (re)assessment of subsidence risk in the SF is given in the table in Figure 5.
Figure 5: (Re)assessment of subsidence risk in the SF
| SUBSIDENCE | Old country factor | New country factor | Details |
|---|---|---|---|
| Belgium | - | 0.02% | New inclusion due to legislative changes. |
| France | 0.05% | 0.06% | Increased due to rising subsidence claims and recent legal enhancements in insurance coverage. |
Monitoring and emerging perils
The Solvency II standard formula (SF) is under review to potentially include emerging perils related to climate change due to their evolving frequency and intensity. The perils under consideration for future inclusion are droughts, wildfires and coastal floods, which historically have had a lower relevance for (re)insurance but are gaining importance.
Wildfires
Wildfires, particularly in the Mediterranean countries, have increasingly affected vast areas and the economy, prompting EIOPA to monitor their impact on the insurance sector for potential inclusion in the SF. Currently, while wildfires are recognised as a growing threat due to climate change, their risk for the insurance sector in Europe is still considered to be low to medium by most National Competent Authorities (NCAs), except for Greece, where the risk is notably high.
Coastal floods
Coastal floods are another peril with rising concern, as climate change is expected to lead to higher sea levels and more intense coastal storms. While traditionally a lower risk, the potential damage and economic impact could grow exponentially without adaptation and mitigation measures. For now, coastal flood risk remains low for most European Member States' insurance sectors, with some exceptions (Denmark and Ireland).
Droughts
Regarding droughts, particularly agricultural droughts not currently included in the SF, there is an acknowledgement that this risk may become material in the future. The increasing temperature and changing precipitation patterns are likely to exacerbate drought conditions, especially in southern and western Europe. NCAs currently assess this risk as low to medium, with Spain the exception as the materiality is assessed as high. Public support schemes play a role in compensation, contributing to variability in insurance penetration across countries.
Inclusion in the SF
Incorporating these perils into the SF will require careful consideration, potentially introducing them as separate perils or within existing ones. EIOPA has opened a dialogue with stakeholders to gather insights on the impact of these perils and the best approach to including them in the SF, reflecting the insurance sector's exposure to and the materiality of these emerging risks.
Impact assessment
Impact on internal models
Notably, this recalibration requires insurers using internal models (IMs) for natural catastrophe risks to consider the revised parameters and determine whether adjustments to the structure and parametrisation of their models are necessary. This update is important for maintaining compliance with the regulatory framework and accurately reflecting the risk profile, particularly considering climate change and its impact on natural catastrophe events.
EU-wide impact
EIOPA assessed the EU-wide impact of the proposed changes of the 2023/2024 Solvency II standard formula (re)calibration. The assessment process uses annual Quantitative Reporting Templates (QRTs) to approximate the impact of proposed changes at a country level, revealing that, while the overall Solvency Capital Requirement (SCR) level change across the EU is less than 1%, the Nat Cat SCR net of reinsurance is expected to increase by approximately 10%. The impact varies by peril, with hail, flood and subsidence showing the most significant changes. This adjustment process highlights the importance of accurate data and the need for assumptions in the absence of specific exposure information for new perils or regions.
Impact on the Netherlands
As result of the 2023/2024 Solvency II standard formula recalibration exercise, the following changes were proposed by EIOPA for recalibration of the SF for Nat Cat risk in the Netherlands.
Figure 6: Updated SF Nat Cat Risk for the Netherlands
| NETHERLANDS | Old factor | New factor | Details |
|---|---|---|---|
| Hail risk country factor | 0.02% | 0.03% | - |
| Motor risk country factor | 5 | 10 | - |
| Flood risk | - | 0.035% | Additional calibration of region weights, aggregation matrix and country correlation |
To estimate the impact on insurers in the Netherlands, we assume a fictive average non-life insurer that underwrites fire, motor, and marine policies, operates solely within the Netherlands, and has no reinsurance coverage. For this example, the recalibration of the Solvency II standard formula has led to an estimated 6% increase in the SCR for non-life Nat Cat, as shown in Figure 7. The adjustment is partly due to updates in hail-related factors, with the hail motor factor (HA MF) contributing a 1% increment and the hail country factor (HA CF) adding an additional 3%. The inclusion of flood risk (FL) results in a 2% increase in the SCR non-life Nat Cat. In our example the impact of adding flood risk is mitigated by the diversification effect due to the significant size of windstorm risk for this average non-life insurer.
It is important to note that the relative proportion of insured sums between the motor and fire portfolios significantly influences the overall impact. Insurers primarily focussed on motor insurance may experience a higher impact. Furthermore, the country factor for flood risk in neighbouring countries (i.e. Belgium and Germany) is significantly higher than that of the Netherlands. As a result, insurers with exposure in these neighbouring countries would face a more pronounced impact of flood risk on their SCR non-life Cat.
Figure 7: Impact update of the SF on SCR Non-Life Catastrophe risk in the Netherlands
1 EIOPA (8 July 2021). Methodological Paper on Potential Inclusion of Climate Change in the Nat Cat Standard Formula. Retrieved 18 April 2024 from https://www.eiopa.europa.eu/publications/methodologicalpaper-potential-inclusion-climate-change-nat-cat-standard-formula_en.
2 Milliman (April 2024). Extreme Weather Events in Europe. Retrieved 18 April from https://www.milliman.com/en/extreme-weather-events-in-europe.
3 Natural Disaster Insurance Pool (PAID). About PAID. Retrieved 18 April 2024 from https://www.paidromania.ro/about-paid/.
4 The country factor for Sweden is set to 0.45% in the main document, whilst the executive summary mentions a factor of 0.045%.