SCR Target Ratios – Eight Considerations for (Re)Insurers

What is an appropriate Solvency Capital Requirement (‘SCR’) target ratio? It’s a question we have heard many times since the introduction of Solvency II in 2016. Yet, many boards and management groups still grapple with the problem. The short answer? It depends on each (re)insurer's own circumstances and risk appetite. There is no blanket approach. Practices vary widely, although there has recently been some convergence across the industry toward a middle ground.

In this article, we reflect on recent trends and factors that insurers should consider—and document—when setting their SCR target ratio.

There is no one-size-fits-all answer, but no one wants to stand out too much from the crowd. Maintaining an SCR ratio significantly below your peer group’s average may invite regulatory scrutiny.

At the end of 2023, Irish-domiciled insurers reported a median SCR ratio of 196%. In other words, half held SCR ratios above this level and half below. Remarkably, this threshold has remained steady since 2017. Of greater interest, however, is the narrowing deviation around the median.

Holding a 100% SCR ratio is technically compliant, though nearly all insurers opt to maintain a buffer well above the regulatory minimum. In 2018, 19 out of 20 insurers reported an SCR ratio greater than 121%. By 2023, 19 out of 20 held ratios above 139% as higher capital cushions became the norm. Insurers maintaining a ratio below this level may be justified, but would be well advised to document a compelling rationale for their position.

Interestingly, the 25th percentile has increased from 154% coverage in 2017 to 163% in 2023. In other words, three out of four insurers now hold more than 1.63 times their SCR.

And while flirting with low SCR ratios has become less common, we’ve also seen a shift away from the other extreme — fewer insurers are opting to maintain very high capital levels. In 2018, one in four insurers reported coverage ratios exceeding 316%. By the end of 2023, this figure had dropped sharply to 258% — a decline accelerated by the pandemic.

In summary, while practices remain diverse, Irish insurers appear to be converging closer to a common middle ground.

Most risk appetite statements reference point-in-time SCR coverage, but only higher quality statements assess the future outlook. This assessment is particularly relevant for growing insurers that plan to “eat up” more capital as premium volumes expand.

Leading insurers are moving away from static point-in-time metrics toward forward looking SCR ratios. Emerging best practice links risk appetite metrics with the firm’s ORSA time horizon.

How can one insurer set a risk appetite limit at 120% while another with a similar profile opts for 160%? Surely, one must be wrong? — No, not necessarily.

Before setting a risk appetite limit, it’s standard practice to brainstorm, assess, and quantify a wide range of severe but plausible stresses, shocks, and scenarios—often as part of the ORSA process.

The adequacy of reinsurance mitigation plays a major role here. Many low-complexity captive insurers in the Irish market write business with low policy limits and stop-loss reinsurance thresholds. For these insurers, extreme disaster scenarios might only result in modest SCR ratio deteriorations.

Most insurers have reasonably well-developed ORSA stress and shock tests, though some still fail to fully challenge the effectiveness of reinsurance arrangements under market-wide stress conditions — an area where regulators have called for greater professional scepticism.

For more complex insurers, large policy limits, high reinsurance thresholds, or looser asset-liability matching policies can create exposure to significant risks. Higher SCR target ratios may be merited in such cases.

While it’s tempting to distil considerations into a single number and benchmark against peers, a strong risk framework should include robust documentation supporting chosen risk limits.

Insurers prone to quarter-to-quarter SCR volatility will naturally target higher SCR ratios.

Our analysis of median SCR ratios by undertaking type provided some interesting insight. Life insurers maintained higher ratios, compared to non-life insurers and reinsurers, from 2017 to 2019 — a period of economic stability. However, life insurers proved the most vulnerable subgroup during the COVID-19 pandemic in 2020, and to interest rate volatility from 2021 to 2023.

Between 2022 and 2023, the median SCR ratio for life insurers fell by 19 percentage points, while non-life insurers and reinsurers exhibited greater stability.

To understand inherent volatility, insurers should consider sensitivity testing against a broad range of risks. This may include interest rates, investments, options and guarantees, counterparty exposures, and underwriting risks. Establishing links between SCR target ratios and capital sensitivity risks outlined in the risk register is a must.

How much capital is too much? It’s not a bad problem to have! Though for some insurers, capital optimisation remains a challenge.

Since Solvency II’s introduction, some undertakings have consistently held enough capital to meet their SCR several times over. Strategic reasons for doing so vary. For example, reinsurers and non-life insurers often build up buffers in anticipation of growth. In 2018, one in four reinsurers reported SCR ratios above 328%. Similarly, one in four non-life insurers exceeded 321% in 2019. Much of this capital was subsequently deployed as these (re)insurers exploited opportunities post-Brexit.

Life insurers, whose capital needs are predominantly driven by back-book business, have fewer opportunities for dramatic portfolio growth. The SCR of life insurers also tends to be much higher than other undertaking types. As such, holding many multiples of the SCR would be a more demanding capital ask.

Some insurers still continue to hold plenty excess capital, but not to the extent observed pre-pandemic. Rising interest rates and costs of capital has increased scrutiny from shareholders on how insurers optimise capital, discouraging excessive capitalisation levels in some cases.

Financial support from groups and the fluidity of capital across group entities are critical considerations in setting SCR target ratios. Insurers with the lowest SCR ratios often rely heavily on strong group support. As Solvency II has matured, regulators have placed greater scrutiny on the credibility of assumed management actions in the ORSA, particularly around capital injections.

Homing in on reinsurers in the Irish market, most fall into two categories: small captives reinsuring group risks or larger reinsurers that are part of well-capitalised international groups. These reinsurers have grown increasingly comfortable relying on group support to mitigate an SCR breach. In 2018, 1-in-20 reinsurers allowed their SCR ratio to fall below 134%. By 2023, this figure had dropped to 121%.

Conversely, end-consumer facing non-life insurers have trended toward higher local capital retention. This is possibly due to barriers faced in accessing group funds quickly enough during a crisis.