SCR Calculator User Manual

Modelling Cashflows with Optionality

For callable bonds, the issuer reserves the right to return the investor's principal and stop interest payments before the bond's maturity date. Early redemption may happen if the market interest rates were lower than interest rates offered by the bond.

For puttable bonds, the holder reserves the right to redeem the bond with the issuer at a pre-determined price. Early redemption may happen if market rates have gone higher and reinvesting becomes more profitable.

The logic employed by the SCR calculator on assets with potentially-multiple embedded options are the same as defined under the Canadian LICAT (Life Insurance Capital Adequacy Test) rules.

• The cashflows in the case of each call/put being used are projected and their present values compared against each other.
• Call holders are assumed to wish to capture the lowest PV in time; and put holders the highest PV in time. Everyone is looking at things from present value perspective.
• Following a look-back algorithm, the most likely option implementation scenario is determined and the corresponding cashflows are used.

Below are extracted pages of methodology and an example calculation from LICAT. A spreadsheet of the same calculation is also attached.

Source: Life Insurance Capital Adequacy Test 2024

The above mechanism is used in each case of curve stressing. As a result, the up/down interest rate stresses might cause cashflows to be different for an asset with optionality. Those cashflows can be downloaded using the "Download CFs" button in the Cashflows & Sensitivities Form. The present values used in the decision-making processes are also available in the downloaded spreadsheet.

Example spreadsheet illustrating the above calculation: Here

To replicate the case in the SCR Calculator, you can use the following inputs in the Single Asset form, together with the tailored curves (spreadsheet 1) and call put schedule (spreadsheet 2):

• Inputs:
  
• Spreadsheet 1 - Yield Curves - to be uploaded using "'Data & Parameters' &rarrow; Solvency II Risk-free Curves &rarrow; Set" in the Menu of the Single Asset form.
• Spreadsheet 2 - Call Put Schedule - to be uploaded using the "Schedule" button in the Single Asset form.