burden on a user. With this approach, the SERD method follows the logic of the European Solvency II approach that allows an insurance company to apply a “simplified” approach by using the Standard Formula instead of a Full or Partial Internal Model, if the latter represents a heavy technical (and cost) burden for the company. Hence, the SERD can be seen as the “Standard Formula” method of the ERD calculation framework.

The level of method’s customization can be adjusted depending on how much information about the individual risk exposure to be modeled is available to the method’s user. For example, the volatility parameters of the chosen probabilistic loss distributions or the loss development patterns can be either used at their default values which will be suggested by the SERD method, or, if available, at their unique values for a given individual case. The default parameter values have been taken from the Solvency II (QIS5) and Swiss Solvency Test frameworks; see Annex II for more details.

Based on the user inputs as well as the default values of risk exposure parameters, the SERD method then provides a comprehensive set of probabilistic scenarios (stochastic model) for the severity of the reinsurer’s net economic loss (similar to the format of Table III.2 above) and finally automatically calculates the ERD based on the obtained probabilistic scenarios.

The SERD method comprises the following four modules:

1. Loss modeling module

2. Reinsurance transaction module 3. Loss development patterns module 4. Scenario generating and ERD calculating module Below we provide a short description of these modules and the results for the Example of the Financial Quota Share (as introduced in Section III) obtained with the SERD method. More technical details on the modules and on the calculation for the Example Financial Quota Share can be found in Annex II.

# 1. Loss modeling module

The user will be given the possibility to choose the line of business covered by the contract from the list comprising the main standard non-life lines of business. Following the approach of Solvency II and Swiss Solvency Test [18, 19], the SERD method allows for assuming some correlation between basic losses in different lines of business. However, no correlation is assumed between basic, large and catastrophe loss exposures.

In the loss modeling module the SERD tool allows to differentiate between basic, large and cat loss burdens. The basic loss modeling is based on the assumption that the loss ratio of the basic loss aggregated over the annual contract term is distributed according to the lognorm distribution. With this choice we follow the Solvency II (QIS5) approach [18]. The user will be asked to enter the expected ultimate loss ratios<sup>25</sup> for all lines of business covered by the contract. Further, the user will be given the choice to use the individual user defined values of the volatility per line of business or to use the default values imported by the SERD method from the Solvency II framework.

> 25 The term “ultimate loss ratio” is used to describe the ratio between the ultimate loss attached to an annual contract term period after its full development and the insurance premium belonging to this annual term period.

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