The Solvency Capital Requirements and the related solvency ratios (SCR Ratio) describes the concept of having assets available to cover your liabilities. In other words, if you have more assets than liabilities then you are solvent.
The requirement itself is an amount in the company’s functional currency. The ratio is a percentage.
Solvency Capital Requirement
Since Solvency II came into force at 1 January 2016 the rules for required capital changed. As a result, insurance companies have two regulatory capital requirements to manage and monitor.
- Solvency Capital Requirement (SCR)
- Minimum Capital Requirement (MCR)
In almost all cases the SCR (find more here) is the normal and higher requirement and the MCR (read more about the MCR here) is the very minimum. If the MCR is breached it usually means that the company has to cease to do business.
SCR Ratio and MCR Ratio
As described above, when companies report solvency this is often done as a percentage. A SCR or MCR ratio. For both of them the lowest acceptable ratio is 100%. As any ratio it can be high for two reasons, because of the nominator or the denominator. Meaning, either the Solvency Capital Requirement is low or the company has a lot of capital.
The ratio is calculated using Own Funds. Most of the times the Eligible Own Funds (EOF) to be specific. There is some variations and special cases, but as a concept the Own Funds is the Excess of Assets over Liabilities.
The formulas can be described as per below,
SCR Ratio = EOF / SCR
MCR Ratio = EOF / MCR
If the EOF is 10 million and the SCR is 5 million the ratio would be 2 or in percentages 200%.
As a result and with other words, the assets are twice the liabilities.