SCR and MCR

Think of two warning lines painted on the wall of a reservoir. There is a comfortable line: as long as the water stays above it, everything is fine and nobody panics. And there is a much lower danger line near the bottom: if the water ever drops below that, the dam is in crisis and authorities step in immediately. Solvency II paints exactly these two lines for an insurer's capital — the higher comfortable line is the SCR, and the lower emergency line is the MCR.

The Solvency Capital Requirement (SCR) is the main target: the amount of capital an insurer should hold so that, over the coming year, the probability of becoming insolvent is no more than 0.5% — that is, it can withstand a 1-in-200-year loss. Calibrated as a one-year 99.5% Value at Risk on the change in basic own funds, it can be computed with the standard formula or an approved internal model. The Minimum Capital Requirement (MCR) is the hard floor — a simpler calculation bounded between roughly 25% and 45% of the SCR (and an absolute monetary minimum). The graded consequence is the whole point: breach the SCR and the supervisor demands a credible recovery plan to restore capital within months; breach the MCR and the ultimate supervisory action follows — the authorization to operate can be withdrawn.

This two-line design matters because it gives supervision both an early-warning trigger and a final backstop. The SCR is meant to be breached only in genuinely bad years and to prompt orderly correction; the MCR marks the point where policyholders are judged to be at unacceptable risk. A frequent confusion is thinking an insurer must always sit far above the SCR; in fact a firm can dip below the SCR temporarily and survive through a recovery plan — it is dropping toward the MCR that signals true endgame.