Solvency II. A comparison of the standard model with internal models to calculate the Solvency Capital Requirements (SCR)

Master's Thesis , 2015 , 67 Pages

Business economics - Banking, Stock Exchanges, Insurance, Accounting

The Solvency II Directive, which will come into effect from January 2016, is a very important project of the European insurance industry. It will set new rules to the European insurance business. Because of being the biggest insurance market of the world - European insurers generate more than € 1,100 bn p.a. and invest around € 8,600 bn in the economy - the new directive will also act as a signal for the worldwide regulation of insurance companies. So it is also intended to have a framework, which is in line with the international developments in solvency, risk management, supervisory and accounting.
After 15 years of planning and development the regulation is now implemented step-by-step. The aim of the EU Solvency II Directive is to prevent insurers from becoming insolvent. For this purpose, among other things, a uniform capital adequacy for all European insurance companies is provided. Core of the proposed amendments with respect to the investment is that eligible capital at any time must be higher than the calculated risk.
One of the main parts of the Solvency II project is the determination of the capital requirements. The idea is to asses both the assets and the liabilities with the aim of a more realistic modelling and assessments of the risk to which an insurer may be exposed to. The solvency capital requirements (SCR) for an one year horizon is then calculated on the 99.5% Value-at-Risk. The determined SCR answers the question how much capital is required today to cover losses, which may occur during the next 12 months, with a probability of 99.5%.
For the calculation of the SCR the insurer can choose between standard model, internal models or a hybrid model. Since internal models allow a better assessment of the companies risk than the standard model, insurers are encouraged to implement such stochastic internal models. But the implementation of internal model is as well costly as sophisticated. That is why the European Commission with support of the Committee of Insurance and Occupational Pension Supervisors (CEIOPS) has established a scenario based standard model. The standard model defines in a first step different sub modules (e.g. market risk, operational risk) for which the capital requirements are calculated. The different SCR’s are “then aggregated under the assumption of a multivariate normal distribution with prespecified correlation matrices to allow for diversification effects”. [...]

Inhaltsverzeichnis (Table of Contents)

• 1 Introduction
• 2 Solvency II
  • 2.1 The need for a new solvency regime
  • 2.2 Basic architecture of Solvency II
    • 2.2.1 Pillar I: Quantitative Requirements
    • 2.2.2 Pillar II: Qualitative Requirements
    • 2.2.3 Pillar III: Transparency Requirements
• 3 Solvency Capital Requirements
  • 3.1 The Solvency Balance Sheet
  • 3.2 Definition of SCR
  • 3.3 Standard Model
    • 3.3.1 Basic Solvency Capital Requirements
    • 3.3.2 Market Risk Module
      • 3.3.2.1 Interest Rate Risk
      • 3.3.2.2 Equity Risk
      • 3.3.2.3 Property Risk
      • 3.3.2.4 Currency Risk
      • 3.3.2.5 Spread Risk
      • 3.3.2.6 Concentration Risk
      • 3.3.2.7 Illiquidity Risk
    • 3.3.3 Life Module
      • 3.3.3.1 Mortality Risk
      • 3.3.3.2 Longevity Risk
      • 3.3.3.3 Disability and Morbidity Risk
      • 3.3.3.4 Lapse Risk
      • 3.3.3.5 Expense Risk
      • 3.3.3.6 Revision Risk
      • 3.3.3.7 CAT Risk
    • 3.3.4 Non-Life Module
      • 3.3.4.1 Premium and Reserve Risk
      • 3.3.4.2 Non-Life Lapse Risk
      • 3.3.4.3 Non-Life CAT Risk
    • 3.3.5 Counterparty Default Risk
    • 3.3.6 Intangible Asset Risk Module
    • 3.3.7 Operational Risk
  • 3.4 Internal Model
    • 3.4.1 The Internal Model Approval Process
  • 3.5 Summary
• 4 Current Topics on Solvency II
  • 4.1 Long Term Guarantee Assessments
• 5 Quantitative Comparison
  • 5.1 Literature Review
  • 5.2 Research Question
  • 5.3 Model Framework
    • 5.3.1 Calculating SCR in the standard approach
    • 5.3.2 Calculating SCR in the internal approach
  • 5.4 Input parameter and calibration
  • 5.5 Results
• 6 Conclusion

Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

This master's thesis aims to compare the standard model and internal models used to calculate the Solvency Capital Requirement (SCR) under Solvency II. The study analyzes the differences in the two approaches and investigates the impact of these differences on the calculated SCR. The key themes explored in the thesis include: * **Solvency II framework:** The thesis provides a comprehensive overview of the Solvency II framework, including its three pillars and the key elements of the regulatory regime. * **Solvency Capital Requirements (SCR):** The study delves into the definition and calculation of SCR, exploring both the standard model and internal models. * **Comparison of standard model and internal models:** The thesis compares the two approaches in terms of their underlying assumptions, methodology, and potential outcomes. * **Quantitative analysis:** The study conducts a quantitative analysis to compare the SCR calculated using the standard model and an internal model. * **Implications for insurance companies:** The thesis discusses the implications of the findings for insurance companies, including the potential impact on their capital requirements and risk management strategies.

Zusammenfassung der Kapitel (Chapter Summaries)

• Chapter 1 provides an introduction to the topic of Solvency II and its importance in the context of financial regulation.
• Chapter 2 presents a comprehensive overview of the Solvency II framework, including its three pillars: quantitative requirements, qualitative requirements, and transparency requirements.
• Chapter 3 focuses on the Solvency Capital Requirements (SCR), explaining the concept of the solvency balance sheet and the definition of SCR. It then dives into the details of the standard model, covering its various modules and sub-modules.
• Chapter 4 explores the concept of internal models for calculating SCR, outlining the approval process and the key considerations for using internal models.
• Chapter 5 presents a quantitative comparison of the standard model and internal models, including a review of relevant literature, the research question, and the model framework used in the analysis.

Schlüsselwörter (Keywords)

The primary focus of this thesis is on the Solvency II framework, the calculation of Solvency Capital Requirements (SCR), and the comparison of the standard model with internal models. Key concepts include: risk management, insurance regulation, financial stability, quantitative analysis, and capital adequacy. The study also touches upon aspects of long-term guarantees and the impact of Solvency II on insurance companies' risk management strategies.

• College: University of Frankfurt (Main)
• Author: Shahrok Shedari (Author)
• Publication Year: 2015
• Pages: 67
• Catalog Number: V339677
• ISBN (eBook): 9783668298484
• ISBN (Book): 9783668298491
• Language: English
• Tags: solvency, capital, requirements