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”. [...]
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
Objectives and Core Topics
This thesis examines the regulatory framework of Solvency II, specifically focusing on the methodologies for calculating the Solvency Capital Requirements (SCR). The primary objective is to perform a quantitative comparison between the standardized model provided by the regulator and internally developed stochastic models, analyzing how different asset portfolio compositions impact capital requirements for life insurers.
- Comparison of the Standard Model versus Internal Models under Solvency II.
- Detailed analysis of the Market Risk Module and its components.
- Scenario-based analysis of asset classes including stocks, real estate, and bonds.
- Impact of asset quality and portfolio weighting on calculated risk capital.
- Discussion of the internal model approval process and regulatory governance.
Excerpt from the Book
3.3.2 Market Risk Module
According to the findings of QIS5 this module has with a share of 67.4% the most important impact on the calculation of BSCR in life undertakings.
Market risk arises from “the level or volatility of market prices of financial instruments, which have an impact upon the value of the assets and liabilities”. The market risk module consists of seven risk submodules: interest rate, equity, property, currency, spread and concentration, illiquidity premium.
The calculation of the market risk module is given by a square function which includes two correlation matrices for two scenarios (interest rate up and interest rate down):
All the submodule capital requirements are calculated in such a manner that the aggregation of Mktmkt results from a stress test consistent with all the worst case scenarios happening in one point of time. If one of the submodules leads to a negative SCR, the respective SCR will set to 0.
Summary of Chapters
1 Introduction: Provides an overview of the Solvency II Directive, its background, and the goal of establishing a market-consistent risk management framework for European insurers.
2 Solvency II: Details the necessity for a new regulatory regime and explains the three-pillar architecture including quantitative, qualitative, and transparency requirements.
3 Solvency Capital Requirements: Defines the Solvency Balance Sheet and the SCR, describing both the standard model and internal model approaches to quantifying risks.
4 Current Topics on Solvency II: Discusses the Long Term Guarantee Assessments (LTGA) and various measures implemented to address volatility and market stress.
5 Quantitative Comparison: Presents the literature review, research methodology, model framework, and the numerical results comparing the standard and internal models.
6 Conclusion: Summarizes the key findings, highlighting that while internal models often result in lower SCRs, they require significant expertise and supervisory approval.
Keywords
Solvency II, Solvency Capital Requirements, SCR, Standard Model, Internal Model, Market Risk, Life Insurance, Value-at-Risk, Asset Management, Risk Governance, Quantitative Impact Studies, QIS5, Capital Adequacy, Financial Regulation, Risk Sensitivity.
Frequently Asked Questions
What is the core focus of this master thesis?
The thesis focuses on comparing the standard model and internal models for calculating the Solvency Capital Requirements (SCR) under the Solvency II Directive for European life insurers.
What are the primary areas of risk addressed?
The work primarily addresses market risks, including interest rate, equity, property, currency, and spread risks, while also touching upon life underwriting and operational risks.
What is the main objective of the research?
The objective is to identify in which portfolio constellations the SCR varies between the standard and internal model approaches, and how sensitive these models are to changes in asset allocation.
What scientific methods are utilized?
The author uses a stochastic simulation approach, applying the Cox-Ingersoll-Ross (CIR) model for interest rates and Geometric Brownian Motion (GBM) for other asset classes to perform numerical scenario analyses.
What content is covered in the main section?
The main section covers the architecture of Solvency II, the definition of SCR, detailed breakdown of standard formula sub-modules, the internal model approval process, and the quantitative analysis of asset portfolios.
Which keywords best characterize this research?
Key terms include Solvency II, SCR, Market Risk, Standard Model, Internal Model, Life Insurance, Value-at-Risk, and Capital Allocation.
Why are internal models considered more complex than the standard model?
Internal models require advanced mathematical modeling, significant IT resources, expert personnel, and a rigorous, time-consuming approval process by national supervisory authorities.
How do the results typically differ between the two models?
The research indicates that the standard model often overestimates risk compared to internal models, though internal models are highly sensitive to specific asset quality and volatility parameters.
- Citar trabajo
- Shahrok Shedari (Autor), 2015, Solvency II. A comparison of the standard model with internal models to calculate the Solvency Capital Requirements (SCR), Múnich, GRIN Verlag, https://www.grin.com/document/339677
