TITLE:
An Assessment of the Market Risk Solvency Capital Requirement Simplifications for Insurance Undertakings
AUTHORS:
Thomas Poufinas, Panagiota Tsitsika
KEYWORDS:
Solvency II, Solvency Capital Requirement, Simplification, Market Risk, Interest Rate, Duration
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.11,
August
15,
2018
ABSTRACT: The Solvency II regulatory framework has been
implemented as of January 1st, 2016 and among other things it introduced
economic risk-based capital requirements across all EU Member States for the
first time, applicable for insurance and reinsurance undertakings. Similar to
Basel II whose scope is banks, the Solvency II directive provides a new regime
based on three pillars for insurers and reinsurers: 1) pillar 1: harmonized valuation and risk based
capital requirements, 2) pillar
2: harmonized governance and risk management requirements and 3) pillar 3: harmonized
supervisory reporting and public disclosure. The Solvency Capital Requirement
(SCR) should correspond to the Value-at-Risk of the basic own funds of an
insurance or reinsurance undertaking subject to a confidence level of 99.5%
over a one-year period. The Solvency II directive provides a range of methods
to calculate the SCR. This allows insurance or reinsurance undertakings to
choose a method that is proportionate to the nature, scale and complexity of
the risk that is measured. In order to calculate the SCR, an insurance undertaking
can use a fully internal model, the standard formula and a partial internal
model, the standard formula with undertaking-specific parameters, the standard
formula as it is or a simplification. When introducing a simplification, the
SCR estimate could deviate from the calculation without the simplification. A
simplification could lead in important/crucial information missing from the SCR
calculation. In some occasions the SCR is overestimated and in some others it
is underestimated. It is therefore of interest to find the range of this
deviation, potential bounds—if any and the effect it can have on the
required capital. In this paper we attempt to measure this deviation for
simplifications pertaining to the interest rate risk for insurance companies.