Solvency II's Market Risk Standard Formula: How Credible is the Proclaimed Ruin Probability?

Item Type Journal paper
Abstract

In this paper, we address the issue of calculating actual ruin probabilities under the market risk standard formula of Solvency II. Our discussion begins with a short overview of the Solvency II market risk module and a partial internal model, which both can be used to calculate the insurer's capital requirements for market risk. Consistent with the Solvency II guidelines, the internal model relies on the value at risk measure with a ruin probability of 0.5 percent per year. In a next step, we then derive efficient portfolios under budget and short sale constraints as well as the prevailing legal investment limits in Germany in order to determine the capital requirements under both approaches for each individual portfolio. Finally, by inverting our internal model, the actual ruin probabilities of the Solvency II standard formula can be calculated. Our analysis reveals that the latter deviate substantially from the proclaimed one by the regulator. Based on these results and given the fact that a large fraction of European insurance companies may apply the standard formula, Solvency II can be expected to create wrong incentives and cause a high level of hidden risks in the insurance sector.

Authors Braun, Alexander; Schmeiser, Hato & Schreiber, Florian
Journal or Publication Title Journal of Insurance Issues
Language English
Keywords Solvency II, Standard Formula, Internal Model, Ruin Probability
Subjects business studies
HSG Classification contribution to scientific community
Refereed Yes
Date 1 March 2015
Publisher Western Risk and Insurance Association (WRIA)
Place of Publication Northridge, Calif.
Volume 38
Number 1
Page Range 1-30
Number of Pages 30
ISSN 1531-6076
Official URL https://www.jstor.org/stable/43295110
Depositing User Prof. Dr. Alexander Braun
Date Deposited 10 Jul 2013 09:04
Last Modified 25 Sep 2021 00:22
URI: https://www.alexandria.unisg.ch/publications/224240

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Citation

Braun, Alexander; Schmeiser, Hato & Schreiber, Florian (2015) Solvency II's Market Risk Standard Formula: How Credible is the Proclaimed Ruin Probability? Journal of Insurance Issues, 38 (1). 1-30. ISSN 1531-6076

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https://www.alexandria.unisg.ch/id/eprint/224240
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