Alexander Braun
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Prof. Dr.
Last Name
Braun
First name
Alexander
Email
alexander.braun@unisg.ch
Phone
+41 71 224 3653

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Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula

2017-03-01 , Braun, Alexander , Schmeiser, Hato , Schreiber, Florian

We optimize a life insurance company's asset allocation in the context of classical portfolio theory when the firm needs to adhere to the market risk capital requirements of Solvency II. The discussion starts with a brief review of the standard formula and the introduction of a parsimonious partial internal model. Subsequently, we estimate empirical risk–return profiles for the main asset classes held by European insurers and run a quadratic optimization program to derive nondominated frontiers with budget, short-sale, and investment constraints. We then compute the capital charges under both solvency models and identify those efficient portfolio compositions that are permitted for an exogenously given amount of equity. Finally, we consider a systematically selected set of inefficient portfolios and check their admissibility, too. Our results show that the standard formula suffers from severe shortcomings that interfere with economically sensible asset management decisions. Therefore, the introduction of Solvency II in its current form is likely to have an adverse impact on certain parts of the European insurance sector.

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Ökonomische Widersprüche - Solvency-II-Standardformel für Marktrisiken generiert keine konsistente Kapitalanlageregulierung

2014-02-03 , Braun, Alexander , Schmeiser, Hato , Schreiber, Florian

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Evolution or Revolution? How Solvency II Will Change the Balance Between Reinsurance and ILS

2017-06 , Braun, Alexander , Weber, Joel

The introduction of Solvency II has decreased regulatory frictions for insurance-linked securities (ILS) and thus redefined how insurance and reinsurance companies can use these instruments for coverage against natural catastrophe risk. We introduce a theoretical framework and run an empirical analysis to assess the potential impact of Solvency II on the market volume of ILS compared to traditional reinsurance. Our key model parameter captures all determinants of the relative attractiveness of these two risk mitigation instruments other than market prices. It is estimated by means of OLS, decomposed into a trend and cyclical component using the Hodrick-Prescott filter, and forecasted with an ARMA(3,3) model. We complement the resulting baseline prediction by a scenario analysis, the probabilities for which are based on a Gumbel distribution. Judging by our findings, we expect Solvency II to increase the volume of ILS to more than 24 percent of the global property-catastrophe reinsurance limit or approximately USD 101.14 billion by the end of 2018.

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

2015-03-01 , Braun, Alexander , Schmeiser, Hato , Schreiber, Florian

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.

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