Caroline Siegel

The Impact of Private Equity on a Life Insurer's Capital Charges under Solvency II and the Swiss Solvency Test

In this article, we conduct an in‐depth analysis of the impact of private equity investments on the capital requirements faced by a representative life insurance company under Solvency II as well as the Swiss Solvency Test. Our discussion begins with an empirical performance measurement of the asset class over the period from 2001 to 2010, suggesting that limited partnership private equity funds may be suited for the purpose of portfolio enhancement. Subsequently, we review the market risk standard approaches set out by both regulatory regimes and outline a potential framework for an internal model. Based on an implementation of these solvency models, it is possible to demonstrate that private equity is overly penalized by the standard approaches. Hence, life insurers aiming to exploit the asset classs return potential may expect significantly lower capital charges when applying an economically sound internal model. Finally, we show that, from a regulatory capital perspective, it can even be less costly to increase the exposure to private rather than public equity.

The risk of model misspecification and its impact on solvency measurement in the insurance sector

Purpose - The purpose of this paper is to study the risk of misspecifying solvency models for insurance companies. Design/methodology/approach - Based on a basic solvency model, the authors examine the sensitivity of different risk measures with respect to model misspecification. An analysis considers the effects of introducing stochastic jumps and linear, as well as non-linear dependencies into the basic setting on the solvency capital requirements, shortfall probability and expected policyholder deficit. Additionally, the authors take a regulatory view and consider the degree to which the deviations in risk measures, due to the different model specifications, can be diminished by means of requiring interim financial reports. Findings - The simulation results suggest that the sensitivity of solvency capital as a risk measure – as it is in regulatory practice – underestimates the actual misspecification risk that policyholders are exposed to. It is also found that semi-annual mandatory interim reports can already reduce the model uncertainty faced by a regulator, significantly. This has important implications for the design of risk-based capital standards and the implementation of internal solvency models. Originality/value - The results from the Monte Carlo simulation show that changes in the specification of a solvency model have a much greater impact on shortfall probabilities and expected policyholder deficits than they have on capital requirements. The shortfall risk measures react much more sensitively to small changes in the model assumptions, than the capital requirements. This leads us to the conclusion that regulators should not solely rely on capital requirements to monitor the solvency situation of an insurer, but should additionally consider shortfall risk measures. More precisely, an analysis of model risk focusing on the sensitivity of capital requirements will typically underestimate the relevant risk of model misspecification from a policyholders perspective. Finally, the simulation results suggest that mandatory interim reports on the solvency and financial situation of an insurance company are a powerful tool in order to reduce the model uncertainty faced by regulators.

Basel III versus Solvency II: An Analysis of Regulatory Consistency under the New Capital Standards

Over the past decade, European banking and insurance regulation has been subject to significant reforms. One of the declared goals of the authorities was the enhancement of market stability through adequate and consistent capital standards. This paper provides a critical analysis of the Basel II, III, and Solvency II capital standards for asset risks in light of this regulatory objective. Our discussion begins with a detailed overview of the current standard approaches for market and credit risk. Furthermore, we describe the two new capital adequacy proposals under Basel III – the partial and fuller risk factor approach. Based on a theoretical analysis and a numerical comparison of the capital charges, our paper reveals an inaccurate treatment of risk categories and severe inconsistencies between the capital standards for banks and insurers. While the latter could lead to an exploitation of regulatory arbitrage opportunities across industries, the former might result in severe distortions to the financial institutions’ investment decisions. The unduly promotion of government bond holdings under all three frameworks is able to further deteriorate the postcrisis issue of moral hazard in the financial industry.

Basel III Versus Solvency II: An Analysis of Regulatory Consistency Under the New Capital Standards: Basel III Versus Solvency II

This article provides a critical analysis of the consistency of the standard approaches for market and credit risks under Solvency II and the current and forthcoming Basel III standards. The comparability is assessed both theoretically via a detailed comparison of the capital standards and in a numerical analysis that contrasts the capital charges for a stylized portfolio. Our examination reveals substantial discrepancies in the design of the frameworks. These lead to vastly differing capital requirements for the same risks. Moreover, the analysis indicates higher charges for banks than insurers, especially under the proposed new Basel III standard approaches.