It may appear somewhat hasty, asking for a lesson learned for a framework which has not yet been implemented. Taking another perspective, it even sounds implausible, to force an industry which has been very successful with managing risks for their customers in the past to use a new regulatory risk framework. Nevertheless, to question whether the lesson has been learned or the usefulness of the introduction of a new risk based regulatory framework, seems to be more up-to-date than it has ever been.
The pace of our time is getting faster. “Nothing is as consistent as change” - these wise words uttered by Greek philosopher Pythagoras over 2500 years ago adequately describe today’s world in which change is rather the rule than the exception. The supervisory system for EU insurers which was proofed to be sufficient in 1997 was considered to be insufficient only five years later. Recently, the latest financial crisis has shown that the strength of companies is not a matter of balance sheet size anymore; it is rather the result of understanding the risk a company takes. The cutting-edge Solvency II framework is now going to replace the current existing supervisory system, adopting the latest developments for measuring risk in financial markets. However, with the recent financial crisis in mind, modern financial theories, investment strategies or risk measurement techniques look again like a fancy part of academia without any connection to the real financial world. Basel II, the EU wide regulatory framework for banks which has failed to protect the banking industry from the risk arising in the financial markets, can be quoted as a good example for the necessity of a new framework. As a consequence, Basel III is being developed at the moment.
One might be led to believe, that these issues do not concern the insurance industry. Insurers are long-term investors and usually follow a rather conservative investment policy. This did not protect them from losses but they were still able to sit out the last crisis, except for AIG which gambled in markets far off from their core business. Financial markets and their volatile behavior have not affected them directly but now Solvency II is going to introduce a market consistent valuation for their assets and liabilities. The value of both sides of their balance sheet, of every insurer in the EU will be linked directly to the financial markets. Changed market conditions will impact on all EU insurers at once [...]
Inhaltsverzeichnis (Table of Contents)
- 1. Introduction
- 1.1 Subject and background of the study
- 1.2 Objectives of this thesis
- 1.3 Course of the analysis
- 1.4 Scope and limitations
- 2. Solvency II - A major European regulatory initiative
- 2.1 The development of Solvency II
- 2.2 The three pillar approach
- 2.3 The current second phase
- 2.4 Quantitative impact studies
- 2.5 A risk based economic system
- 2.5.1 The economic balance sheet
- 2.5.2 Overall structure of the standard formula
- 2.5.3 Measurement and assessment of risk
- 3. Treatment of investment risk under the standard formula
- 3.1 Interest rate risk
- 3.1.1 The discount rate
- 3.1.2 The illiquidity premium
- 3.2 Equity risk
- 3.2.1 Symmetric adjustment mechanism
- 3.2.2 Duration based equity dampener
- 3.3 Spread risk
- 3.3.1 Spread risk on bonds
- 3.3.2 Spread risk on structured credits
- 3.3.3 Spread risk on credit derivatives
- 3.4 Illiquidity premium risk
- 3.5 Property risk
- 3.6 Currency risk
- 3.7 Concentration risk
- 3.8 Counterparty default risk
- 3.9 Aggregation of risk modules
- 4. Potential implications caused by Solvency II
- 4.1 The beginning of an EU wide asset reallocation
- 4.1.1 The driver for solvency capital requirements
- 4.1.2 Summary of capital requirements of major asset classes
- 4.1.3 The changing investment behavior
- 4.2 The possibility of new risk due to changed market conditions
- 4.2.1 Negative feedbacks as a consequence of market consistent valuation
- 4.2.2 A new interesting investment market
- 4.2.3 Multiple additional threats for the insurers and the market
- 5. Conceptual drawbacks of Solvency II
- 5.1 Theory, reality and the model
- 5.1.1 The independence of price changes
- 5.1.2 Price changes adhere to a probability distribution
- 5.2 False confidence in Value at Risk
- 5.2.1 Underestimation of tail risk
- 5.2.2 Sub-additive
- 5.2.3 Different methodology leads to a different Value at Risk
- 5.3 Black Swans and the Big Bang
- 5.4 Reliance on credit rating agencies
- 5.4.1 The non transparent business model
- 5.4.2 No liability or regulation
- 5.4.3 Mistakes in the past
Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)
This thesis aims to examine the impact of Solvency II, a major European regulatory initiative, on the insurance industry. It analyzes the potential consequences of the new regulations on investment behavior, asset allocation, and overall market stability.- Impact of Solvency II on investment behavior
- Analysis of potential risks and opportunities arising from Solvency II
- Evaluation of the standard formula used for calculating solvency capital requirements
- Assessment of the implications of market consistent valuation for insurance companies
- Discussion of the challenges and limitations of Solvency II
Zusammenfassung der Kapitel (Chapter Summaries)
The first chapter introduces the subject and background of the study, outlining the objectives of the thesis and the scope of analysis. Chapter two provides a detailed overview of Solvency II, focusing on its development, the three-pillar approach, and the quantitative impact studies. It also delves into the risk-based economic system, highlighting key components like the economic balance sheet, the standard formula, and risk measurement methods. Chapter three explores the treatment of various investment risks under the standard formula, covering areas such as interest rate risk, equity risk, spread risk, illiquidity premium risk, property risk, currency risk, concentration risk, and counterparty default risk. Finally, it examines the aggregation of these risk modules. Chapter four analyzes the potential implications of Solvency II on the insurance industry. It discusses the driver for solvency capital requirements, summarizes capital requirements for major asset classes, and explores the changing investment behavior of insurance companies. The chapter also explores the possibility of new risks arising from altered market conditions and the negative feedbacks associated with market-consistent valuation. The final chapter examines the conceptual drawbacks of Solvency II, focusing on the disconnect between theory and reality, the limitations of the standard formula, and the reliance on credit rating agencies.Schlüsselwörter (Keywords)
Solvency II, Insurance regulation, Investment behavior, Asset allocation, Risk management, Standard formula, Market consistent valuation, Credit rating agencies, Tail risk, Black Swans, Value at Risk.- Quote paper
- Michael Gutsche (Author), 2011, Solvency II - Lesson learned?, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/177552
