Optimal Investment Strategies for Insurance Companies when Capital Requirements are Imposed by a Standard Formula

Abstract

The Solvency II standard formula employs an approximate value-at-risk approach to define risk-based capital requirements. This paper investigates how the standard formula's stock risk calibration influences the equity position and investment strategy of a shareholder-value-maximising insurer with limited liability. The capital requirement for stock risks is determined by multiplying a regulation-defined stock risk parameter by the value of the insurer's stock portfolio. Intuitively, a higher stock risk parameter should reduce risky investments as well as insolvency risk. However, we find that the default probability does not necessarily decrease when reducing the investment risk (by increasing the stock risk parameter). We also find that, depending on the precise interaction between assets and liabilities, some insurers will invest conservatively, whereas others will prefer a very risky investment strategy, and a slight change of the stock risk parameter may lead from a conservative to a high-risk asset allocation.

Underwriting, Investing and Value: Evidence from Simulation and from Market Data

“…Note, however, that Figure 1 shows only self-contained scenarios unconstrained from regulatory and market considerations. For example, while taking on investment risk, this simulation is consistent with the modeling results of Fischer and Schlutter (2015), as regulation prevents an actual insurer from investing all of its assets in volatile investments. Also, actual insurers operate under the influence of simultaneous changes in decision variables and are thus able to otherwise replicate the result of a decision that in itself is not encouraged by public policy.…”

Investment Activity of Insurers and the State Economic Growth

“…This is especially important in the light of the introduction of Solvency II standards. K. Fischer and S. Schlutter, (2015) study the issues of the formation of an optimal investment strategy of the insurer, taking into account the requirements of Solvency II. It is considered that higher stock market risk parameters should reduce risky investments, based on the requirements of the regulator.…”

Responsible investments in life insurers’ optimal portfolios under solvency constraints

“…Recent work examines investment strategies of life insurers and accounts for additional aspects, such as the multi-period maturity structure of life insurance liabilities (Huang & Lee 2010), default risk, and surplus sharing (Gatzert 2008, Bohnert et al 2015, Eckert et al 2016. Fischer & Schlütter (2015) investigate the optimal equity ratio and capital adequacy of an insurance company for which capital requirements are calculated using the Solvency II standard formula. The authors show that the impact of risk weights in the standard formula on the optimal strategy and the resulting solvency level is very heterogeneous across different insurers and depends, specifically, on the correlations between their asset and liability risks.…”