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Quantifying credit and market risk under Solvency II: Standard approach versus internal model

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  • Gatzert, Nadine
  • Martin, Michael

Abstract

Even though insurers predominantly invest in bonds, credit risk associated with government and corporate bonds has long not been a focus in their risk management. After the crisis of several European countries, however, credit risk has recently been paid greater attention. Nevertheless, the latest version of the Solvency II standard model (QIS 5), provided by regulators for deriving solvency capital requirements, still does not require capital for credit risk inherent in, e.g., EEA issued government bonds from Greece or Spain. This paper aims to provide an alternative approach and compares the standard model with a partial internal risk model using a rating-based credit risk model that accounts for credit, equity, and interest rate risk inherent in a portfolio of stocks and bonds. The findings demonstrate that solvency capital requirements strongly depend on the quality and composition of an insurer’s asset portfolio and that model risk in regard to model choice and calibration plays an important role in the quantification.

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  • Gatzert, Nadine & Martin, Michael, 2012. "Quantifying credit and market risk under Solvency II: Standard approach versus internal model," Insurance: Mathematics and Economics, Elsevier, vol. 51(3), pages 649-666.
  • Handle: RePEc:eee:insuma:v:51:y:2012:i:3:p:649-666
    DOI: 10.1016/j.insmatheco.2012.09.002
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    Cited by:

    1. Lautier, Jackson P. & Pozdnyakov, Vladimir & Yan, Jun, 2023. "Pricing time-to-event contingent cash flows: A discrete-time survival analysis approach," Insurance: Mathematics and Economics, Elsevier, vol. 110(C), pages 53-71.
    2. Daniela Laas & Caroline Franziska Siegel, 2017. "Basel III Versus Solvency II: An Analysis of Regulatory Consistency Under the New Capital Standards," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 84(4), pages 1231-1267, December.
    3. Schlütter, Sebastian & Fianu, Emmanuel Senyo & Gründl, Helmut, 2022. "Responsible investments in life insurers' optimal portfolios under solvency constraints," ICIR Working Paper Series 45/22, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    4. Schlütter, Sebastian, 2017. "Scenario-based capital requirements for the interest rate risk of insurance companies," ICIR Working Paper Series 28/17, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    5. Georgios Deligiannakis & Alexandros Zimbidis & Ioannis Papanikolaou, 2023. "Earthquake loss and Solvency Capital Requirement calculation using a fault-specific catastrophe model," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 48(4), pages 821-846, October.
    6. Nadine Gatzert & Thomas Kosub, 2014. "Insurers’ Investment in Infrastructure: Overview and Treatment under Solvency II," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 39(2), pages 351-372, April.
    7. van Riet, Ad, 2016. "Government Funding Privileges in European Financial Law : Making Public Debt Everybody's Favourite?," Discussion Paper 2016-045, Tilburg University, Center for Economic Research.
    8. Alexander Braun & Hato Schmeiser & Florian Schreiber, 2017. "Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 84(1), pages 177-207, March.
    9. Aigner, Philipp, 2023. "Identifying scenarios for the own risk and solvency assessment of insurance companies," ICIR Working Paper Series 48/23, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    10. Eckert, Johanna & Gatzert, Nadine & Martin, Michael, 2016. "Valuation and risk assessment of participating life insurance in the presence of credit risk," Insurance: Mathematics and Economics, Elsevier, vol. 71(C), pages 382-393.
    11. Laurens Swinkels & David Blitz & Winfried Hallerbach & Pim Vliet, 2018. "Equity Solvency Capital Requirements - What Institutional Regulation Can Learn from Private Investor Regulation," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 43(4), pages 633-652, October.
    12. Christian Biener & Martin Eling, 2013. "Recent Research Developments Affecting Nonlife Insurance—The CAS Risk Premium Project 2012 Update," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 16(2), pages 219-231, September.
    13. Jiří Valecký, 2017. "Calculation of Solvency Capital Requirements for Non-life Underwriting Risk Using Generalized Linear Models," Prague Economic Papers, Prague University of Economics and Business, vol. 2017(4), pages 450-466.
    14. Eling, Martin & Pankoke, David, 2013. "Basis Risk, Procylicality, and Systemic Risk in the Solvency II Equity Risk Module," Working Papers on Finance 1306, University of St. Gallen, School of Finance.
    15. Aur'elien Alfonsi & Adel Cherchali & Jose Arturo Infante Acevedo, 2019. "A full and synthetic model for Asset-Liability Management in life insurance, and analysis of the SCR with the standard formula," Papers 1908.00811, arXiv.org.
    16. Michael Heinrich & Thomas Schreck, 2017. "Effects of Solvency II on Portfolio Efficiency, The Case of Real Estate and Infrastructure Investments," LARES lares_2017_paper_8, Latin American Real Estate Society (LARES).

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    More about this item

    Keywords

    Solvency II; Internal model; Rating-based credit risk model; Market risk; Credit risk;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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