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Solvency Regulation of Insurers: A Regulatory Failure?

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  • Peter Zweifel

Abstract

This paper puts forth a critique of European solvency regulation of the type imposed on insurers by Solvency I and II. Insurers’ underwriting and investment divisions seek to maximize the expected risk-adjusted rate of return on capital (RA-ROC) in period 0. For them, higher solvency serves to increase demand and hence premium income but ties costly capital. Sequential decision making by insurers is tracked over three periods. In period 1, exogenous changes in expected returns and involatility occur, causing optimal adjustments of solvency in period 2. In period 3, the actual change in solvency triggers adjustments in underwriting and investment, resulting in new values of expected returns and volatility. These changes create an endogenous efficiency frontier in (µ,s)-space for the insurer. Both Solvency I and II are shown to modify the slope of this frontier, inducing senior management to opt for a higher volatility in several situations. Therefore, both types of solvency regulation can run counter their stated objective, which may also be true of Solvency III.

Suggested Citation

  • Peter Zweifel, 2014. "Solvency Regulation of Insurers: A Regulatory Failure?," Journal of Insurance Issues, Western Risk and Insurance Association, vol. 37(2), pages 135-157.
    • Handle: RePEc:wri:journl:v:37:y:2014:i:2:p:135-157
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    Cited by:

    1. Pavel Wünsch, 2017. "Own Funds Under Solvency Regime," European Financial and Accounting Journal, Prague University of Economics and Business, vol. 2017(3), pages 87-102.
    2. Zweifel Peter, 2019. "Planned Solvency III Regulation: Should It Be Adopted Outside the European Union?," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 13(1), pages 1-12, January.
    3. Peter Zweifel & Dieter Pfaff & Jochen Kühn, 2015. "A Simple Model of Bank Behaviour—With Implications for Solvency Regulation," Studies in Microeconomics, , vol. 3(1), pages 49-68, June.

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