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

Katharina Fischer and Sebastian Schlütter
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Katharina Fischer: Faculty of Economics and Business Administration, Chair of Insurance and Regulation, International Center for Insurance Regulation, Goethe University Frankfurt, Grüneburgplatz 1, Frankfurt/Main 60323, Germany
Sebastian Schlütter: Faculty of Economics and Business Administration, Chair of Insurance and Regulation, International Center for Insurance Regulation, Goethe University Frankfurt, Grüneburgplatz 1, Frankfurt/Main 60323, Germany

The Geneva Risk and Insurance Review, 2015, vol. 40, issue 1, 15-40

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.

Date: 2015
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