A Solution for Solvency II Quantitative Requirements Modeling with Long-Tail Liabilities

David Munroe, David Odell, Serge Sandler and Ben Zehnwirth

North American Actuarial Journal, 2015, vol. 19, issue 2, 79-93

Abstract: The European Parliament’s Solvency II Directive introduced a new regulation for insurance and reinsurance business designed to establish a consistently improved level of policyholder protection by means of a three-pillar process. Pillar 1 of the directive contains quantitative requirements for the insurance industry in respect to technical provisions (TPs) and the solvency capital requirement (SCR). The cornerstone of Solvency II one-year risk horizon is the Fair Value of Liabilities (FVL). The SCR and Economic Balance Sheet at inception should be able to withstand a first future calendar year in distress (at the level of 1-in-200-year event). We provide a rigorous statistical treatment of the risk metrics required to fulfil Solvency II requirements for internal models applicable to reserve risk with long-tail liabilities. The proposed internal model is novel in not relying on the proportionality proxy. A tractable simulation based solution ensures adequate capital to restore the economic balance sheet to its FVL should the first future calendar year be in distress.

Date: 2015
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DOI: 10.1080/10920277.2014.997934

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