Solvency 2/Individual Capital

Assessment challenges

Life insurers that target the implementation of internal models for risk management and ICA purposes face a number of challenges such as:

• Is it best to fit asset returns to parametric or non parametric distributions?
• How many independent factors affect the risk profile across rates, equities, property, fx, commodities and alternatives?
• How to reconcile implied and historical volatility inputs?
• What tenors to use for correlation estimates?
• Is always the development of a complicated model an optimal solution?

Legacy books typically contain minimum interest rate guarantees. In a low interest rate environment the management of these liabilities entails a number of challenges such as:

• What is the optimal asset allocation in terms of shortfall risk for meeting the guarantees?
• When to transact tactical interest rate derivative hedges?
• What structured derivatives can help alleviate expected shortfall?  

Participating with profits business, both unitised and conventional, require the management of reversionary bonuses (RBs) and smoothing costs. To this end a number of questions arise:

• How to optimise the balance between cash flow matching of RBs and equity backing ratio?
• Does hedging the smoothing cost with vanilla or basket options is more efficient?
• How to reconcile RB policy with optimal asset allocation?
• What derivative tenors and strikes to use for tactical hedging purposes? 

Regulatory capital requirements for ALM mismatches regarding interest rate risk can be onerous. Insurers face a number of challenges such as:

• What are the optimal derivative securities that can match the interest rate risk efficiently?
• When to pay for options and when to execute zero cost structures?
• How to optimise strike, time to expiry and derivatives' notional?
• When hedging and when capital raising provides the best alternative?