Abstract
The introduction of the Solvency II regulatory framework in 2011 and unprecendented property and casualty (P/C) claims experienced in recent years by large insurance firms have motivated the adoption of risk-based capital allocation policies in the insurance sector. In this article, we present the key features of a dynamic stochastic program leading to an optimal asset-liability management and capital allocation strategy by a large P/C insurance company and describe how from such formulation a specific, industry-relevant, stress-testing analysis can be derived. Throughout the article the investment manager of the insurance portfolio is regarded as the relevant decision-maker: he faces exogenous constraints determined by the core insurance division and is subject to the capital allocation policy decided by the management, consistently with the company's risk exposure. A novel approach to stress-testing analysis by the insurance management, based on a recursive solution of a large-scale dynamic stochastic p...
Highlights
Record property and casualty (P/C) insurance claims reported by global players in recent years (CEA 2010, Europe Economics 2009) and the introduction of the Solvency II regulatory framework (European Parliament 2009) have induced a majority of global P/C firms to increase their technical reserves and at the same time revise their capital allocation policies under growing market competition
We present the key features of a dynamic stochastic program (DSP) leading to an optimal asset-liability management (ALM) by a P/C insurance company (Bertocchi et al 2011, Birge and Louveaux 2011) and describe how from such formulation a specific, industry-relevant, stress-testing analysis can be derived
Throughout the article the investment manager of the P/C portfolio is regarded as the relevant decision-maker: he faces exogenous constraints determined by the core insurance division and is subject to the capital allocation policy determined by the management, consistently with the risk exposure estimated by an independent risk management division
Summary
Record property and casualty (P/C) insurance claims reported by global players in recent years (CEA 2010, Europe Economics 2009) and the introduction of the Solvency II regulatory framework (European Parliament 2009) have induced a majority of global P/C firms to increase their technical reserves and at the same time revise their capital allocation policies under growing market competition. In Consigli et al (2011), we presented a first version of the long-term P/C portfolio problem under a set of simplifying assumptions, including the lack of any risk capital constraint, the absence of risk-adjusted reward measures and associated targets and a simplistic liability model. Our contribution lies primarily on (i) the explicit introduction in the optimization problem of control equations on the allocated risk capital (as a function of the portfolio strategy and leading to risk capital bounds for different risk factors correlation matrices), (ii) the extension of the DSP approach to accommodate a post-optimality stresstest analysis (with stress generated by the insurance business) and the associated iterative solution method for worsening input technical conditions.
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