Abstract
The objective of this document is to analyze different methods that an insurer can use to allocate capital to his or her different lines of business or business segments under Solvency II. For this analysis, a review of the main methods developed in the literature is carried out. Many of the proposed methods in the literature can only be implemented with the internal data from the company’s loss distributions. In addition to this, in some of the methods that can be applied with external data, the diversifying effect is in essence not assigned to the lines of business (LoBs) that cause it. Therefore, in this paper, we compare the results of the main methods that can be used with public data and propose a simple method of capital allocation for insurance companies, which does not require knowledge of the loss distribution of an LoB, and which allows the diversification benefit to be assigned only to the LoBs that really cause such an effect. A practical example of the differences between the different methods and the one proposed is shown for better understanding.
Highlights
Capital allocation, known as capital attribution in insurance companies, has given rise in recent years to a renewed interest due to the current solvency regulatory rules in Europe, namely, Solvency II
The bottom–up aggregation formula proposed by the regulator allows for a diversification effect, but there is no specific allocation formula provided to evaluate the contribution of each risk source on the overall solvency capital requirement (SCR) [1]
While Pillar I is related to the capital adequacy, the allocation of capital is responsible for distributing the capital of the organization among the subdivisions of a company
Summary
Known as capital attribution in insurance companies, has given rise in recent years to a renewed interest due to the current solvency regulatory rules in Europe, namely, Solvency II. While Pillar I is related to the capital adequacy (the capital needs at the level of the insurance company), the allocation of capital is responsible for distributing the capital of the organization among the subdivisions of a company. The said author states that the allocation of an insurance company’s capital involves distributing the total resources of a company in business segments (business units, lines, geographical areas and products). The literature understands these segments primarily as lines of business (LoBs) within an insurance company, but from a theoretical point of view, each LoB can have access to all available capital of the company if necessary, such as in the event of an extremely adverse result. It does not mean that capital is physically shifted across the
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