Defining principles of a robust insurance solvency regime

Abstract

The article deals with the fundamental features of a solvency regime: valuation and risk modelling. The paper argues that for solvency testing purposes the valuation method of choice is market consistent valuation. Statutory valuation based on historical costs is at best irrelevant and possibly misleading in the case of a compulsory winding up of a company and of forced sales of assets. As far as risk modelling is concerned, it is argued that stress tests and scenarios have an important role to play. They can complement or replace stochastic risk models. They have in particular the advantage of enabling an effective involvement of senior managers and Board members in the company’s quantitative risk management. It is argued that supervisors could use two co-existing models for solvency testing purposes: a probabilistic model and a set of scenarios based Solvency Capital Requirements. The paper draws on the experience of the EU regulatory authorities, CEIOPS and EIOPA, with the development of Solvency II. It also draws on the experience of FINMA, the Swiss supervisory authority, with the implementation of the Swiss Solvency Test. Finally, it takes into account the lessons of the Japanese life insurance crisis from 1997 to 2001.