Market Consistent ALM for Life Insurers—Steps toward Solvency II

We investigate the impact of the upcoming Solvency II guidelines on the risk/return trade-off for life insurance companies. Using the Dutch (FTK) regulatory framework (Financieel ToetsingsKader or Financial Assessment Framework) as an example, we demonstrate the huge impact of the elements of Solvency II (balance sheet approach, market valuation, etc.) on capital requirements. Much attention is also paid to the impact of the investment policy on the required capital. It is shown that by reducing the short-term risk (as measured by the required capital) the long-term expected returns may also decrease. Insurers should therefore (still) perform additional multi-period calculations for different stochastic scenarios in order to truly optimize their risk/return trade-off.