New Risk-Based Capital Standards in the EU: A Proposal Based on Empirical Data

The current EU rules governing the solvency of insurance companies essentially base the required minimum equity capital on the volume of insurance business the companies write. Thus, no attempt is made to identify or quantify the central risks borne by insurance companies. In response to criticism of this approach, the European Commission is currently drafting the “Solvency II” project, which develops a totally new approach to solvency regulation. In analogy to the ideas discussed, and in part implemented in the European banking sector, a two-stage approach is being considered:- An evaluation model used by an internationally recognised rating agency serves as the basic concept (Stage I).- Instead of the Stage I basic concept, insurance companies can opt to use internal risk-management models (Stage II). Such internal risk-management models use quantification approaches whose validity is generally recognised and that are used regularly by insurers already in the context of inhouse risk management. Before an internal model can be used as the external measure of a company’s solvency, regulator approval is required. (...)The primary goal of this article is not to discuss these questions theoretically, but to show a practical implementation of the Stage II concept by using empirical data from a German property-liability insurance company. The ap-proach originates in dynamic financial analysis (DFA).