Solvency II – The Ultimate Formula for Managing Solvency Capital Requirement

Solvency Capital Requirements – or SCR – are the key numbers of Pillar I of Solvency II. Any company concerned (e.g. an insurer) must calculate a capital according to its liabilities and its assets. The resulting number gives the theoretical level of capital that provides the solvency and viability of the company. Therefore, it should be essential to understand how each line contributes to the total SCR of the balance sheet. Of course, for assets or liabilities that are exposed to a single risk factor, it is not difficult. However, if some of them are subject to two or more risk factors, we must consider the correlations between these factors.We present in this short article a formula that gives this contribution (called marginal SCR) of each line of the balance sheet. This decomposition integrates the correlation matrix of risk factors and the sum of the marginal SCR gives to total SCR. This formula should be an important tool to manage the financial statement and in particular to manage liquid assets of the company. In addition, an asset manager exposed to multiple risk factors for a single instrument (like a corporate bond or a structured product) will use this formula to select assets in light of Solvency II