Strategic Asset Allocation and Risk Budgeting for Insurers Under Solvency II

Solvency II is a new risk-based framework for setting the capital requirements of European insurance companies, in force since January 2016. The solvency capital requirement (SCR) is set such that the insurer can meet its obligations over the next 12 months with a probability of at least 99.5%. In this paper we derive expressions for an investment's marginal contribution to the solvency capital requirement, to provide insight in the risk allocation and the trade-off between return and marginal risk. In addition we derive the optimal strategic asset allocation for an insurer that maximizes the expected return on its own funds, subject to a limit on the SCR for market risk determined with the Solvency II standard formula. We then provide numerical examples to illustrate how the new framework for asset allocation and risk budgeting under Solvency II can be applied at a representative European life insurance company