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

ABSTRACT

In response to criticism concerning the current solvency system, the European Commission is developing new rules for insurance companies operating in the member states of the European Union (EU). Under this so-called Solvency II concept, an insurer is allowed to verify its solvency by using an internal risk management model previously approved by the regulatory authority. In this article we develop such an internal risk management approach for property-liability insurers that is based on dynamic financial analysis (DFA). The proposed concept uses a simulation technique and models the central risk factors from the investment and underwriting areas of an insurance company. On the basis of the data provided by a German insurer, the ruin probabilities under different scenarios and varying planning horizons are calculated.