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Economic Scenario Generators and Solvency II

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  • Varnell, E. M.

Abstract

The Solvency II Directive mandates insurance firms to value their assets and liabilities using market consistent valuation. For many types of insurance business Economic Scenario Generators (ESGs) are the only practical way to determine the market consistent value of liabilities. The directive also allows insurance companies to use an internal model to calculate their solvency capital requirement. In particular, this includes use of ESG models. Regardless of whether an insurer chooses to use an internal model, Economic Scenario Generators will be the only practical way of valuing many life insurance contracts. Draft advice published by the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) requires that insurance firms who intend to use an internal model to calculate their capital requirements under Solvency II need to comply with a number of tests regardless of whether the model (or data) is produced internally or is externally sourced. In particular the tests include a ‘use test’, mandating the use of the model for important decision making within the insurer. This means that Economic Scenario Generators will need to subject themselves to the governance processes and that senior managers and boards will need to understand what ESG models do and what they don't do. In general, few senior managers are keen practitioners of stochastic calculus, the building blocks of ESG models. The paper therefore seeks to explain Economic Scenario Generator models from a non-technical perspective as far as possible and to give senior management some guidance of the main issues surrounding these models from an ERM/Solvency II perspective.

Suggested Citation

  • Varnell, E. M., 2011. "Economic Scenario Generators and Solvency II," British Actuarial Journal, Cambridge University Press, vol. 16(1), pages 121-159, May.
  • Handle: RePEc:cup:bracjl:v:16:y:2011:i:01:p:121-159_00
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    Cited by:

    1. Klerkx, Rik & Pelsser, Antoon, 2022. "Narrative-based robust stochastic optimization," Journal of Economic Behavior & Organization, Elsevier, vol. 196(C), pages 266-277.
    2. Pfeifer Dietmar & Ragulina Olena, 2021. "Generating unfavourable VaR scenarios under Solvency II with patchwork copulas," Dependence Modeling, De Gruyter, vol. 9(1), pages 327-346, January.
    3. Gan Guojun & Valdez Emiliano A., 2017. "Valuation of large variable annuity portfolios: Monte Carlo simulation and synthetic datasets," Dependence Modeling, De Gruyter, vol. 5(1), pages 354-374, December.

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