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Return on Risk-Adjusted Capital Under Solvency II: Implications for the Asset Management of Insurance Companies

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  • Alexander Braun

    (Institute of Insurance Economics, University of St. Gallen)

  • Hato Schmeiser

    (Institute of Insurance Economics, University of St. Gallen)

  • Florian Schreiber

    (Institute of Insurance Economics, University of St. Gallen)

Abstract

We derive a European life insurer’s return on risk-adjusted capital (RORAC) under the Solvency II capital requirements. To do so, we draw on historical time series data and construct a large number of asset allocations, taking into account current portfolio shares of the German life insurance industry. Subsequently, we determine expected profits and market risk capital charges by means of the standard formula. Our results indicate that the RORAC is mainly driven by the capital requirements, while the expected profits are almost irrelevant. Moreover, we show that less-diversified portfolios with high asset risk need to be backed by low capital buffers and therefore result in high RORAC values. Well-diversified portfolios with balanced risk–return profiles, on the other hand, involve higher capital charges and thus achieve low RORAC figures. Hence, under Solvency II, a RORAC-based performance measurement may have detrimental effects for a life insurer’s stakeholders.

Suggested Citation

  • Alexander Braun & Hato Schmeiser & Florian Schreiber, 2018. "Return on Risk-Adjusted Capital Under Solvency II: Implications for the Asset Management of Insurance Companies," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 43(3), pages 456-472, July.
    • Handle: RePEc:pal:gpprii:v:43:y:2018:i:3:d:10.1057_s41288-017-0076-x
    DOI: 10.1057/s41288-017-0076-x
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    References listed on IDEAS

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    1. Martin Eling & Hato Schmeiser & Joan T. Schmit, 2007. "The Solvency II Process: Overview and Critical Analysis," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 10(1), pages 69-85, March.
    2. Alexander Braun & Hato Schmeiser & Florian Schreiber, 2017. "Portfolio Optimization Under Solvency II: Implicit Constraints Imposed by the Market Risk Standard Formula," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 84(1), pages 177-207, March.
    3. Alexander Braun & Hato Schmeiser & Florian Schreiber, 2015. "Solvency II's Market Risk Standard Formula: How Credible Is the Proclaimed Ruin Probability," Journal of Insurance Issues, Western Risk and Insurance Association, vol. 38(1), pages 1-30.
    4. Düll, Robert & König, Felix & Ohls, Jana, 2017. "On the exposure of insurance companies to sovereign risk—Portfolio investments and market forces," Journal of Financial Stability, Elsevier, vol. 31(C), pages 93-106.
    5. Katharina Fischer & Sebastian Schlütter, 2015. "Optimal Investment Strategies for Insurance Companies when Capital Requirements are Imposed by a Standard Formula*," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 40(1), pages 15-40, March.
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    Cited by:

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