Solvency and systemic risk of European life insurers

The paper presents two risk-based capital frameworks for systemically important European life insurers by drawing a distinction between solvency risk and systemic risk. Solvency risk arises when the value of a life insurer's assets falls below some threshold proportion of its liabilities. To assess solvency risk we implement the Merton-Vasicek portfolio credit risk model and determine capital adequacy of life insurers that correspond to a value-at-risk measure. We measure systemic risk as the expected capital shortfall of an insurer conditional on the overall European life insurance sector being in distress. Our results show that European life insurers have been growing in systemic risk exposure since 2007 and suggest that regulatory capital requirements should account for this. We also find evidence of interconnectedness between systemically important banks and insurance companies, as measured by the transmission of volatility shocks, which increased during periods of financial stress.