The Research On Insurance Groups Regulatory Capital Arbitrage That Based On VaR And CTE Risk Models

Regulatory capital arbitrage is the financial institutions’ action to maximize their own interests or pursue improper benefits, by reducing the regulatory capital requirements, without changing the actual risk level. The difference between economic capital and regulatory capital is the root of the arbitrage. Economic capital is necessary for the financial institutions which is used to make up the unexpected loss and makes the institutions operate normally; regulatory capital is the minimal capital required by the authority, and regulatory capital is usually larger than economic capital to keep the financial system stable.Regulatory capital arbitrage could reduce the capital levels and ability to resist risks of financial institutions. In particular, the regulatory capital arbitrage behavior of the large financial institutions will be more likely to cause systemic risks. After the reflection on global financial crisis 2008, Guoping Huang (2014) and other scholars attributed the crisis to regulatory capital arbitrage and mismanagement of systemically important financial institutions. At present, domestic and foreign researchers have made some systematic study and achievements on commercial banks’ arbitrage. But in the insurance sectors, the study is still in its infancy. At the end of 2012, the total assets of our ten insurance groups accounted for 75.61 percent of the insurance industry. So insurance groups have systematic effects on the entire insurance industry as well as the financial system stability. Additionally, China Insurance Regulatory Commission is stepping up the construction of the second generation of solvency regulatory system, which means that it needs to absorb the latest research. Therefore, the insurance groups regulatory capital arbitrage has the very important research value.Qingjie Shen (2013) and many other scholars have made deep study on the meanings and measures of regulatory capital, economic capital, and analyzed the commercial banks’ specific ways, motives and effects of the arbitrage. They also probe the probability of the Basel regulatory agreement on eliminating the differences in economic capital and regulatory capital. Regarding measures to avoid regulatory capital arbitrage, the researchers also discussed the effectiveness of limiting the size of asset securitization, improving capital adequacy requirements, strengthening the management of rating agencies, and enhancing the bank’s specific risk analysis. The researches above provide us a reference on insurance sectors. Jianping Zhu and Rongjun Fang (2010) have researched insurance group’s special risks, such as capital double counting, insider trading, reinsurance risks, risks of infection. They also studied the financial holding company’s regulatory capital arbitrage parrerns. Their efforts offer a certain significance in this field. However, the existing literature still focus on bank regulatory capital arbitrage analysis, and based less on insurance companies and insurance group. They also don’t get rid of the shadow of commercial banks’content and methods.VAR and CTE model have been widely used in the world. Basel III, Solvency II and the Swiss Solvency Test (SST) all use these models to measure risk and capital adequacy. Shoukang Peng(2013) suggested that risk measurement model is also an important mode of regulatory capital arbitrage. Insurance companies, especially insurance group, whether through risk measurement model for arbitrage has not yet been examined. Because of the extremely subtle and complex nature, quantitative analysis and empirical study of regulatory capital arbitrage is another problem for the current banking or insurance industry. So the existing literature are basicly descriptive explanation and example-based analysis.This article analyzes regulatory capital arbitrage’s motives and patterns of the insurance group, and explains from the perspective of economic theory. Then, taking the widely used model VaR and CTE for example, though the built regulatory capital arbitrage model, the author investigates the effects and strategies of arbitrage in three different risk model scenarios, in which a insurance group consisted of two subsidiaries takes the related risk model. Aiming to generating reasons of the arbitrage, the paper designs a policy adjustment model to reduce the adverse effects of arbitrage. The results show that the use of risk measurement models can reduce the insurance group’s capital requirements, but the arbitrage action contains a huge risk. The results also indicate that policy adjustment model designed by the author can effectively reduce the negative impact of the arbitrage.The paper takes PICC’s historical data for example to conduct a quantitative empirical test by using R software. The test finds that the arbitrage can doubtlessly save a lot of capital for the group. To test whether our insurance groups carrying out regulatory capital arbitrage or not, the paper constructs three indicators to conduct a qualitative empirical test using solvency adequacy ratio as well. The test finds that some insurance groups inflate real capital, and contract minimal capital. In addition, the paper also estimates the impact of China insurance group’s arbitrage to consumers’ welfare by using 31 provincial-level panel data from 2008 to 2012 and Marshall demand function.Based on the perspective of risk models, the article enriches and promotes the theoretical research on regulatory capital arbitrage of the insurance industry; the quantitatively and qualitatively empirical analysis enriches and develops the arbitrage empirical research methods. These conclusions may provide valuable reference for the design of a sound regulatory system. They will also make our second generation regulatory system be able to consider the issue of regulatory capital arbitrage in the beginning of its establishment, and avoid the arbitrage hazards.