The Research On Economic Capital Allocation Of Solvency Risk In Property Insurance Company

Running a business dealt with risk, insurance companies face more uncertaintycompared than other financial firms. With the rapid development of the industry, thecompanies‘business environment has undergone profound changes, which bringsmore new risks to the insurance companies. Capital is the signal of the company‘sability against risks. Abundant capital ensures that the company has sufficient capitalto absorb the adverse situations. Effective capital management can help the insurancecompany with the accumulation of capital, sustainable sound operation anddevelopment. From within the company, the economic capital reflects its own risk andhas been widely used in foreign insurance industry as a new management tool. Theprocess of economic capital management includes economic capital measurement,allocation, optimization etc. Economic capital calculation can effectively identify andquantify the solvency risk, in turn determining the risky range that should to becovered by the economic capital. In addition, efficient economic capital allocationallows limited capital to the most profitable business, which avoids the waste ofresources. Meanwhile, by comparing the capital allocation efficiency among differentlines of business, the insurer can adjust the proportions of lines in orde r to get the bestcombination and maximize the return under a given risk. In general, the managementbased on economic capital is capable to guide the company’s risk management,strategic management and value management, which provides a basis for operatingdecisions, prevents the solvency risk effectively and as a result, increases the value ofthe company. Thus, the research of solvency risk based on economic capital is ofgreat significance in theory and practice.This dissertation starts from the definition of solvency risk and economic capital,which defines the solvency risk and compares economic capital with book capital andregulatory capital to make the connotation of economic capital clear. After settingforth the researches of solvency risk, economic capital measurement and allocation,this dissertation explains the theory of risk measurement, co-dependence and capitalallocation. Then it analyzes the solvency risk of the domestic property-liabilityinsurance market. After examining the influencing factors of solvency risk based onthe gray correlation analysis in order to find the essence of the solvency risk, thesolvency risk is decomposed into underwriting risk, market risk, credit risk and operation risk.On the basis of the above research, four different models are set consideringdifferent characteristics of the four risks. T-Copula is used to capture the correlationsamong the eight business lines of underwriting risk. Copula-GARCH-EVT model,data extrapolation technology and a topology model are used to describe the exposureof market risk, credit risk and operation risk respectively. Finally, an empiricalanalysis is introduced to get the loss distributions of each risk.Further, it constructs a model to calculate the total economic capital that theproperty-liability insurance company should hold in which vine copula is introducedto depict the co-dependence among the four risks and Wang transform is alsointroduced to adjust the integration loss distribution. Vine copula is used to integratethe losses caused by the four risks because that the existing multivariate copulas cannot choose appropriate function forms adapted to actual data flexibly. Besides, thisdissertation uses Wang transform instead of VaR as risk measure, which not onlymeets the characteristics of the consistency measures of risk, but also effectivelyovercomes the shortage of underestimating tail risk of the traditional methods. Basedon the model above, taking a representive property-liability insurance company as anexample, it calculates the total economic capital needed, which is compared with thatgained by Solvency II standard coefficient method. Emperical results show that whenmeasuring a company’s actual solvency risk, the method used in this dissertationallows the company holding less economic capital, proving that vine copula candepict co-dependence among different risks more effectively than Solvency IIstandard coefficient method, and that it has obvious advantages in calculatingeconomic capital an insurance company actually needs.As for underwriting risk and market risk, according to the smallest deviationmeasurement, minimuming deviation between each line of business and actual risk,this dissertation sets different allocation models to allocate economic capital. Theresults show that the capital allocated on auto insurance should be the biggest in theunderwriting risk and the financial bonds should be the biggest in the market risk. Asfor business line adjustment, aimed at maximize risk adjusted return on capital,ignoring real limitations, it sets up optimization model for underwriting and marketrisk. As empirical results shows, for underwriting risk, allocating all capital to theauto insurance is the best choice, while for market risk, treasury bonds and corporatebonds investment proportion should be increased, at the same time other‘s investmentproportion should be decreased. Finally, against the problems encountered in the capital allocation process, thisdissertation puts forward improvement suggestions from three aspects: the regulation,the association and the corporate. Regulatory authority should create economic capitalregulation system of solvency. The association should fully display its functional role.The corporate should construct economic capital allocation system. The constructionof regulatory system contains two aspects: deversifying economic capitalmeasurement methods and reinforcing the audit of methods and data. The associationshould play its functional role by keeping communication available, enhancing thecultivation of the specialized personnel and speeding up the construction ofinformation system. The economic capital allocation system of corporate contains fiveaspects, including cultivating economic capital management admosphere, improvingthe solvency risk economic capital measurement methods, choosing scientific capitalallocation models, selecting proper performance evaluation indexes and establishingcapital allocation feedback mechanisms.