Equity Solvency Capital Requirements: What Institutional Regulation Can Learn from Private Investor Regulation

20 Pages Posted: 29 Aug 2017 Last revised: 16 Apr 2018

See all articles by David Blitz

David Blitz

Robeco

Winfried G. Hallerbach

Robeco Asset Management, Quantitative Investment Research

Laurens Swinkels

Erasmus University Rotterdam (EUR); Robeco Asset Management - Quantitative Investing

Pim van Vliet

Robeco Asset Management - Quantitative Investing

Date Written: April 3, 2018

Abstract

Solvency II has one standard equity solvency capital requirement for type 1 or developed market stocks (39 percent) and one for type 2 or emerging market stocks (49 percent). As such, differences in financial economic risk of stock portfolios within developed or emerging markets do not influence solvency requirements. This encourages risk-seeking behavior by insurance companies, and could sustain or even create structural mispricing in the cross-section of stock returns. We argue to improve Solvency II regulation by aligning it with more sophisticated European regulation that is already in place for mutual funds. Specifically, we propose to multiply the standard solvency charge of 39 percent with the ratio of equity portfolio volatility to broad equity market volatility. This ratio will be above one for more risky portfolios and below one for less risky portfolios, meaning that high-risk stock portfolios require more solvency capital than the market, while low-risk stock portfolios require less. Our approach encompasses the existing distinction between emerging and developed markets, and reduces geography to just one of many potential sources of risk that should be recognized. The proposed approach gives better incentives to institutional investors, contributes to market efficiency, and is much less prone to regulatory arbitrage than the existing approach.

Keywords: Capital requirements, Equities, Insurance, Pensions, Regulation, Solvency II

JEL Classification: G11, G18, G22, G23, G28, L51

Suggested Citation

Blitz, David and Hallerbach, Winfried George and Swinkels, Laurens and van Vliet, Pim, Equity Solvency Capital Requirements: What Institutional Regulation Can Learn from Private Investor Regulation (April 3, 2018). Geneva Papers on Risk and Insurance - Issues and Practice, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3024484 or http://dx.doi.org/10.2139/ssrn.3024484

David Blitz

Robeco ( email )

Weena 850
Rotterdam, 3014 DA
Netherlands

Winfried George Hallerbach

Robeco Asset Management, Quantitative Investment Research ( email )

Weena 850
Rotterdam, 3014 DA
Netherlands
+31102242316 (Phone)

HOME PAGE: http://www.robeco.com/quant

Laurens Swinkels (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Robeco Asset Management - Quantitative Investing ( email )

Rotterdam, 3000
Netherlands
+31 10 224 2470 (Phone)
+31 10 224 2110 (Fax)

Pim Van Vliet

Robeco Asset Management - Quantitative Investing ( email )

Rotterdam, 3011 AG
Netherlands

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