Will Solvency II Market Risk Requirements Bite? The Impact of Solvency II on Insurers’ Asset Allocation

The European insurance industry is among the largest institutional investors in Europe. Therefore, major reallocations in their investment portfolios due to the new risk-based economic capital requirements introduced by Solvency II would cause significant disruptions in European capital markets and corporate financing. This paper studies whether the new regulatory capital requirements for market risk are a binding constraint for European insurers by comparing the required market risk capital of the Solvency II standard model with the Standard & Poor's rating model for a fictitious, but representative, European-based life insurer. The results show that for a comparable level of confidence, the rating model requires 68 per cent more capital than the standard model for the same market risks. Hence, Solvency II seems not to be a binding capital constraint for market risk and thus would not significantly influence the insurance companies’ investment strategies.