Reinsurance as Capital Optimization Tool under Solvency II

The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues.An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished.The papers carry the names of the authors and should be cited accordingly.The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors.They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. Policy Research Working Paper 6306This paper compares solvency capital requirements under Solvency I and Solvency II for a sample mid-size insurance portfolio.According to the results of a study, changing the solvency capital regime from Solvency I to Solvency II will lead to a substantial additional solvency capital requirement that might represent a heavy burden for the company's shareholders.One way to reduce the capital requirement under Solvency II is to increase reinsurance protection, which will reduce the net retained risk exposure and hence also the solvency capital requirement.Therefore, this paper proposes an extended reinsurance structure that, under Solvency II, brings the capital requirement back to the level of that required under Solvency I.In a step-by-step approach, the paper demonstrates the extent of solvency This paper is a product of the Non-Banking Financial Institutions, Finance and Private Sector Development.It is part of a larger effort by the World Bank to provide open access to its research and make a contribution to development policy discussions around the world.Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org.The author may be contacted at egurenko@worldbank.org.relief attained by the insurer by applying different possible adjustments in the reinsurance structure.To evaluate the efficiency of reinsurance as the solvency capital relief instrument, the authors introduce a costof-capital based approach, which puts the achieved capital relief in relation to the costs of extending the reinsurance protection.This approach allows a direct comparison of reinsurance as a capital relief instrument with debt instruments available in the capital market.With the help of the introduced approach, the authors show that the best capital relief efficiency under all examined reinsurance alternatives is achieved when a financial quota share contract is chosen for proportional reinsurance.