Reinsurance as capital optimization tool under Solvency II

This paper compares solvency capital \n requirements under Solvency I and Solvency II for a sample \n mid-size insurance portfolio. According to the results of a \n study, changing the solvency capital regime from Solvency I \n to Solvency II will lead to a substantial additional \n solvency capital requirement that might represent a heavy \n burden for the company's shareholders. One way to \n reduce the capital requirement under Solvency II is to \n increase reinsurance protection, which will reduce the net \n retained risk exposure and hence also the solvency capital \n requirement. Therefore, this paper proposes an extended \n reinsurance structure that, under Solvency II, brings the \n capital requirement back to the level of that required under \n Solvency I. In a step-by-step approach, the paper \n demonstrates the extent of solvency relief attained by the \n insurer by applying different possible adjustments in the \n reinsurance structure. To evaluate the efficiency of \n reinsurance as the solvency capital relief instrument, the \n authors introduce a cost-of-capital based approach, which \n puts the achieved capital relief in relation to the costs of \n extending the reinsurance protection. This approach allows a \n direct comparison of reinsurance as a capital relief \n instrument with debt instruments available in the capital \n market. With the help of the introduced approach, the \n authors show that the best capital relief efficiency under \n all examined reinsurance alternatives is achieved when a \n financial quota share contract is chosen for proportional reinsurance.