An Evaluation of Volatility Adjustment under Solvency II
Specialeforsvar ved Marie Louise Bitsch Lauritzen
Titel: An Evaluation of Volatility Adjustment Under Solvency II
Abstract: In the Solvency II framework, the European Insurance and Occupational Pensions Authority (EIOPA) allows the addition of a volatility adjustment to the risk-free rate in the discounting of long term insurance guarantees under specific circumstances. This thesis studies the arguments and mathematics behind the volatility adjustment and whether using the volatility adjustment can or cannot be said to be market consistent. We find that the volatility adjustment is not market consistent and that it is not market consistent to price any claim with other than the risk-free rate. We study the sensitivity of the reserve to the volatility adjustment and introduce the phenomenon duration. In addition, we introduce the solvency capital requirement (SCR) and calculate it with and without the volatility adjustment. Through stress scenarios of mortality risk, we find that volatility adjustment has a significant impact on the solvency coverage of a firm. Finally, we introduce callable bonds and the new and reduced volatility adjustment and discuss the impact of it.
Vejleder: Mogens Steffensen
Censor: Jeppe Woetmann