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Title: Quantification of economic capital and its constituent risk components for life insurance annuity portfolios
Author: Gaven, Mayukh
Awarding Body: University of Kent
Current Institution: University of Kent
Date of Award: 2013
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Financial services firms are in the business of accepting risks on behalf of their customers. To protect the customers' interests, firms are generally required by financial services regulators to back their risks using an adequate amount of capital. This capital is often termed as risk-based or economic capital. More formally, economic capital is the amount of capital required to ensure that a firm remains solvent, over a specified time horizon, wit h a prescribed probability. With the advent of Basel 2 and 3 for banks and Solvency 2 for insurers, it is apparent that the regulators are keen to move towards an economic capital framework for assessing the solvency of financial services firms. In a Solvency 2 world, or otherwise where there is a need to place the business on a risk-based platform, the value of quantifying business risks appro- ~_ priately is critical. Economic capital can be calculated in many different ways and the implications of choosing a particular approach can have far-reaching consequences for the underlying business. In this thesis, we demonstrate the implications of solvency on an annuity business based on different approaches to compute economic capital. Moreover, financial services firms are exposed to different sources of risks simultaneously. These risks are often correlated and the economic capital required to mitigate individual risks vary immensely. Identification of individual business risks lies at the heart of a risk management process. Thus: the quantification should be based on a sound mathematical footing and should be appropriate as well as practical. Recently, longevity risk has been a major concern for the UK annuity business. Current England and Wales mortality trends show that annuita.nts are living longer than expected. Historically~ actuaries have consistently underestimated the mortality improvements in the UK, as evident from the Continuous Mortality Investigation reports, which resulted in increasing unexpected cost of guarantees. Furthermore, for the upcoming Solvency 2 regime, latest quantitative impact studies by Financial Services Authority have shown that the annuity business is faced with higher economic capital requirement than the current regulations require. Given trus backdrop, for a proper risk-based assessment of annuity business, adequacy of economic capital and identifi- cation of its true longevity risk component becomes a necessity. We thus study economic capital and its different risk components by analysing the surplus/ deficits of these components arising over the time horizon under con- sideration. We found that for this class of business and under traditional investment strategies, longevity is a less prominent threat than market risk. Then we compare our results with the corresponding Solvency 2 capital requirements. Further, due to the existence of mutual dependencies, capital required to mitigate multiple risks rarely adds up to the total economic capital. Clearly, there are potentially huge benefits if financial services firms choose to diver- sify their business across risk profiles, business lines and geographies. We investigate how the component risks could be diversified based on the firm size, gender combinations, risk interactions and over different geographical locations, under various economic capital calculation approaches.
Supervisor: Not available Sponsor: Not available
Qualification Name: Thesis (Ph.D.) Qualification Level: Doctoral
EThOS ID:  DOI: Not available