Evaluating the solvency capital requirement of interest rate risk in Solvency II

This report addresses whether the Solvency II standard formula provides a good measure for the interest rate risk an insurer is facing. To answer this question, several simplifications of the standard formula are considered and an alternative method is proposed to simulate the future term structures of interest rates to provide a better insight in the interest rate risk of an insurer. A case study considers three illustrative liability portfolios and the Solvency Capital Requirement (SCR) of interest rate risk is calculated based on the standard formula and the alternative method. The case study shows that simplifications in the standard formula can lead to serious drawbacks in the management of interest rate risk, especially with respect of liabilities with high expected premium income, long term guarantees and/or a material risk margin.