Life Modelling features@theactuary.com
Michael Kim describes the benefits and challenges of using realworld economic scenario generators (ESGs) for life insurance modelling purposes
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Solvency II is expected to come into effect in January 2016, and insurers who are not already doing so will be required to calculate a Solvency Capital Requirement (SCR). This is, in a nutshell, an answer to a ‘what-if’ question, namely, given the current mix of assets and liabilities, how much of a loss would be incurred if a 1-in-200 adverse event were to happen in the next 12 months? The internal model approach to answering this question involves generating a set of scenarios to represent possible states of the world, and revaluing the balance sheet under each. This is where ‘real-world’ economic scenario generators (ESGs) come in. From here, they can be used to gain insight into other risk management type questions. For example, if an alternative hedging or risk management method were to be implemented, how much residual risk would remain? Having a set of scenarios also gives us a means to assess how extreme a given stress scenario is, and help to identify which of the worst-case scenarios is most likely to cause the current business plan to become unviable. This is the so-called reverse-stress testing. In contrast to real-world ESGs, we have the so-called risk-neutral ESGs, which are typically used to perform a market-consistent valuation of liabilities both in the base balance sheet and the stressed scenarios. Calculation of all components of the
THE ACTUARY • November 2013 www.theactuary.com
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