In the valuation of the Solvency II Capital Requirement, the correct appraisal of risk dependencies acquires particular relevance. These dependencies refer to the recognition of risk diversification in the aggregation process and there are different levels of aggregation and hence different types of diversification. For instance, for a non-life company at the first level the risk components of each single line of business (e.g. premium, reserve and CAT risks) need to be combined in the overall portfolio, the second level regards the aggregation of different kind of risks as, for example, market and underwriting risk, and finally various solo legal entities could be joined together in a group. Solvency II allows companies to capture these diversification effects in capital requirement assessment, but the identification of a proper methodology can represent a delicate issue. Indeed, while Internal Models by simulation approaches permit usually to obtain the portfolio multivariate distribution only in the independence case, generally the use of copula functions can consent to have the multivariate distribution under dependence assumptions too. However the choice of the copula and the parameter estimation could be very problematic when only few data are available. So it could be useful to find a closed formula based on Internal Models independence results with the aim to obtain the capital requirement under dependence assumption. A simple technique, to measure the diversification effect in capital requirement assessment, is the formula, proposed by Solvency II Quantitative Impact Studies (QIS), focused on the aggregation of capital charges, the latter equal to percentile minus average of total claims amount distribution of single line of business (LoB), using a linear correlation matrix. On the other hand, this formula produces the correct result only for a restricted class of distributions, while it may underestimate the diversification effect. In this paper we present an alternative method, based on the idea to adjust that formula with proper calibration factors (proposed by Sandström, (2007)) and appropriately extended with the aim to consider very skewed distribution too. In the last part considering different non-life multi-line insurers, we compare the Capital Requirements obtained, for only premium risk, applying the aggregation formula to the results derived by elliptical copulas and Hierarchical Archimedean Copulas.
- Aggregation and dependency in non-life insurance
- Hierarchical Archimedean copulas
- Internal Model
- Premium Risk
- reinsurance treaties