Capital Allocation Methods under Solvency II: A Comparative Analysis

Abstract

The objective of this document is to analyze different methods that an insurer can use to allocate capital to his or her different lines of business or business segments under Solvency II. For this analysis, a review of the main methods developed in the literature is carried out. Many of the proposed methods in the literature can only be implemented with the internal data from the company’s loss distributions. In addition to this, in some of the methods that can be applied with external data, the diversifying effect is in essence not assigned to the lines of business (LoBs) that cause it. Therefore, in this paper, we compare the results of the main methods that can be used with public data and propose a simple method of capital allocation for insurance companies, which does not require knowledge of the loss distribution of an LoB, and which allows the diversification benefit to be assigned only to the LoBs that really cause such an effect. A practical example of the differences between the different methods and the one proposed is shown for better understanding.