Solvency capital requirement for insurance products via dynamic cash flow matching under lattice models

Abstract

PurposeThe purpose of this paper is to propose a framework based on cash flow matching for computing the Solvency Capital Requirement under Solvency II.Design/methodology/approachThe time horizon of the insurance liabilities is typically longer than the maturities of bonds available in the market. With the assumption that a collection of bonds will be available for purchase in the future, the authors study the cash flow matching program under interest rate lattice models.FindingsThe solution can be interpreted as the worst‐case cost and the economic capital can be found accordingly.Originality/valueThe paper illustrates the methodology of computing the Solvency Capital Requirement using a dynamic cash flow matching framework under lattice models. The proposed method is particularly useful for insurance products with a typical long time horizon when most duration matching techniques are not easily applicable.