Research On Counter-cyclical Solvency Of Insurance Company

Investors can come to understand the risk level of insurance companies timely by solvency indicators which are key risk indicators of insurance companies. But sometimes the volatility of this indicator doesn’t mean the varying of the real risk level, and it would weaken the monitoring function of the indicators and the fairness of the indicators. For example, the solvency adequacy ratio of China Life has experienced a volatility of528%to164%during the period of2007to2011.In2010, China’s regulatory authorities declared that "We need to study the relationship between insurance regulatory policy and the economic cycle. Specifically, we should find the potential procyclical factors in our regulatory system, such as the internal risk assessment, reserve extraction, fair value measurement and solvency standard."The procyclical problems would have the systematic influence to the insurance field. However, taking a wide view of the existing studies on procyclicality, mainly concentrated on the theoretical studies and empirical analysis of the existence and the cause factors of bank’s procyclicality, proposes ways to mitigate the procyclicality and the research of counter-cyclical prudential regulation on the standpoint of banking practice. Just a few Scholars had discussed this phenomena in the insurance field, but these studies are superficial and sometimes their conclusions are inconsistent.Based on this background, this paper has study the relationship between the solvency adequacy ratio and the economic cycle by empirical methods. The research found that there is a close connection between the economic cycle and the investment risk.Firstly, the economic cycle can affect the investment risk which is a key factor in the pricing of financial assets. Secondly, the volatility of the value of financial assets will change the solvency adequacy ratio. So the procyclicality of investment risk is one of the reasons leading to solvency fluctuation.After discussing the impact of the procyclicality of investment risk on the solvency, the paper have put forward some interesting proposals to alleviate these procyclical effects.In this article, we have four sections to analyze our problem:The first chapter of this article, we briefly introduces the study purpose, the meaning of research and study the status, the content and methods.The second chapter and the third chapter is theory for this paper, detailed information about the meaning of procyclicality and the relevant theory such as Business Cycle Theory and the procyclical mechanism of solvency. In particular, we discuss the various reasons which make the solvency procyclical in detail. It includes the cyclical fluctuation of interest rate, the relationship between the insurance cycle and the economic fluctuations and the volatility of the investment risk of the insurance funds. Then our discussion focus on how financial assets of insurance companies lead to the procyclicality of the solvency under the assumption that there is positive correlation between business cycle and the level of investment risk of insurance funds.We conduct an empirical study about the above procyclical phenomenon, in chapter4. Firstly, we decompose the original time series of quarterly GDP growth rate and get the fluctuation components by H-P filter. Secondly, we introduce the KMV credit risk measurement model and use Matlab to calculate default distances of China’s50listed companies. Finally we construct an vector auto-regression model to study the fluctuating correlation dynamics between the default risk of the listed companies and the fluctuation components of the GDP growth rate. We find a positive correlation between the both of the above.Under the macro-prudential regulation, we should carry out counter-cyclical regulation in order to mitigate the impact of procyclicality on the economy. We suggest that, insurers or supervisors, should pay more attention to the procyclical effect in the solvency of insurance regulation. In order to mitigate the procyclicality of China’s insurance regulation, we have introduced the counter-cyclical capital buffer and the Risk-based capital requirement such as EU Solvency Ⅱ. Finally, we made some recommendations to improve the rules of the basic norms for measurement of financial assets in calculating the solvency of insurance companies.