Economic Scenario Generator: Best Practice in Solvency II

In 2009 European Union approved Solvency II, the new regulatory framework for insurance companies to achieve stability for the financial system. The first part of the thesis provides a general description of the main challenges introduced by the European Directive. It states the main differences with the previous framework, focusing on the new capital requirements to better understand and quantify the insurance risk profile. A particular attention is given to the calculation of the best estimate liabilities and to the market consistent valuation, designed to reach a more relevant approach for the estimation of technical provisions, irrespective of accounting purposes. In the second part of the thesis it is introduced the concept of Economic Scenario Generator (ESG), a well-defined stochastic environment that permits insurance companies to achieve a market consistent valuation of the best estimate liabilities. It is provided the properties and targets of the methodology by looking at the main phases of an ESG process. In the last part it is given a general framework about the stochastic approach used to build an ESG, by looking at the modelling of the main risk an insurance company is exposed to: interest rate, equity and credit. In particular, the last chapter present a comparative analysis of two of the most important models used by insurance undertaking to account for interest rate in an ESG.