Navigating the Volatility Adjustment in Solvency II : Portfolio Optimization for Balance Sheet Stability

Sammanfattning: This thesis investigates volatility adjustment from the Solvency II regulation and portfolio allocation methods for pension- and life insurance companies aiming to maintain a stable balance sheet. The volatility adjustment is a component added to the risk-free rate for discounting the present value of future liabilities, and it is calculated monthly based on the spread levels in the fixed-income market. A change in the methodology of calculating the volatility adjustment is expected in the coming years, and therefore this is also examined. This study employs historical data analysis to estimate the volatility adjustment values and uses a comparative study approach to analyze the present value of liabilities. Portfolio optimization methods are performed to compare ways that an insurer can keep a stable balance sheet, such as mean-variance optimization, along with monitoring the duration of the assets and liabilities. One of the anticipated changes in the volatility adjustment calculation is the introduction of a company-specific factor, which may lead to a higher or lower value than the current volatility adjustment. This factor, reliant on the insurers' asset-liability composition, may incentivize insurance companies to alter their portfolio structure to achieve a higher volatility adjustment. Results from the portfolio optimization indicate that reducing the duration gap between the asset portfolio and liabilities can mitigate volatility and enhance returns on the surplus, likely by balancing the interest rate sensitivity.