In recent years we have witnessed the rapid emergence of national and international regulations that enforce a stricter oversight on the financial markets. Prime examples are the Financial Assessment Framework (FTK) in the Netherlands, Twin Peaks and Individual Capital Assessment (ICA) in the United Kingdom, and the Swiss Solvency Test (SST), as well as more international-oriented directives such as Basel II and Solvency II. This increased awareness of all kinds of financial risks has resulted in a growing attention for the concept of Risk-Based Capital (RBC).
RBC is the buffer that a company needs to survive unexpected losses with an acceptable level of confidence, usually over a period of one year. In this case assets and liabilities are typically valued on an economic basis (i.e., market value including guarantees and embedded options). Risks are divided into different kinds of risks on the one hand (such as market risks, credit risks, insurance risks and operational risks) and product groups on the other hand. RBC results are used to calculate the required capital, but also form an important component in assessing the Risk-Adjusted Return On Capital (RAROC) at the balance sheet, portfolio or product level.
RBC calculations can be carried out on the basis of a number of deterministic shocks as well as on the basis of comprehensive stochastic simulation techniques. ALS Life is perfectly suited for calculating the RBC because all components required for such calculations (like the market valuation of assets and liabilities) are standard features of the model.
A special case of RBC calculations is formed by the Dutch (FTK) solvency test. Although these requirements are momentarily postponed for Dutch insurers, the calculations are already used by insurers to justify their policy to the supervisory authority (the Dutch central bank).