Trade-off between asset allocation and Solvency II requirements - the case of a Portuguese life insurer

This study examines the trade-off between asset allocation and Solvency II requirements in the context of a specific Portuguese life insurer. Under the Solvency II regime, life insurers must maintain sufficient capital to cover risks, particularly market risk, which is significantly impacted by asset allocation decisions. The challenge lies in balancing profitability with the necessity to maintain a strong solvency position. To address this, an optimization model was developed to derive optimized asset allocation strategies that aim to maximize the insurer’s profitability while adequately accounting for the Solvency Capital Requirement for the Market Risk sub-module (SCR Market). The model also incorporates investment limits to ensure that the asset allocations align with the life insurer’s investment strategy. The results demonstrate that the life insurer’s profitability can be increased while maintaining the same SCR Market value by reallocating toward more capital-efficient asset classes, such as corporate bonds and property. However, despite their higher return potential, equities were excluded from the optimized portfolio due to their significant impact on the SCR Market. An efficient frontier analysis further illustrates the trade-off between profitability and solvency, showing how asset allocation shifts to maximize profitability as different solvency positions are targeted. This work provides valuable insights for life insurers, demonstrating how optimized asset allocation strategies focused on capital-efficient assets can improve profitability while still maintaining strong solvency positions.