Target Solvency Ratio and Risk Appetite

Bogie Ozdemir

With respect to ORSA, the target (surplus) solvency ratio defines the minimum surplus capital required in terms of the relative relationship between available capital and risk capital under both expected and stressed economic outlooks. Analogous to target surplus ratios under regulatory frameworks (eg, 200% under MCCSR), the ORSA target solvency ratio is the ratio of internally estimated available capital to internally estimated risk capital. The relationship is formulated as:

$$\frac{\text{Available}\text{capital }\left(\text{ORSA-based}\right)}{\text{Required}\text{capital }\left(\text{risk capital}\right)}\ge Target\left(surplus\right)solvencyratio$$

We can start this chapter with a question: since risk capital is a more reliable measure, specific to our risk profile and measured at a higher confidence level than regulatory capital (eg, 99.5% under Solvency II versus 99.85% under ORSA), why do we need to hold surplus capital at all (ie, why do we need the target solvency ratio to be above 100%)? If we only hold the minimum required capital, then any loss would require the firm to raise capital to maintain its rating. This is simply not practical, as the firm cannot continuously raise capital. Moreover, firms