Interest rate models in Solvency II

Abstract

The best estimate of liabilities is important in the Solvency II framework. The best estimate of liabilities should be probability weighted average of future cash flows discounted to its present value. Life insurance companies need stochastic models to produce future paths for interest rates, bond returns and currency. These paths should be risk-neutral, meaning that interest rate models is important to consider in the Solvency II framework. In this thesis we have studied three different interest rate models, namely; the Hull-White extended Vasicek model, the CIR++ model and the G2++ model. We calibrated our interest rate models to the same historical data and generated 10 000 simulations based on the yield curve and the parameter estimations. Based on the interest rates simulated we presented a synthetic example for calculating the best estimate of liabilities. In this example, the duration of the liabilities turned out to be an important factor.