Measuring risk charge for market risks

An insurance company is significantly affected by market risks. In many current risk-based capital models, the market risk capital charge is determined by applying the fixed pre-determined percentage to the annual statement values regardless of market conditions. Many questions have been raised as to whether the fixed predetermined percentage is the accurate measure of market risks. In response to this problem, this paper undertakes to determine a suitable percentage for the market risks faced by life insurers in Malaysia. The data involved in this paper are Kuala Lumpur Composite Index (KLCI), Malaysia Bond Index, foreign exchange rates and Housing Price Index (HPI) for year 1994 to 2008. The volatility of the percentage returns for each index and foreign exchange rate is calculated. Based on the analysis, the percentage of risk charge for market risks is higher during the crisis as compared to the normal market condition. As the ups and downs of the market conditions significantly affect the percentage of risk charge for market risks, it can be concluded that the fixed pre-determined percentage is not a practical measure.