View source for Definition:Equity risk sub-module

📉 '''Equity risk sub-module''' is a component of the [[Definition:Market risk module | market risk module]] within the [[Definition:Solvency II | Solvency II]] [[Definition:Standard formula | standard formula]], designed to capture the potential loss an [[Definition:Insurance carrier | insurer]] could suffer from adverse movements in the market value of its equity holdings. Insurance companies routinely invest portions of their [[Definition:Investment portfolio | investment portfolios]] in listed and unlisted equities to generate returns that support long-term [[Definition:Policyholder | policyholder]] obligations, and the equity risk sub-module quantifies the capital charge required to absorb a severe decline in those asset values over a one-year period consistent with a 99.5% [[Definition:Value at risk (VaR) | value-at-risk]] confidence level.

⚙️ The sub-module applies prescribed stress factors — calibrated shocks — to different categories of equity holdings. Under the standard formula, equities are typically divided into Type 1 (listed in regulated markets in EEA or OECD countries) and Type 2 (other equities, including unlisted holdings, private equity, hedge funds, and equities listed in non-OECD markets), with Type 2 attracting a higher stress percentage to reflect its greater volatility and illiquidity. A [[Definition:Symmetric adjustment | symmetric adjustment mechanism]] modifies the base stress up or down depending on the current level of a reference equity index relative to its three-year weighted average, preventing pro-cyclical capital requirements during market extremes. Insurers using an [[Definition:Internal model | internal model]] rather than the standard formula may calibrate equity shocks based on their own portfolio composition and historical analysis, subject to [[Definition:Insurance regulator | supervisory]] approval. [[Definition:Correlation matrix | Correlation]] parameters prescribed in the standard formula then aggregate the equity risk charge with other market risk sub-modules — [[Definition:Interest rate risk sub-module | interest rate]], [[Definition:Spread risk sub-module | spread]], [[Definition:Property risk sub-module | property]], and [[Definition:Currency risk sub-module | currency]] — to produce an overall market risk capital requirement that accounts for diversification.

🌍 The equity risk sub-module has a direct influence on how insurers allocate their assets. Because the capital charge for equities is among the most punitive in the standard formula, many European insurers have shifted portions of their portfolios away from equities toward [[Definition:Fixed income | fixed income]] instruments since Solvency II took effect in 2016 — a behavioral shift that regulators and policymakers continue to debate, particularly in the context of long-term infrastructure investment and economic growth. To address this tension, mechanisms like the [[Definition:Long-term equity investment | long-term equity]] treatment and the [[Definition:Duration-based equity risk sub-module | duration-based approach]] offer reduced charges for qualifying holdings, encouraging insurers with long-dated liabilities to maintain strategic equity allocations. Outside Europe, other capital regimes handle equity risk differently: the [[Definition:Risk-based capital (RBC) | NAIC RBC framework]] in the United States applies asset risk factors (C-1 charges) that vary by equity class, while [[Definition:C-ROSS | C-ROSS]] in China and the [[Definition:Hong Kong Insurance Authority | Hong Kong RBC framework]] each embed their own equity stress calibrations. Regardless of jurisdiction, the treatment of equity risk remains one of the most consequential design choices in any [[Definition:Insurance solvency regulation | solvency regime]], shaping investment behavior across the industry.

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Market risk module]]
* [[Definition:Standard formula]]
* [[Definition:Symmetric adjustment]]
* [[Definition:Spread risk sub-module]]
* [[Definition:Interest rate risk sub-module]]
* [[Definition:Internal model]]
{{Div col end}}