Soft Comput
DOI 10.1007/s00500-015-1847-6
METHODOLOGIES AND APPLICATION
Relevant applications of Monte Carlo simulation in Solvency II
Giuseppe Casarano1 · Gilberto Castellani2 · Luca Passalacqua2 ·
Francesca Perla3 · Paolo Zanetti3
© Springer-Verlag Berlin Heidelberg 2015
Abstract The definition of solvency for insurance com-
panies, within the European Union, is currently being
revised as part of Solvency II Directive. The new defini-
tion induces revolutionary changes in the logic of control
and expands the responsibilities in business management.
The rationale of the fundamental measures of the Directive
cannot be understood without reference to probability dis-
tribution functions. Many insurers are struggling with the
realisation of a so-called “internal model” to assess risks
and determine the overall solvency needs, as requested by
the Directive. The quantitative assessment of the solvency
position of an insurer relies on Monte Carlo simulation,
in particular on nested Monte Carlo simulation that pro-
duces very hard computational and technological problems
to deal with. In this paper, we address methodological
and computational issues of an “internal model” designing
Communicated by V. Loia.
B Paolo Zanetti
paolo.zanetti@uniparthenope.it
Giuseppe Casarano
giuseppe.casarano@alef.it
Gilberto Castellani
gilberto.castellani@uniroma1.it
Luca Passalacqua
luca.passalacqua@uniroma1.it
Francesca Perla
francesca.perla@uniparthenope.it
1 Alef Avanced Laboratory Economics and Finance, Rome,
Italy
2 Department of Statistical Sciences, Sapienza, University of
Rome, Rome, Italy
3 Department of Management and Quantitative Studies,
University of Naples “Parthenope”, Naples, Italy
a tractable formulation of the very complex expectations
resulting from the “market-consistent” valuation of funda-
mental measures, such as Technical Provisions, Solvency
Capital Requirement and Probability Distribution Forecast,
in the solvency assessment of life insurance companies. We
illustrate the software and technological solutions adopted
to integrate the Disar system—an asset–liability compu-
tational system for monitoring life insurance policies—in
advanced computing environments, thus meeting the demand
for high computing performance that makes feasible the cal-
culation process of the solvency measures covered by the
Directive.
Keywords Life insurance policies · Monte carlo simula-
tion · Nested simulation · Modelling uncertainty · Stochastic
models · Risk assessment · Asset–liability management
1 Introduction
With the European Directive 2009/138—Solvency II—
Directive (2009) “on the taking-up and pursuit of the business
of Insurance and Reinsurance”, the probability distribution
functions enter significantly the balance sheets of European
insurance companies. The Directive changes the manage-
ment style of insurance undertakings, changes the logic
of the evaluation process of the fundamental measures
(reserves, solvency margin) and requires insurance under-
takings to evaluate values and risks in a “market-consistent
way”1 , thus giving a prominent role to the “evaluation
1 Whenever the term “market-consistent” valuation is referred in this
paper, it is be construed as follows: if the contracts are hedgeable (and
then market valuation is available) the market-consistent value is given
by the market price, that is to say a “marked to market” valuation; if the
contracts are non hedgeable (and then a market valuation is unavailable)
123

model under conditions of uncertainty”. The Directive intro-
duces hence new valuation criteria (“mark to market” and
“mark to model”), neologisms in the glossary of insurance
companies—Technical Provisions (TP ) in place of math-
ematical reserve, Solvency Capital Requirement (SCR ) in
place of solvency margin, Probability Distribution Forecast
(PDF )—; requires to evaluate the Technical Provisions in a
market-consistent way and to measure the Solvency Cap-
ital Requirement with the Value-at-Risk (VaR) approach
(confidence level = 99.5 %, unwinding period = 1). The
application of the Solvency II principles gives rise to very
hard theoretical and computational problems; the market-
consistent valuation, the estimation of SCR , the elicitation
of distribution functions are very computationally demand-
ing and “time-consuming”, because of the complexity of the
contracts and the great number of contracts in each port-
folio. For portfolios usually held by insurance companies,
closed-form solutions are not available, and evaluation mod-
els rely on Monte Carlo simulation. However, the estimation
of some fundamental measures in Solvency II, like the SCR ,
requires the simulation of a very large number of scenarios
to describe the tails of the distribution, thus resulting in a
“compute-intensive” process. To make the evaluation model
of “effective” use, therefore, the computational performance
of the simulation process plays a crucial role.
The implications and requirements introduced by the
Directive become particularly compelling when the com-
panies calculate TP and SCR using an “internal model”
(Directive 2009, art. 112). The “internal model” is a sys-
tem used by the undertakings to assess risks and determine
the overall solvency needs, ensuring the quality standards
indicated by the Directive and subject to the approval of
the national supervisory authority (Directive 2009, art. 112–
127). Nevertheless, the “internal model” must allow to obtain
responses in a suitable turnaround time; it is then a challeng-
ing matter to focus on numerical simulation, with the aim
of obtaining adaptive solution processes, that is, capable of
being properly scaled to balance accuracy and computational
efficiency on demand, depending on the evaluation context.
There is further an issue of timeliness, beside methods
and culture; the first reporting on Forward Looking Assess-
ment of Own Risks (Directive 2009, art. 45), (EIOPA 2013)
(based on the Own Risk and Solvency Assessment principles
[(Directive 2009, art. 45), (EIOPA 2012)] has been delivered
to the national regulator by 31 October 2014; the first annual
reporting within twenty-two weeks from the end of 2014; the
first quarterly reporting within eight weeks from the end of
third quarter 2015.
Footnote 1 continued
the market consistency must be guaranteed by an evaluation model, that
is to say a “marked to model” valuation.
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G. Casarano et al.
For all this it is mandatory for firms to quickly adopt a com-
plex simulation system, able to provide market-consistent
evaluation of values and risks and to perform timely mea-
surements, as required by regulations, to carry out continuous
verifications. The development of such a system requires
a strong synergy between high-level theory and high-level
technology, that is a synergy between models and tech-
niques of quantitative finance, computational schemes and
data management. The appropriateness of data quality and
models as well as accuracy and efficiency of computation
and the adequacy of the IT infrastructure are more and more
preconditions for an efficient governance of insurance com-
panies.
The contributions in this study are manifold: first, a
tractable formulation of the problem of Risk Margin Assess-
ment in the context of policies with profit is given. Second,
a nested simulation environment is set up that is capable of
handling the problem in its entirety, in contrast with previ-
ous works that only concentrated on partial aspects. Third,
strategies to alleviate the computational burden of the nested
Monte Carlo simulation are analysed and evaluated. Fourth, a
complete architecture for the simulation environment is pre-
sented. The findings of this study can be interesting for other
researchers working in all areas where nested simulation is
applied.
Section 2 gives some technical background and describes
the framework for assessing solvency in an insurance con-
text and sets out a roadmap to the probability distribution
forecast. The following Section sketches the main ideas
of nested Monte Carlo simulations, emphasizing the com-
putational issues to be coped with. Section 4 describes
the architecture of the DISAR (Dynamic Investment Strat-
egy with Accounting Rules), a simulation system designed
for computing Technical Provisions and Solvency Capital
Requirement—also in compliance with the Own Risk and
Solvency Assessment, the ORSA—as requested by the Direc-
tive to the “internal model” (Castellani and Passalacqua
2011). In Sect. 5, our approach to the nested simulation is
detailed. Section 6 illustrates the computational environment
and some results of numerical simulations and performance
evaluation. Section 7 concludes the paper.
2 General scheme for solvency assessment
2.1 Basic definitions: technical provisions, net asset
value, solvency capital requirement
Solvency can be defined as the ability of an insurance under-
taking to discharge its indebtedness. The estimation problem
of Technical Provisions (TP ), Net Asset Value (NAV ) and
Solvency Capital Requirement (SCR ), introduced by the
Directive Solvency II, involves the market-consistent valua-
Relevant applications of Monte Carlo simulation in Solvency II

tion of all components of the asset–liability insurance portfo-

lio. The expected payments and their associated expenses are
the liabilities of an insurance contract. The SCR determines
the amount of capital that ensures that an undertaking will
be able to meet its obligations over 1 year with a probability
of at least 99.5 % (Directive 2009, art. 100), which limits the
chance of falling into financial ruin to less than once in 200
cases.
In the art. 77 of the Directive the TP is defined as the
sum of the Best Estimate (BE) and the Risk Margin (RM)2 .
Art. 77.4 states that the Technical Provisions can be com-
puted “as a whole” “where future cash flows [...] can be
Fig. 1 Fundamental measures in Solvency II
replicated reliably using financial instruments for which a
reliable market value is observable; the value of technical
provisions associated with those future cash flows shall be of NAV (denoted with E[NAV(T )]) and of a percentile, at
determined on the basis of the market value of those finan- a prefixed confidence level α(= 0.005), of the NAV distrib-
cial instruments. In this case, separate calculations of the best ution at a future time T > 0 (NAVα (T ) with T = 1 year).
estimate and the risk margin shall not be required”3 . It is rel- Then the SCR , evaluated in t = 0 for the future time T > 0,
evant to note that that the replication must be interpreted as is given by
referred to risk components (hedgeable or non hedgeable)
and not to cash flows.
SCR(0, T ) = [E[NAV(T )] − NAVα (T )] v(0, T ), (3)
Let V (t; X) be the market-consistent value of the assets
X and V (t; Y) the market-consistent value of the liabilities
Y at time t, where where v(0, T ) is the risk-free appropriate discount factor pre-
vailing in the financial market at time zero for the maturity

nx ny
 T.
y
V (t; X) = Vkx (t), V (t; Y) = Vk (t), (1) In Fig. 1 is represented the graphical illustration of the
k=1 k=1 “fundamental” measures of Solvency II.
In the representation, assets and liabilities are put beside
with n x (n y ) the number of assets (liabilities) and with Vkx (t) for emphasizing the need to adopt an unified set of valuation
y
(Vk (t)) the value of the kth asset (liability) contract4 . criteria able to measure all elements (“assets” vs “technical
With our assumption, the TP is the market-consistent provisions” + SCR ) in the logic of “total balance sheet”,
value of the liabilities, that is V (t; Y). implementing a consistent plan of “asset–liability manage-
The NAV is defined as the difference between the value ment” (ALM)5 .
of assets and liabilities:
2.2 Evaluation principles
NAV(t) = V (t; X) − V (t; Y). (2)
The PDF is defined in art. 13 of the Directive Solvency
The SCR estimation, that is consistent with the definition II: “probability distribution forecast means a mathemati-
of discounted VaR as referred to in the Directive for “inter- cal function that assigns to an exhaustive set of mutually
nal models”, involves the evaluation of the expected value exclusive future events a probability of realisation”; it is con-
sidered a fundamental component of the “internal model”.
2 The BE “shall correspond to the probability-weighted average of Art. 121 says that the calculation the probability distribution
future cash-flows, taking account of the time value of money (expected forecast has to “be consistent with the methods used to calcu-
present value of future cash-flows), using the relevant risk-free interest
late technical provisions” and the art. 122 says that “where
rate term structure, [...] up-to-date and credible information and realistic
assumptions and be performed using adequate, applicable and relevant practicable” the SCR should be evaluated “directly from
actuarial and statistical methods”; the RM “shall be such as to ensure
that the value of the technical provisions is equivalent to the amount 5
that insurance [...] undertakings would be expected to require in order The asset–liability management, in the Professional Actuarial Spe-
to take over and meet [...] obligations” (Directive 2009, art. 77). cialty Guide (Luckner et al. 2002), is defined as “the practice of
3
managing a business so that decisions on assets and liabilities are
Otherwise, the risk margin is calculated using a “Cost-of-Capital” coordinated; it can be defined as the ongoing process of formulating,
approach (Salzmann and Wüthrich 2010). implementing, monitoring and revising strategies related to assets and
4 Here and in the following it is supposed that the RM for the non liabilities in an attempt to achieve financial objectives for a given set of
hedgeable risk components is zero. risk tolerances and constraints”.

123

the probability distribution forecast generated by the inter-
nal model” using the Value-at-Risk approach at a confidence
level of 99.5 %, over a one-year period.
An evaluation principle must be introduced since, for esti-
mating TP , NAV , SCR , the valuation of both assets and
liabilities is required. The valuation is performed assuming
that all the random variables concerning the valuation prob-
lem are defined on a probability space(, F , P), where 
denotes the space of events, F the σ -algebra of the measur-
able events and P is the physical probability measure (also
known as the real-world measure).
The most relevant technical issues in the evaluation
can be illustrated—without loss of generality—taking into
account only the “risk drivers” of financial risk. The risk
drivers (interest rate, inflation, stock price, exchange, credit,
contract-specific risk sources) are modelled by a multivariate
stochastic process, possibly a Markov one, Z(t).
The value in 0 ≤ t ≤ H , V (t), of a generic contract (asset
or liability) with term H , under the necessary assumptions,
is given by
  
 2.3 Life insurance policies “with profit”
V (t) = EP ξ(H )V (H )Ft , (4)
where ξ(t) is a suitable “state-price deflator”. In this market,
we assume the existence of a suitable equivalent martingale
measure M (risk-adjusted, forward or others) under which
 
V (H ) 
V (t) = N (t) EM Ft , (5)
N (H )
where N (t) is the corresponding numéraire such that the
process Y (t) = V (t)/N (t) is a M-martingale; Ft is the
filtration at time t.
The interested reader may refer to Glasserman (2004) for
an introductory treatment of the mathematical background
involved. If the time t = 0 is the current time, V (0) is known
with certainty, while V (T ), 0 < T ≤ H is a random variable
depending on the Z(t) trajectory in [0, T ].
In many cases of practical interest, the closed-form solu-
tion (or accurate approximations at least) of assets’ value
is available, while liabilities value, due to the complexity
of payoff, cannot be computed analytically; thus a viable
approach is to rely on numerical simulations. The numerical
approach for evaluating liabilities, shown below, can also be
applied to assets when no closed-form solution on the asset
side is accessible.
V (t) is the expected value of a multivariate distribution
that, as is the case of insurance contracts, is defined on a very
complex domain and with a cumulative distribution function
not available in closed form. This leads to having to neces-
sarily use Monte Carlo simulation for computing the integral
in (5), possibly in combination with other techniques for the
management of complex payoff.
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G. Casarano et al.
The SCR estimation requires the evaluation of the
expected value E[NAV(T )] and the percentile NAVα (T ). In
general, the NAV distribution is not available even in cases
in which the joint distribution of risk drivers is known and
a closed-form valuation of NAV is available [e.g. a straddle
on stock (Hull 2012)]. So also in this case it is necessary
to use simulation methods to numerically calculate approxi-
mate values of SCR , Monte Carlo simulation being the most
suitable one to elicit an empirical probability distribution of
NAV .
In summary, considering the typical composition of insur-
ance company portfolio, in the evaluation process of NAV ,
the liability value V (t; Y) has to be evaluated using Monte
Carlo simulation, either for t = 0 or for t = T , while in gen-
eral the asset value V (t; X) can be calculated in closed-form
otherwise using in the same way Monte Carlo simulation.
It is relevant to note that in accordance with the ORSA
requirements, NAV(T ), E[NAV(T )] and SCR(T, s) must be
calculated with 0 < T < s < H .
Participating life insurance contracts are characterized by an
interest rate guarantee and some “profit sharing rules”, which
provide the possibility for the policyholder to participate
in the earnings of the insurance company. These contracts
then usually contain “embedded options”, typically “cliquet”
options (De Felice and Moriconi 2004). The discussion of the
valuation of such policies provides the opportunity to eluci-
date most of the theoretical and computational issues in the
application of Solvency II principles, as well as the comput-
ing methods and technologies needed to achieve timely and
reliable risk estimates.
In the following, the general methodological approach of a
Solvency II compliant simulation scheme is applied to
profit sharing life insurance policies (PS policies) with min-
imum guarantees6 . In these contracts—widely diffused in
Italy7 —the benefits which are credited to the policyholder are
indexed to the annual return of a specified investment portfo-
lio, called the segregated fund (in Italian gestione separata).
A profit sharing policy is a “complex” structured contract,
with underlying the segregated fund return. Since the policies
are “non hedgeable” contracts, the market-consistent valua-
tion requires a “mark to model” approach based on a suitable
stochastic model calibrated on the market data, where uncer-
tainties are of actuarial and financial type.
6The extension to unit-linked and index-linked policies is straightfor-
ward in more usual cases.
7 At the end of year 2011 the Italian Supervisory Authority listed 386
segregated funds, belonging to 70 insurance companies, with the overall
amount of statutory reserves summing up to about 305 billions euros.
Relevant applications of Monte Carlo simulation in Solvency II
2.4 Contractual structure of profit sharing life
insurance policies
The asset–liability framework for evaluation of “Italian style”
PS policies with minimum guarantees can be described
considering a single-premium pure endowment insurance
contract, written at time 0 for a life of age x and initial sum
insured C0 . Following a typical interest crediting mechanism,
the benefits are readjusted at the end of the year T according
to the revaluation rule
C T = C 0 T , (6)
where the readjustment factor T is defined as

Y T = Y0 T px is the actuarially expected benefit. Notice that
T
T = max (1 + ρk ), (1 + γk ) T
, (7)
k=1
where γk is the minimum guaranteed annual rate at the year k
(beyond the tecnical rate). The readjustment rate ρt is defined
as
max {min{βk Ik , Ik − ηk } − ck − i k , δk }
ρt = , (8)
1 + ik
where Ik is the annual rate of return of the segregated fund
in the year [k −1, k], δ k is the minimum guaranteed annual
cliquet rate, βk ∈ (0, 1] is the participation coefficient, ck is
the management fee, ηk is the minimum annual rate retained
by the insurance undertaking, and i k is the technical rate. Ik
is a random variable; it is computed using “accounting rules”
and it depends on the management strategy of the fund. All
the other quantities are contractually defined and in many
cases are constant values.
If we denote by ε(x, T ) the event that outcomes to pay-
ment (e.g. “the aged x insured is alive at time T ”), then the
benefit for the policyholder—the liability of the company—
in T is given by
YT = C0 T Iε(x,T ) ,
where Iε(x,T ) is the indicator function of ε(x, T ), expressing
“technical” (actuarial) uncertainty. YT is then affected by
financial and actuarial uncertainty.
2.5 On the valuation of financial component
In a market-consistent valuation framework of the policy,
the value of liability at time t, V (t; YT ), can be expressed
as the expected value of the payoff at time t = T , weighted
by a suitable state-price deflator (see Sect. 2.2). Assuming
independence between actuarial and financial uncertainty,
the expectation can be factorised. Finally, the expectations
can then be rewritten with a change of measure, employing
the so-called risk-neutral probability measure Q. Under Q
prices measured in units of the value of the money market
account are martingales. Accordingly,
  
YT 
V (t; YT ) = E Q
T Ft T px
r (u)du 
e t
 
 T

= Y T E Q T e− t r (u) du Ft , (9)
where rt is the instantaneous intensity of interest rate ( “spot”
rate) determining the value of the money market account, Ft
is the filtration containing the information about financial
events, T px is the risk-neutral probability that an individual
aged x will persist for T more years (lapse included) and
both ρt and rt are Ft -adapted random variables.
A closer inspection of the payoff of the policy in eq. (9)
shows that it includes embedded options8 , whose underlying
is the segregated fund return. The presence of the options can
be made explicit by expressing V (t; YT ) using either a put or
a call decomposition (De Felice and Moriconi 2005, p. 91):
V (t; YT ) = Bt + Pt = G t + Ct , (10)
where Bt is the value of a risky investment (base component)
and Pt that of a put option; G t is the value a guaranteed invest-
ment and a Ct that of a call option, or—in the words of the
Directive—the policy guaranteed benefits and its future dis-
cretionary benefits (FDB) (Castellani and Passalacqua 2011).
The put and call decompositions are very relevant to control
the values of financial guarantees; the evaluation of call com-
ponent is explicitly requested by the Commission Delegated
Regulation (EU) (OJ 2015, art. 15): [...] when calculating
technical provisions, insurance and reinsurance undertakings
shall determine separately the value of future discretionary
benefits.
The liability side of the policy then contains complex
options which are hard to value.
Further, the return of the segregated fund—which repre-
sents the “underlying” of the policy—is strongly influenced
by the “management actions” of the insurer (Castellani and
Passalacqua 2011). The complexity of profit sharing rule and
the management actions involved entails to use numerical
simulation for valuating the liability; the risk-neutral expec-
tation V (t; YT ) in (9) is then computed by Monte Carlo
simulations on fine grained grid time 9 .
8
A call option gives right to buy, whereas a put option means the right
to sell, an asset—the underlying—at a predetermined price.
9 For an exhaustive analysis of the basic principles and methodological
approach for a valuation system of profit sharing policies with mini-
mum guarantees we address to Castellani et al. (2004); De Felice and
Moriconi (2004, 2005).
123

3 Nested Monte Carlo simulation
The nested Monte Carlo simulation is a technique widely
used for valuating risks with fixed time horizons. A well-
known application of nested simulation approach in finance
literature was originally proposed for pricing American
options by Broadie and Glasserman (2007). An exposure of
the application of nested simulation approach to portfolio risk
measurement is given in Glasserman (2004) and McNeil et al.
(2006). Now the nested simulation is beginning to find appli-
cation in calculation of insures’ capital requirements (Bauer
et al. 2012).
The nested Monte Carlo simulation is at present, for insur-
ance undertakings, the most suitable approach to measure
the Solvency Capital Requirement with the Value-at-Risk
approach as required by the Directive Solvency II, since it
allows to elicit an empirical probability distribution function
of the contracts values in future time and then the correspond-
ing moments and percentiles.
Considering the evaluation of an insurance liability V (T )
with term H , in 0 ≤ T ≤ H (for example the liability value
V (T ; YH ) of a policy with profit in Sect. 2.3), the nested
Monte Carlo technique requires the following:
1. the simulation of n P sample paths (Z(t)(i) ), i =
1, . . . , n P , from t = 0 to t = T under the real-world
measure P, conditional to F0 (in particular conditional
to Z(0) if Z(t) is a Markov process);
2. for each of the n P sample paths (Z(t)(i) ) from t = 0 to
t = T , the simulation of n M sample paths (Z(t)(i, j) ),
j = 1, . . . , n M , from t = T to t = H under the equiva-
lent martingale measure M (for example the risk-neutral
probability Q), conditional to FT (in particular condi-
tional to Z(T ) if Z(t) is a Markov process).
The number of simulations in each of the two levels, that is
the values of n P and n M , must be sufficient to ensure that
the selected risk measure can be calculated with a prefixed
approximation error and in pre-established computing time.
It has been shown that the value of n M —the number of
“inner” simulations—influences the accuracy in the V (T )
estimation, while the value of n P —the number of “outer”
simulations—affects the numerical precision in the valua-
tion of the percentile of V (T ). In more detail, it has been
demonstrated that, in the evaluation of the percentile, the
asymptotic variance of the estimator is determined by the
number of real-world scenarios, while the asymptotic bias
of the estimator is influenced by the number of risk-neutral
scenarios used in each portfolio re-valuation (Broadie et al.
2011; Gordy and Juneja 2010).
Nested Monte Carlo simulation sounds simple in prin-
ciple, but its implementation in practice is a computational
challenge; it results in a nested “stochastic” simulation with
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G. Casarano et al.
a large number of “inner” simulation for each “outer” sce-
nario for the risk drivers valuation. The total number of
simulations—“inner” and “outer”—may be very high in view
of typical values of the number of simulations used by insur-
ers to valuate future liability cash-flows and of the number of
“outer” simulations that may be needed to obtain reliable esti-
mates. Further, the amount of computational effort depends
not only on the total number of simulations but also on the
computational cost required to valuate liability cash-flows in
each “outer” scenario.
The nested Monte Carlo simulation can also be applied in
the calculation of the PDF and the “parallel” implementation
can drastically reduce the computational effort required, as
the experiments results in Sect. 6 show.
Recently, different techniques have been proposed in liter-
ature with the aim to reduce the computational cost of “full”
nested simulation, Least-squares Monte Carlo (Bauer et al.
2010a, b) and Replicating portfolio (Lesnevski et al. 2008)
techniques among the others.
The Replicating portfolio approach requires to find a port-
folio of relatively simple assets that in some sense replicates
the behaviour of the liability cash flows, so that this portfo-
lio can be used as a proxy to value the liabilities. However,
in practice it is unlikely to find a replicating portfolio with
this properties. Capturing complex liabilities in insurance
portfolio, containing embedded options and reflecting the
management actions of insurance business, with portfolio of
simple assets can give rise to significant errors in the evalu-
ation of capital requirement.
The Least-squares Monte Carlo technique (Longstaff and
Schwartz 2001) allows to reduce the number of “inner”
scenarios: the value of an insurance liability V (T ) is approx-
imate by a finite linear combination of “basis” functions,
generally polynomials. Nested Monte carlo simulation and
least-squares regression are employed to determine the coef-
ficients in the linear combination. The choice of which
economic variables will act as state variables in the regres-
sion and of the basis functions in the linear combination is
crucial to have good estimations of future liabilities.
At present, the Least-squares Monte Carlo seems the most
promising approach; nevertheless, the investigation field is
still open and several solutions can be explored.
Soft computing techniques have a long account of appli-
cations to insurance solvency. In his survey, Shapiro reported
attempts dating back to the early nineties at using Neural Net-
works (NN) to predict bankruptcy of insurance undertakings,
with a major focus on early-warning systems leveraging the
classification power of NNs when analysing balance sheets
looking for factors that are predictive of bankruptcy (Shapiro
2002). The same author surveyed the literature on the appli-
cation of fuzzy logic to insurance-related problem in Shapiro
(2004). The different effects of stochastic uncertainty (risk)
and imprecision uncertainty (vagueness) in the Value-at-Risk
Relevant applications of Monte Carlo simulation in Solvency II
Fig. 2 Disar system
architecture
server
methodology were discussed in Zmeškal (2005), leading
to the fuzzy-stochastic approach. The fuzzy representation
of financial asset returns has been used by many authors
including, e.g. Yoshida (2009). More recent approaches have
been proposed for the quantification of claim reserving under
ambiguity (de Andrés-Sánchez 2012).
4 The DISAR system
Disar (Dynamic Investment Strategy with Accounting Rules)
is a simulation system for the monitoring of portfolios of
profit sharing Italian life insurance policies with minimum
guarantees, linked to “segregated funds”. Disar works in an
ALM framework and embodies the set of accounting rules
and the ALM strategy of the assets of the segregated fund,
which in turn determines the rate of return underlying the
policy10 . Disar is composed of a Database Management Sys-
tem and a set of computing engines. The simulation of the
evolution of market risk drivers is based on a stochastic
model; Monte Carlo simulation is used11 . As required by
the Solvency II Directive, Disar performs computations in a
market-consistent way at individual and aggregated level and
meets the requirements needed for the approval of internal
models.
4.1 The computing process
The computing process in Disar consists in two phases:
A—Actuarial valuation, that is the calculation of actuar-
ially expected cash-flows generated by the policies;
10 The methodological asset-liability management (ALM) framework
in which DISAR has been designed is detailed in Castellani et al. (2004).
11 A more detailed description of the Disar system is given in Castellani
and Passalacqua (2011).
Computing
Units
Service
B—ALM valuation, that is the evaluation of market-
consistent values of policies.
The cash-flows produced by A are an input to B.
The following definitions are useful to describe the com-
puting process of Disar:
• Elementary Elaboration Block (eeb) one of the two phases
A o B corresponding to a given segregated fund, for a given
set of parameters. An eeb is a computing “atomic unit”.
• Collective Elaboration (ce) one of the two phases A o B
corresponding to a set of given segregated funds. A ce is
a set of eeb.
4.2 The Disar architecture
The components of the system, shown in Fig. 2, are the fol-
lowing:
1. A Database Server, hosting a Relational DataBase Man-
agement System;
2. A Master Server, hosting the Disar Master Service
(DiMaS), that receives the primary requests from the
Clients, defines the elementary elaboration blocks, esti-
mates the complexity of the elaborations, establishes the
elaboration schedule, distributes the elementary requests
to the processing units and monitors the process.
3. A set of Computing Units: each unit hosts the Disar
Engine Service (DiEngS) that manages the Disar Actu-
arial Engine (DiActEng) and the Disar Alm Engine
(DiAlmEng).
– The (DiActEng) is in charge of phase A, that is per-
forms an eeb of type A;
– The (DiAlmEng)is in charge of phase B, that is per-
forms an eeb of type B;
123

– The (DiEngS) executes a single eeb of either one of
the two engines, it may write the results directly to
the Database or return them to the Master Server.
4. A set of Clients, each hosting the Disar Interface (DiInt)
that allows to set computational parameters and monitors
the progress of the elaborations.
4.3 Sources of uncertainty
Disar considers different sources of uncertainty, both finan-
cial risks, including interest rate risk, equity risk, inflation
risk, currency risk, credit risk, contract specific risk sources
and actuarial risks, such as longevity/mortality risk and thus
involves a large number of random variables. Actuarial risks
are assumed to be independent of each other, while finan-
cial risks are possibly correlated. A list—not exhaustive—of
the models used for the evaluation of the main risk drivers
includes, among the others, the Cox–Ingersoll–Ross (CIR)
model for the interest rate risk (Cox et al. 1985), the Black
and Scholes (BS) model (Black and Scholes 1973) for the
equity benchmark and the CAPM for the equity prices, the
lognormal model for the consumer prices and a determinis-
tic model for the expected inflation, the Duffie and Singleton
(1999) model for the credit spreads and the lognormal model
for the exchange rates12 .
5 Simulation process of Solvency II fundamental
measures in Disar
There is no doubt that the elicitation of the PDF of insur-
ance firm and the Forward Looking Assessment of Own
Risks, in compliance with the ORSA, raise severe theo-
retical problems on how to aggregate individual “random
components” and technical problems in relation to the
computational efficiency. The methodological approach that
insurance companies must put in place requires the invoking
of not only sophisticated valuation models—that is high-level
theory—but also efficient computation processes and high
computational capabilities—that is high-level technology.
Disar is able to provide (inter alia) the market value of
the policies, the (NAV ) of the ALM portfolio and the corre-
sponding components (base, call, put and guaranteed); the
Value of Business In Force (VBIF ); the overall SCR and its
components (interest rate, equity, mortality, etc.).
With the aim to improve the efficiency of simulation
processes, a reduction of the computation complexity of
the valuations is implemented in Disar by decomposing the
overall evaluation in the two phases A (actuarial) and B
12 See Table 1 in Castellani and Passalacqua (2011) for the list of main
risk drivers with the corresponding model used in Disar for the valuation.
123
G. Casarano et al.
(ALM) (See Sect. 4.1); by performing scenarios genera-
tion separately from the actuarial and ALM valuation—this
decoupling allows to use exogenous reference trajecto-
ries, moreover, the simulation of the trajectories can be
parallelised—; by performing on the liability side a decom-
position of the contracts, followed by an aggregation of
elementary contracts; by sub-dividing the evaluations to be
performed by processing and assembling eeb.
The above operations allow the implementation of Disar
in a distributed and parallel computing environment.
Disar is a high complexity simulation system; it is “data
intensive” and “cpu intensive”. To meet the needs of calcula-
tions and to preserve the data quality as well as the accuracy
and efficiency of computation, as required by the Directive
in the development of “internal models”, a grid computing
architecture of Disar has been designed to parallelize the
computing processes on a grid of conventional computers
with “reentrant” code. A strong reduction of the computing
time has been obtained already with a small number of non
specialised nodes (Castellani and Passalacqua 2011).
Since the most time-consuming jobs are those processed
by the ALM engine (DiAlmEng)—for evaluating (inter alia)
TP , NAV and SCR —that involve Monte Carlo calculations,
a further improvement of the system is achievable by par-
allelising the simulations13 . The parallelization strategy is
based on the distribution of simulations among processors;
processors work concurrently to compute the “local” aver-
ages that are afterwards combined to obtain the “global” final
sample values.
In the parallel simulation of TP —that is of V (t; Y)—,
let P the number of “parallel processes”, each process, con-
currently with the others, simulate n M /P trajectories under
the probability measure M and compute “local” average val-
ues; then concurs with other processes to perform a suitable
combination—generally an addition operation—of partial
results. (Communication among processes is limited to the
final phase.)
In Disar the evaluation of the empirical probability distrib-
ution of NAV(T ) with T = 1 year (See (2)), which is needed
to calculate the NAVα (T ) and the SCR(0, T ) in (3), is per-
formed by a “parallel” nested Monte Carlo simulation. The
simulations of the trajectories under the real-world measure
P are now assigned to concurrent processes; each process
performs, independently from the others, n P /P “outer”
simulations and for each of them performs the n M “inner
simulations”. (Communication among the processes requires
only the “collection” of results.)
13 The first experiences of parallelization of the algorithm implemented
in DiAlmEng are reported in Corsaro et al. (2009) presented to the 18th
International AFIR Colloquium (2008). A complementary approach to
the strategy described in Castellani and Passalacqua (2011) based on
the parallelization of the simulations on multicore architecture has been
developed in Corsaro et al. (2011) and De Angelis et al. (2013).
Relevant applications of Monte Carlo simulation in Solvency II
The coherence between the results of the sequential and
parallel simulations is guaranteed by the application of
suitable techniques of implementation of random numbers
generators; more precisely the generation of independent
streams is realized using the block-splitting (also called skip-
ahead) technique (Haromoto et al. 2008) that consists of
splitting the original sequence into k non-overlapping blocks.
Each of k blocks provides an independent sequence. If M
is the total number of random numbers generated in the
sequential simulation with a given initial seed, in the parallel
simulation fixing the same seed, each of P processes gener-
ates random numbers only from a block of length M/P that
is assigned to it.
The parallel approach in nested Monte Carlo simulation
can be used also to evaluate the NAV(T ), E[NAV(T )] and
SCR(T, s) with 0 < T < s < H in accordance with ORSA.
Bearing in mind the put or call decomposition in (10) of
the expected liability value of a policy with profit, the parallel
nested Monte Carlo simulation implemented in DiAlmEng
produces the empirical distributions of all components: base
and put components in the put decomposition and guaran-
teed and call component—that is the future discretionary
benefits—in the call decomposition.
6 Computational environment and numerical
simulations
The performance of Disar system was investigated on
multicore computing systems—standard “low cost” high-
performance architectures. The numerical experiments have
been performed on a multicore system installed at the Uni-
versity of Naples “Parthenope”: a Blade Server HP ProLiant
BL460c G6 with eight blades equipped with two Quad-Core
Intel Xeon E5540. The development software environment
used ensures portability and efficiency of the system. For
handling parallel processes the MPI library, that is de facto
standard library for message passing parallel programming,
is used; in particular, the Intel version is used that is com-
pliant with “MPICH ABI Compatibility Initiative” (Oyanagi
2014) ensuring the portability on a wide range of hardware
and software platforms.
The random numbers generators used are the MT 2003
(Matsumoto and Nishimura 2000) and MT 19937 (Mat-
sumoto and Nishimura 1998) based on the Mersenne Twister
algorithm for Large-Scale Monte Carlo simulation in dis-
tributed computing environments—respectively, a 64-bit
generator with period length 22203 − 1 and a 128-bit genera-
tor with period length 219937 − 1. Those random generators
provide mutual independence of the sequences and allow the
coherence between the results of the sequential and parallel
simulations by using the block-splitting method implemented
by the skip-ahead function. An input parameter to Disar
determines the generator to be used.
The analysis has been carried out on a single eeb of a
segregated fund of an Italian insurance company with seven
financial sources of uncertainty, including interest rate risk,
equity risk, inflation risk and currency risk.
6.1 Numerical results
The results reported below have been obtained by fixing the
computational budget n P × n M = 107 , since an analysis car-
ried out using different computational budgets has shown
that it is a suitable value for a testing from the accuracy and
computational point of view. Further, a simulation performed
with n P = 105 and n M = 104 is considered as a “full nested
simulation” for a comparison of the results.
Figures 3, 4 show, respectively, the empirical density func-
tion and the empirical cumulative distribution function, for
values of percentile at a confidence level between 0.1 and
0.9 %, of NAV(T ), with T = 1 year, of the considered eeb
at the evaluation date 31/12/2014, with different combina-
tions of values of real-world and risk-neutral trajectories.
As expected, Fig. 3 shows that more the value of n M
decreases more the distribution is dispersed, having a neg-
ative effect on the estimation of a percentile in the tail.
Analysing in more detail the behaviour of the distributions in
the tail (Fig. 4) in comparison with that of the “full nested”
distribution, it can be noted that the value of percentiles
decreases when the n M reduces, resulting in an underestima-
tion of the worst case value. On the other hand, low values
of n P produces non-smooth distributions and overestimation
of percentiles. In Table 1 are also shown the values of the
1.2e−05
empirical density function
8.0e−06
4.0e−06
5000 x 2000
10000 x 1000
25000 x 400
100000 x 100
100000 x 10000
0.0e+00
4e+05 5e+05 6e+05 7e+05 8e+05
NAV(1) (euro)
Fig. 3 Empirical density function of NAV(T ) with T = 1 year for
different value of n P × n M
123
 G. Casarano et al.

(n P and n M ) but also on the portfolio size; as the portfolio

size increases the computational effort to generate an inner
0.8

step simulation sample is large compared to the effort for

the generation of an outer sample (see Sect. 6.2). In Broadie
et al. (2011) is demonstrated that the variance is asymptot-
0.6

ically dominating the bias squared and then that it is better

percentile (%)

to use fewer inner trajectories and to increase the number

of real-world scenarios; in the experience of the authors, for
example, insurance companies apply 25,000 natural scenar-
0.4

ios and a number of risk-neutral simulations lesser than 100

in conjunction with Least-squares Monte Carlo technique or
5000 x 2000
equivalent methods.
0.2

10000 x 1000
25000 x 400
100000 x 100
100000 x 10000 6.2 Performance evaluation

435000 440000 445000 450000 455000
NAV(1) (euro)
Fig. 4 Empirical cumulative distribution function of NAV(T ) with
T = 1 year for different value of n P × n M
ratio between the estimated SCR(0, T ) with T = 1 year,
for each empirical distributions, and the Best Estimate; the
result, in per cent, provides guidance on the riskiness of
the policy. Further, the relative error in the estimation of
SCR(0, T ), assuming the “full nested” SCR as the exact
value, is reported. Now, the estimated ratios increase as n M
decreases. A reduction of the bias and then an improvement
of the estimation of a percentile in the tail require many
inner samples in each real-world scenario, but at the same
time a not small number of “outer” scenarios. Referring to
the performed experiments, the better approximation of the
“full nested” SCR , for the considered segregated fund, is the
combination 104 × 103 . In general, as already mentioned,
the selection of the value of the “inner” and “outer” scenar-
ios depends on the required approximation error and on a
pre-established acceptable computing time. The execution
times however, depend not only on the number of simulation
460000 465000 An analysis of the computational effort required to perform
the previous simulations is now described. The performance
of DiAlmEng is illustrated in the Tables 2, 3. Execution
times and the values of speed-up (the ratio of the sequen-
tial execution time to the parallel one) and efficiency (the
ratio of the speed-up to the number of cores) are reported for
the values of “inner” and “outer” simulations considered in
Sect. 6.1, varying the number of cores.
The execution times, fixed the number of cores, are very
similar. On one core, a slight increment of the execution times
is observed for higher values of “inner” trajectories.
The gain in terms of execution times is evident; “paral-
lel” nested Monte Carlo simulation speeds-up consistently
the simulation process. The speed-up increases almost lin-
early with the number of cores and the efficiency values are
very high (quite close to the ideal value of 1) for all numbers
of cores and for all combinations of n P and n M ; lower effi-
ciency values are obtained for the highest value of “inner” or
“outer” simulations. On several cores the computation with
the highest number of “outer” scenarios has lower value of
efficiency due to the increment of the number of results to
be collected (and then to the increment of communication
among the cores).

Table 1 SCR (0,1)/BE of the empirical distributions

nP × nM 5000 × 2000 10,000 × 1000 25,000 × 400 100,000 × 100 100,000 × 10,000

SCR (0,1)/BE (SCR relative error) 0.551 % (0.03349) 0.587 % (0.02829) 0.597 % (0.04574) 0.663 % (0.1618) 0.571 %

Table 2 Execution time

# cores 5000 × 2000 10,000 × 1000 25,000 × 400 100,000 × 100
(hh:mm:ss) for the eeb at
valuation date 31/12/2014 1 5:43:10 5:37:20 5:36:21 5:33:10
4 1:27:04 1:24:47 1:24:30 1:25:30
8 0:43:51 0:43:02 0:42:14 0:42:50
16 0:23:56 0:23:13 0.23:05 0:23:08
32 0:13:04 0:12:36 0:12:02 0:12:14
64 0:06:07 0:06:06 0:06:10 0:06:13

123
Relevant applications of Monte Carlo simulation in Solvency II
Table 3 Speed-up (efficiency)
# cores 5000 × 2000
4 3.94 (0.985)
8 7.83 (0.978)
16 14.34 (0.896)
32 26.26 (0.821)
64 56.10 (0.877)
Table 4 Performance on Collective elaboration at valuation date
31/12/2014
# cores n P = 100000, n M = 100
Execution time (dd:hh:mm) Speed-up (efficiency)
1 100:15:45 (estimated)
64 2:11:19 40.72 (0.64)
Similar performance results are obtained for a Collective
Elaboration, that is for the ALM valuation of a set of eeb.
In Table 4 the performance results, on 1 and 64 cores, of a
ce composed by six eeb for three segregated funds with both
financial and actuarial risks are reported. The combination
n P = 100,000, n M = 100 has been tested since, as shown,
produces the lower value of efficiency. High values of the
speed-up can be obtained scheduling the assignment to the
cores of the evaluation in sequence of eeb s in the ce; this
is because the number of real-world simulations is generally
very high and this ensures the full and optimal use of hard-
ware resources. In any case, when it is necessary, a different
“scheduling” procedure can be implemented using a “score”
that Disar calculates and assigns to each eeb on the basis of
an estimation of its computational complexity.
The values in Table 4 attest that the evaluation of the
overall solvency needs of an insurer is a strongly “time-
consuming” process.
Throughout the analysis makes evident that a Solvency II
“compliant” simulation system that allows a computationally
feasible and a reasonably accurate assessment of an insurer’s
solvency position requires an adequate IT infrastructure and
simulation procedures able to exploit the whole computing
power.
7 Conclusions
Monte Carlo—and nested Monte Carlo—simulation is in any
case the computational kernel of the simulation process in
the “internal model” of insurance undertakings and it is a
“compute-intensive” process when applied to the evaluation
of future capital requirements. The theoretical framework
and the “high technological” infrastructure of a simulation
system, like Disar, are then needful to meet the requisites of
the Directive Solvency II.
10,000 × 1000 25,000 × 400 100,000 × 100
3.98 (0.995) 3.98 (0.995) 3.90 (0.974)
7.84 (0.980) 7.96 (0.996 ) 7.78 (0.972)
14.53 (0.910) 14.57 (0.911) 14.40 (0.900)
26.77 (0.837) 27.95 (0.873) 27.23 (0.851)
55.30 (0.864) 54.54 (0.852) 53.59 (0.837)
In the end it is important observe that the overall SCR ,
and PDF , must take into account both life and non-life busi-
ness of insurance undertakings. The evaluation framework
described for the life insurance contracts can be applied to
non-life ones, Monte Carlo simulation is used. The simu-
lation process of values and risks of non-life business is,
however, a less time-consuming process. Suitable techniques
have to be used for the calculation of the aggregated SCR —
that is the overall solvency needs (Directive 2009, art. 45).
Compliance with ethical standards
Conflict of interest The authors declare that they have no conflict of
interest.
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