ow quality (Tier 3) should not exceed one third of the total capital.

Secondly, the Solvency Capital Requirement corresponds to the economic capital a (re)insurance undertaking needs to hold in order to limit the probability of ruin to 0.5%, i.e. ruin would occur once every 200 years.

This means than each Insurance company should have its own capital requirement according to the risk they are taking.

AIG balance Sheet analysis and focus on CDSs

We saw previously how AIG was in danger before the crisis. This can be explained by the rapid growth of CDSs market.

Normally, an insurance company manages the risk using premium. They calculate the risk likelihood and establish a premium that cover that risk and allows the company to make profit. In the CDS’s market, the risk does not work that way.

For example, in normal cases, if your neighbor house is burnt, the likelihood that your house will also burn is independent. In the CDS market, the risk is not independent, it is exponential.

When there is one big credit default (bonds), it is contagious and the market is affected by that. We will have more and more credit defaults and a CDS insurer won’t be able to face it. The premium strategy won’t work. This is not the same risk evaluation.

This is exactly the reason why AIG asked for help from the US government during the crisis we are facing. They were not able to pay all the policy holders because the amount of credit defaults was too high.

To go further, we will be interesting to know how we can regulate the CDS market