The risk margin is a regulatory capital buffer required under Solvency II that represents the cost of transferring an insurance liability to a third party under conditions of uncertainty. It is distinct from the best-estimate liability (the probability-weighted mean of future cash flows) and reflects the additional capital a hypothetical buyer would demand to bear the non-hedgeable risks embedded in the portfolio — including longevity risk.
Under Solvency II, the risk margin is calculated using the cost-of-capital method: the insurer must hold sufficient capital such that a hypothetical reference undertaking could absorb a 1-in-200-year (99.5th-percentile) adverse scenario. For longevity-linked liabilities (annuities, pension buy-outs), the relevant shock is an extreme improvement in mortality rates beyond the best-estimate projection.
The risk margin directly determines how much regulatory capital an insurer or pension fund must hold against longevity-linked liabilities. For multi-population portfolios (e.g., insured lives vs. general population), the choice of mortality model — and whether it accounts for subpopulation divergence — can change the required risk margin by tens of percent.