15 Capital Management Flashcards
Define Required Capital (2)
It is the excess of assets over liabilities required such that policyholder claims can be met with a high degree of certainty when they fall due.
Describe the three measures of required capital. (3)
- Economic Capital. This is the internal determination of capital required, based on a company’s own risk profile, risk appetite and ongoing business strategy.
- Regulatory Capital. Capital based on valuation rules for assets and liabilities prescribed by the regulator.
- Rating Agency Capital. The view of rating agencies. Important if you need to maintain a certain credit rating.
List six categories of risk to which a life insurance company is exposed. (6)
- Market risk
- Credit risk
- Insurance risk
- Operational risk
- Liquidity risk
- Group risk
State 3 reasons why life insurance companies require working capital. (3)
- To fund new business, including attracting support from intermediaries.
- To fund overheads and the development costs of organic expansion.
- To acquire other companies or blocks of business.
List seven reasons why life insurance companies need for capital has increased in recent years. (7)
- The costs of mis-selling compensation.
- Enforced flat charging structures (e.g. stakeholder pensions).
- Lower investment returns in a low inflation environment.
- Improving annuitant longevity.
- Implications of TCF.
- Increasing competition from fund management groups.
- Changing distribution patterns.
State four sources of a proprietary life insurance company’s required capital. (4)
- The initial capital from the first shareholders.
- Additional amounts subsequently subscribed by shareholders or raised through subordinated loan stock.
- Profits retained within the company.
- Consistent under-distribution of surplus in respect of past generations of with profits policyholders.
State three reasons why the amount of capital available to a proprietary life insurance company may have been depleted over the years. (3)
- Distribution of capital to shareholders as dividends.
- Losses on without-profit business to which shareholders are exposed to 100% of profit or loss.
- Consistent over-distribution of surplus in respect of past generations of with profit policyholders.
Describe what is meant by the inherited estate in a with profits fund. (5)
- It is the realistic value of the assets held in a with profits fund less the realistic value of the liabilities (taking into account PRE).
- In most with profit companies the estate has built up over many years.
- A company may have decided to retain this capital for commercial reasons (e.g. to attract new business or fund expansion).
- Ownership of the inherited estate and its uses are the subject of much debate.
- A company’s PPFM covers the intended management of its estate, its intended uses and target size.
List five possible uses of the inherited estate in a with profits fund. (5)
- Aiding investment flexibility in a with profits fund.
- Helping to meet regulatory capital requirements.
- Paying tax incurred by the fund on distributions to shareholders.
- Covering over-runs on existing and new business expenses.
- Helping to support smoothing flexibility.
State the two sources of capital available to a mutual life assurance company. (2)
- The initial or subsequent capital injected into the company.
- Any consistent under-distribution of surplus in respect of past generations of policyholders.
Describe the entity approach to running a mutual. (2)
- It assumes the available capital is there to support the company.
- The available capital does not belong to any particular generation of policyholders. In particular, not the current generation.
State six reasons a life insurance company might perform solvency projections. (6)
- To allow it to understand the evolution of its risk profile.
- To allow the impact of key business strategy decisions to be assessed.
- To help in preparing run-off plans for any with-profit funds that are closed or in decline.
- To estimate the pattern of capital releases and assess whether the company is achieving a suitable return on capital.
- To meet Solvency 2 requirements, e.g. for the pillar 2 ORSA. Projections of solvency capital are also required to calculate the risk margin component of technical provisions.
- To play a role in risk measurement and risk management.
Describe the two approaches to calculating economic capital. (2)
- Stochastic modelling. Used to assess market and credit risks using a large number of real world scenarios.
- Stress tests. Used when the distribution of a particular risk is less well understood.
When might different time horizons be suitable when assessing economic capital requirements? (2)
- A one-year time horizon may be suitable if the company’s risks can be hedged through the capital markets.
- A full run-off may be suitable if the risks cannot be hedged.
Outline the steps in using a proxy model. (5)
- Choose the type of proxy model, the key risk factors and their dependencies.
- Generate fitting scenarios using expert judgement and run the heavy model under these scenarios.
- Calibrate the proxy model to provide an acceptable fit in these scenarios, e.g. by using the least squares regression approach.
- Validate by using a set of out of sample scenarios and compare the results of the heavy model and proxy model.
- Re-calibrate the proxy model periodically.
