30. Capital management I Flashcards
Why do we need capital
To cover unexpected losses
What are the types of capital
Economic
Regulatory
Rating agency
What are the two subsets of economic capital
Working capital
Risk capital
Define risk capital
Capital required to cover unexpected losses from exposure to risks associated with an organisation’s existing assets and liabilities
What are other definitions of capital
- Surplus needed to cover all potential utgoings, redcutsions in assets and/or increases in liabilities at a given risk tolerance over a specified time horizon
- Surplus needed to maintain given level of solvency at a given risk tolerance over specified time horizon
- Excess value of assets over value of liabilities at given risk tolerance over specified time horizon
What is free capital?
- Excess of available capital over the required capital
- BoD decide how much to retain and how much to distribute
What are the benefits of effective capital management
Can help transorm risk to increase shareholder value through
* Competititve pricing»_space; adequate ROC
* Reserving e.g. improving reserve estimates needed for claims outstanding
* Performance management- allows business outcomes to be measured and processes to be adapted accordingly
* Risk management - establishing overall risk tolerance, identifying and assessing risks present and keeping risks under control
What are the uses of capital models?
- Help set investment strategy
- Value business being bought/sold
- Analyse impact of mergers/acquisitions or sales/divestments, on risk profile and capital requirements
- Identify impact of a disaster scenario
- Identify weaknesses in business and help develop appropriate solutions and risk mitigation techniques
- Allocate capital across business lines
- Measure risk-adjusted return achieved on capital
- Develop optimal mix of products to sell
- Compare cost of holding capital on balance sheet vs cost of reinsurance
- Incentivise management as part of targeted incentive programme
- Assist in modelling cashflow requirements, assessing volatility of reserves and in setting appropriate prices / premiums
- Set risk limits
- Meet statutory reserving requirements/tests
Outline the main uses of capital models for an insurer
- Determine regulatory capital requirements
- Know amount of capital needed to withstand certain level of loss as part of internal risk control processes
Why is the complexity of generic capital models increasing?
- Increasing sophistication of internal risk management processes
- Previous models failing to appropriately deal with risk
- Increasing pressure to optimise capital
Describe a generic model
- Used by capital providers and regulators to get consistent assessment of capital requirements across different firms
- Usually simple, e.g. factor based approaches
What are tje two types of capital models
- Generic
- Internal
Describe an internal capital model
- Gives company-specific view of the capital needed and aims to cover …
… all the risks faced in a consistent way allowing for interactions between risks - Subjective- results must be used with care
What are the 6 stages of implementing a successful internal model?
- Identify purpose of the model
- Identify and rank key risks to be modelled
- Choose simulation approach for each risk
- Select appropriate risk metrics
- Decide on modelling criteria
- Determine an implementation method
Compare generic and internal models
- Generic modelnused to simulate general environment in which company operates. The model may produce expected profit info / consider risk of incolvencu
- Generic models developed by regulatory bodies or investors, while internal developed by management to assess capital needs
- Generic models may be tailored to some degree to company, while internal models allow for specific circumstances of company concerned and so more accurate and useful in decision-making processes
- Good internal models can break up and aggregate capital requirements between diff lines of business with a view to improve overall capital return