35 - Capital Management Flashcards
Why do we undertake capital management?
- Ensuring the provider has sufficient liquidity/solvency to enable its existing liabilities/growth aspirations to be met in all reasonably foreseeable circumstances
- To maximise reported profits of the provider
Why do individuals need capital?
- Survive financial consequences of unexpected events
- Build up capital to save for a large future expense or in anticipation of a fall in income (retirement)
- Allows people to overcome timing differences b/w incomes and outgo
Why do providers need capital?
PROTECTION
- Dealing with financial consequences of unexpected adverse events
- Cushion against fluctuating trade volumes & u/w cycle
- Meet benefits before sufficient premiums / contributions are received
OPERATION
- Cover new business strain (development exp.)
- Statutory solvency requirements
- Selling products with guarantees
REPUTATION
- Demonstrate financial strength (to attract clients)
- Smooth reported profits by using capital to pay dividends in years of poor profit
FREEDOM
- Strategic aims (new ventures, mergers & acquisitions)
- Invest more freely (mismatch)
What are examples of start-up costs/development expenses for providers in taking on new risks?
- Setting up suitable management systems to administer liabilities
- Collecting premiums & contributions
- Paying commissions to 3rd parties
- Investment expenses
- Administration expenses
Why does the government need to hold capital?
- Govt. may generally not need to build up capital in developed economy. Instead:
> Raises taxes
> Borrows money to meet outgo
> Print money (though inflationary) - However may build up reserves to support:
> Fluctuations in balance of pmts. in the economic
cycle - Short-term funds to manage the timing diff. b/w govt. income & outgo
How do proprietary companies raise capital?
- Issuing shares
- Issuing debt securities
- Refrain from distributing surplus & dividends to improve capital position
How do mutual companies raise capital?
- Require somebody to lend initial capital without need to pay back unless profits emerge
- Issue of subordinated debt
How do microinsurance schemes raise capital?
- Likely to have government support given their usual purpose of supporting low-income individuals
How does reinsurance help with capital needs?
- Reduces amount of capital needed
- Can act as source of capital
- Reinsurers contribute towards initial capital strain of selling a policy via reinsurance commissions
How to match and manage capital needs?
- Need to model the existing business and also the projected new business
- The model can generate the amount of capital needed for provider’s business plans to be achieved at a given ruin probability
- Model may also consider regulatory capital reqs. through lifetime for the lifetime of the business.
Capital management tools:
- Financial reinsurance (FinRe)
- Securitisation
- Subordinated debt
- Banking products
- Derivatives
- Equity capital
- Internal sources of capital
What does Financial Reinsurance entail?
- Exploit some form of regulatory arbitrage in order to manage the capital, solvency or tax position of a provider more efficiently
- Reinsurer may often need to be subject to different regulatory, solvency or tax positions than provider for FinRe to be feasible
Securistisation involves:
Converting an illiquid asset into tradable instruments
Subordinated debt benefits
- Improves the free capital position of the provider as it is not recorded as a liability when demonstrating solvency
Banking Products and their functions:
Liquidity facilities - Provides short-term financing for companies experiencing rapid growth eg funds new business strain
Contingent capital - Capital provided as required following a deterioration of experience ie. post-loss funding
Senior unsecured financing - Normal loan recorded as liability in the balance sheet
