36 - Capital Management

Question 1

What does capital management of a financial benefit provider involve?

Answer 1

1. Ensuring sufficient solvency and cashflow to meet - existing liabilities and future growth aspirations
2. Maximising the reported profits.

Question 2

Give the capital needs of individuals.

Answer 2

1. Provide a cushion against unexpected events

2. Save for the future

Question 3

Give the capital needs of a company

Answer 3

1. Deal with the financial consequences of adverse events
2. provide a cushion against fluctuating train volumes
3. Finance expansion
4. Finance stock and work in progress
5. Obtain premises, hire staff, purchase equipment - start-up capital

Question 4

What characteristics of the business of financial service providers requires that they have more extensive needs for capital management?

Answer 4

The long-term nature of financial services products and the associated uncertainty.

Question 5

Give the extended capital needs of a financial service provider.

Answer 5

REG CUSHIONS

Regulatory requirements and demonstrating solvency
Expenses of launching a new product or operation
Guarantee financing
Cashflow timing management
Unexpected events of adverse experience cushion
Smooth profits
Help demonstrate financial strength
Investment freedom to pursue higher returns through mismatching
Opportunities such as mergers or acquisitions
New business strain capital requirements
Strategic objectives, meeting

Question 6

Give the capital needs of the state.

Answer 6

1. Support fluctuations in the balance of payments and economic cycle
2. Timing differences in income and outgo.

Question 7

How is the state’s capital needs different to that of the individual or company?

Answer 7

The state has unique avenues to raise finance:

1. Taxation
2. Borrowing
3. Printing money

Question 8

What type of reserves does the state normally hold?

Answer 8

Gold and foreign currency

Question 9

Give the unique way of raising finance open to a mutual insurer as an alternative to raising equity.

Answer 9

Subordinated debt: ranked after all other debt and the guaranteed policyholder benefits.

Question 10

What are the capital management tools available to providers?

Answer 10

1. Reinsurance
2. FinRe
3. Securitisation - SPV
4. Subordinated debt
5. Banking products
6. Derivatives
7. Internal restructuring.

Question 11

What two factors influence the effectiveness of any of the capital management tools available to providers.

Answer 11

The regulatory and tax environments that the company operates in.

Question 12

Explain how FinRe can be beneficial?

Answer 12

Requires different regulatory or tax treatments of the reinsurer and insurer, exploits making the repayments/premiums contingent on profit levels or the payment of policyholder benefits.

Question 13

Describe the banking instruments available to providers as capital management tools.

Answer 13

1. Liquidity facilities
2. Contingent capital
3. Senior unsecured financing

Question 14

What are the methods of internal restructuring available to financial providers as forms of capital management.

Answer 14

1. Merging funds
2. Changing assets
3. Weakening the valuation basis
4. Surplus distribution
5. Retaining profits

Question 15

Describe the methods open to a life insurance company that has seen a steady drop in free assets in the most recent period

Answer 15

1. Reduce the level of new business or close to new business
2. Seek assistance from a reinsurer
3. Change investment strategy
4. Change the type of business written to be more capital efficient
5. Defer profit distribution
6. One-off measure to boost the level of capital

Question 16

Describe the considerations for a life insurance company around reducing or closing to new business.

Answer 16

1. Will reduce new business strain - reducing initial expenses and sales commissions and the need to establish cautious levels of regulatory capital
2. This may cause long-run diseconomies of scale
3. Foregoes potential future profits

Question 17

Describe the potential advantaged for a life insurance company around seeking assistance from a reinsurer

Answer 17

1. May reduce regulatory capital requirements - reduces volatility of claims
2. Financial reinsurance could improve the solvency position - loans from the reinsurer that are contingent on future profits
3. Depends on the regulatory regime

Question 18

Describe the considerations for a life insurance company around changing investment strategy

Answer 18

1. Less volatile asset classes can reduce the total level of assets needed to back liabilities
2. Reduce mismatching reserve by seeking out a more matched position to liabilities
3. May be able to increase the discount rate used to value liabilities to improve solvency position
4. Could use derivatives to reduce market risk

Question 19

Describe the types of business to considerations for a life insurance company around changing the type of business written to be more capital efficient

Answer 19

1. reducing the level of guarantees under business sold
2. Selling unit-linked versions of contracts
3. Structure contracts with high initial charges or variable charges - usually with unit-linked contracts

Question 20

Describe the considerations for a life insurance company around deferring profit distribution

Answer 20

1. Reducing regular bonuses for with-profit business - aim to pay more terminal bonuses
2. Need to consider TCF
3. Can hold back dividends - may upset shareholders

Question 21

Describe the considerations for a life insurance company around one-off measures to boost the level of capital

Answer 21

1. Could raise raise capital through a rights issue, securitisation of a block of business or issue of subordinated debt or banking products such as contingent capital