36. Capital management TODO

Question 1

Who takes on risk of experience not being as expected?

Answer 1

• Expenses/costs

Question 2

Method give members a choice?

Question 3

Members need expertise to exercise the option?

Answer 3

• Investments need to be realised- generating associated costs
• Security+ guarantees does the method offer

Question 4

Any scheme surplus or deficit be crystallised?

Answer 4

• Chapter 36 Capital Management

Question 5

What does capital management involve?

Answer 5

• Capital management involves:
• Ensuring the provider has sufficient solvency and liquidity • To meet existing liabilities and future growth aspirations
• In all reasonably foreseeable circumstances.
• As well as maximising the reported profits of the provider.

Question 6

Who requires working capital?

Answer 6

• Providers of financial services- REGulatory CUSHION
•  Regulatory requirement to demonstrate solvency
•  Expenses of launching a new product/ starting a new operation
•  Guarantees can be offered
•  Cashflow timing management
•  Unexpected event cushions
•  Smooth profits
•  Helps demonstrate financial strength/ new business/ good credit rating
•  Investment freedom to mismatch in pursuit of higher return
•  Opportunities, e.g. mergers and accusations
•  New business strain financing
• Individuals
•  Cushion against unexpected events
•  Income and expenses do not match in terms of: o Amount o Timing
•  No Capital= Money needs to be borrowed
• Corporations
•  Financial consequences of adverse events
•  Cushion against fluctuating trade volumes
•  Build up funds- for planned expansion
•  Trading C- cashflow management
•  Venture capital o New business underestimate:
• Amount of Capital required
• Time before sufficient income is generated

Question 7

What costs will the provider be exposed to for taking on a new risk or type of liability for the first time? And how are they linked to business volume?

Answer 7

• Set up of suitable management systems to administer the liabilities- Overhead cost
• Collecting premiums/contributions- depends on business volume
• Paying commission to third parties- Business volume
• Investment expenses- Fixed costs + business volume
• Admin expenses- overheads+ business volume

Question 8

How will these costs be met until before sufficient premiums/ contributions have been collected?

Answer 8

• Capital- Provides an upper limit on the amount of business able to be written.

Question 9

What are the effects of changing amount business volume on capital required?

Answer 9

• Constant=> additional cap rolled over to the next tranche of business
• Increases=> Additional cap required
• Decreases=> permits release of capital

Question 10

What is the minimum capital requirement?

Answer 10

• Capital held in excess of the best estimate amount of future L outgo • Defined by legislation or regulation
•  Require Cap to be held in adv=>Not borrowed when required
•  Beginning+ expansion=> additional funding to maintain statutory requirements
•  Capital Riskiness of the business
• What influences the amount of capital required to be held? Investment Freedom
• The riskier the investment strategy
• With the aim of generating excess returns
• The greater the capital requirement
• Capital cushions any adverse movements Product guarantees
• Products with guarantees have a greater risk attached to them
• Greater capital requirement to write products
• Cap requirement=> max amount of guarantee product able to be written
• The greater the risk of guarantees being exercisable
• The greater the capital requirement Financial strength
• Determine new business levels
• Key determinants by potential clients deciding to place business or not Accounts
• Cap help smooth results
• Good period some income retained
• Bad period income is paid to maintain past levels
• Strategic aims
• Key role in achieving overall strategic direction
• Impacts mergers + acquisitions + new ventures

Question 11

Why does the government not have Cap requirements?

Answer 11

• Raise taxes
• Borrow=> low risk government bonds
• Or Print money=> inflationary in the long run
• MV=PY
• Build up + maintain reserves=> gold + foreign currency
• Require short term funds=>timing mismatch of income + outgo

Question 12

How can companies increase their working Cap?

Answer 12

• Retaining profits=> NO DIVIDENDS+ BONUESES
• Debt=> Creditors
• Equity Capital=> Members

Question 13

What are the two types of companies?

Answer 13

• Proprietary Company=> shareholders o Rights issue o Tender offers o Issues of debt
• Mutual=> policyholders o Less access to capital markets
• o Initial Cap>required to be paid back unless profits emerge o No liability on the balance sheet o Finance raised=>subordinate debt
• â–ª Repayment subordinate to the call of other debt

Question 14

How can benefit schemes raise capital?

Answer 14

• Usually provided by the sponsor of the scheme
• Example- the employer

Question 15

What is an admissible asset?

Answer 15

• Assets permitted by regulators
• To be included in the valuation
• Of supervisory solvency
• What Capital management tools available to financial providers.
• BIRDS FEDS
• Banking products
• Internal sources of capital
• Reinsurance
• Derivatives
• Securitisation
• Financial reinsurance
• Equity
• Derivatives
• Subordinated debt

Question 16

How can reinsurance act as a source of capital?

Answer 16

• Regulator require a smaller solvency capital requirement
• Re help with liquidity issues
• Re commission help manage new business strain
• Financial Re exploit regulatory arbitrage o Crystallise the value of future profits o Loan- repayments contingent on future profits

Question 17

How does securitisation act as a source of capital to a financial provider?

Answer 17

• Securitisation involves o Converting an illiquid asset into a tradeable instrument. o Issuance of bond-interest + capital
• Future profits emerging from a book of business
• Repayment of mortgages or loans o Aim to convert an inadmissible asset into an admissible asset.

Question 18

o Risk involved o Less effective=> Solvency II 16) What is subordinated debt?

Answer 18

• Ranks behind all other liabilities
• Includes policyholder expectation
• Including non-guarantee bonuses
• Regulatory solvency requirements met=> Interest + Cap payments
• Debt Liability on the balance sheet

Question 19

17) What banking products are available as sources of Cap to financial providers?

Answer 19

• LUC
• Liquidity facilities
• Senior unsecured financing
• Contingent cap

Question 20

Why would a derivative contract be used?

Answer 20

• Provider concerned about fall in value of a portfolio
• Trade upside potential for downside protection

Question 21

What are the three sources of equity cap?

Answer 21

• PEN
• Parent company
• Existing shareholders- Rights issue
• New shares

Question 22

20) What are the internal sources of Capital available to a financial provider?

Answer 22

• MAD VS
• Restructuring by Merging funds
• Changing Assets
• Inadmissible to admissible
• Matching more closely to reduce mismatching
• To influence the valuation interest rate used for liabilities
• Not paying Dividends
• Weakening the Valuation basis
• Deferring the distribution of Surplus
• Chapter 37- Capital requirements