Capital Management Flashcards
Regulatory Capital definition
Capital required to protect against risk of regulatory insolvency
This means holding sufficient
Capital to demonstrate solvency under the regulatory regime applying to provider
Economic capital - definition
Capital that a provider determines is appropriate to hold given
Assets
Liabilities
Business objectives
Determined based on
Individual risk profiles of the asset and liability portfolios
Correlation of risks
Desired level of credit deterioration that provider wishes to withstand
Capital needs (provider of financial services)
Assist GPS
1. Impact on accounts
2. Demonstrate Statutory and Solvency capital
3. Start-up capital
4. investment freedom
5. Financial strength
6. Timing mismatch
7. Products with Guarantees
8. Strategic aims
9. Provisions
Financial provider - impact on accounts
5 S (3 smooth, 3 solvency)
1. Smooth income statement
2. Smooth profits
3. Smooth bonus payments and dividend
4. Allows solvency even if mismatched
5. Will allow matching of assets and liabilities/assets to be greater
Financial provider- start up capital
- Fund once off start-up expenses for new products (ciao -p)
* management system
*overhead expenses
*premium collection/contributions
*commission
*investment expense
*administration expenses
2 trajectory depending on business volume
Financial provider - demonstrate statutory and solvency capital
- Regulatory capital
- Economic capital
Financial provider - investment freedom
Ability to mismatch assets and liabilities
Financial provider- Financial strength
- Customers
- Sales intermediaries
- Market
- Rating agencies
Financial provider- timing mismatch
- Fund cash flow strain from writing new business
- Requiremeny to establish prudent supervisory provisions??
Financial provider- guaranteed products
More onerous solvency requirements for this type of business
Financial provider - provisions as cushions against future unexpected event
- Catastrophe
- Fines
- Credit deterioration
Financial provider- strategic objectives
- Mergers and acquisition
- Demutualisation
- New ventures
Capital needs (individuals)
TAU
1. Timing mismatch
2. Accumulation
* big spending
*holiday
* retirement
3. Unexpected cashflows
Capital needs (trading companies)
SCUTA
1. start up capital
* premises
* hire staff
* equipment
2. Cashflow management
* pay suppliers
* fund work in progress
* finance stock before final product is sold
3. Unexpected events
4. Timing mismatch and trade fluctuations
5. Accumulation
*future planned projects
Capital accumulation needs - state
No need for capital accumulation
1. Gold reserves and foreign currency reserves
* support fluctuations in the economy and in the balance of payments
*manage timing differences in oncome and outgo
2. Raise taxes
3. Issue bonds
4. Print money
Sources of capital
Herrd
1. Hybrid
2. Equity
3. Reinsurance
4. Retaining profits
5. Debt
Capital management- subordinated debt
Issue subordinated debt
1. Additional capital
* Improves capital position of provider
2. Liability increase
*does not increase liabilities
*ranks behind all liabilities, including PRE
* does not need to be included as a liability in the assessing of solvency
3. Interest
* Only paid if regulatory solvency requirements will continue to be met
*regulatory authorisation
4. Improves capital position
5. Event of wind up - last repayments
6. Increased assets of the provider
Capital management - securitisation
- Cashflow management
*illiquid inadmissible asset into liquid admissible asset - Tradeable instrument
*receive regulatory/accounting off balance sheet treatment - Risk transfer
*risk associated with value of asset
*potential loss in value of asset being capped - Illiquid assets for securitisation
*asset that generates predictable income stream
*future profits
*mortgages - Special purpose vehicle
- Repay only when profits are realised
- Owner benefits
- Disadvantages
Capital management- derivatives
- Issued by banks
*large enough market to be considered an asset class of its own - Reduce risk - hedging
* Reduce need to hold capital to protect against risk - Increase risk
*increase returns - Prudent financial management
*providers entering jnto derivative market must be cautious
*derivative strategy needs to assist in efficient management of business
*derivative strategy needs to reduce risk
*no speculation
Capital management- banking
- Liquidity facilities
*short term financing for companies facing rapid growth
**cover new business strain - Contingent liability
*arranging terms to raise funds with bank in the event that something happens
**cost effective way of protecting ting capital base of insurance company
**capital received as requires and when needed
**similar to post loss funding
++improve financial strength
++recognised by rating agency
–lacks visibility
—not reflected on balance sheet
—not reflected in financial strength comparison against other companies
— not considered by others when making decisions
—issues may arise when considering how much regular recognises this to demonstrate solvency - Derivative
- Senior unsecured financing
*no capital benefits for jnsurer - will increase both assets and liabilities
*financing at group level cam be used within the group structure
–group capital remains unchanged but hit is taken else where in the group
++ more cost effective than other options
Deciding on capital sourse
Cam note
1. Cost of capital and implementation
2. Available capital
3. Market conditions
4. Nature of assets held
5. Overall strategic objectives
6. Time scales
7. Existing exposure
Capital Managemeng - equity
Defn: reorganise existing financial structure of organisation in more efficient ways
(Merry Christmas with rein-deer)
- Merge funds
*especially if calculations are calculated as monetary - changing assets
*inadmissible for admissible
*closer matching
*discount - Weaken val basis
*Reduce value of liabilities relative to assets
*improve reported solvency
*only acceptable if can be justified - Defer distribution of surplus
* defer bonuses
*Reduce level of guaranteed PH benefits PRE
*risk reputational damage - Retain capital in organisation
*Defer payment of dividends
*pay lower dividends
*impact on shareprice
Capital management tools
Rebids
Reinsurance
Equity
Banking
Internal
Subordinated debt
Securitisation
Internal sources
Retain profits
Parent company
Restricture
Surplus distribution defer
Basis weaken
Asset change
