Capital Management

Question 1

What does capital management of a financial product provider involve

Answer 1

• ensuring sufficient solvency and cashflow to meet:
- existing liabilities
- future growth aspirations

• maximizing the reported profits

Question 2

Capital is needed by individuals to

Answer 2

• provide a cushion against unexpected events

• save for the future

Question 3

Capital is needed by companies to

Answer 3

• deal with the financial consequences of adverse events

• provide a cushion against fluctuating trading volumes

• finance expansion

• finance stock and work in progress

• obtain premises, hire staff, purchase equipment (start-up capital)

Question 4

Due to the long-term nature (and associated uncertainty) of many of the benefits, providers of financial products have additional needs for capital to

Answer 4

• meet benefits before sufficient premiums/contributions are received

• meet development expenses

• hold a cushion against unexpected events

• meet statutory/solvency requirements (fund new business strain, reflect risk)

• invest more freely (mismatch)

• sell products with guarantees

• demonstrate financial strength to attract business

• smooth reported profits

• achieve strategic aims

Question 5

Capital (gold and foreign currency reserves) is needed by the State to support

Answer 5

• fluctuations in the balance of payments and economic cycle

• timing differences in income (from tax, borrowing or printing money) and outgo

Question 6

Meeting capital needs

Answer 6

Proprietary company:
Owned by shareholders
May raise funds through the issue of shares or debt securities

Mutual
Owned by its members to whom all profits (ultimately) belong
Less access to the capital markets
No shareholders => no share issues
Can use subordinated debt

The sponsor may be prepared to put up the initial capital for a benefit scheme

The State may be a source of capital, e.g. for microinsurance schemes

Question 7

Capital management tools: a range of tools available to financial product providers to help them with capital management, this includes

Answer 7

• reinsurance - to reduce the amount of capital required

• financial reinsurance (FinRe) - a reinsurance arrangement that provides capital, typically by exploiting some form of regulatory, solvency or tax arbitrage

• securitization - which in its most general form involves converting an illiquid asset into tradable instruments

• subordinated debt

• banking products - including liquidity facilities, contingent capital and senior unsecured financing

• derivatives

• equity capital

• internal restructuring - including merging funds, changing assets, weakening the valuation basis, deferring surplus distribution and retaining profits

The effectiveness of a tool depends upon the regulatory and tax environment within which the provider operates