Capital Requirements And Capital Management Flashcards
What is a risk solvency regime?
Require an insurer to hold sufficient capital for the probability of ruin to be below a specified threshold
Greater the variability, the larger the VaR will be
Define capital management
Involves ensuring that the provider has sufficient liquidity and solvency to meet existing liabilities and future growth aspirations in all reasonably foreseeable events. This often involves maximizing the reported return for the provider
Capital is needed by individuals to:
Provide a cushion against unexpected events
Build up capital for future large expenses
Why do providers need capital?
Provide a cushion against unexpected events
Provide for future expansion costs
Meet regulations
Provide product with guarantees
Achieve strategic aims
Meet benefits before sufficient premiums/contributions have been collected
Invest more freely
Demonstrate financial strength to investors
Smooth reported profits
Capital management tools:
Reinsurance - reduce amount of capital required
Financial reinsurance - provide capital
Subordinate debts - generate additional capital without adding liability
Securitization - converting an illiquid asset into traded instruments
Banking products:
liquidity facilities
contingent capital
senior unsecured borrowing
Derivatives
Equity capital internal restructuring
Importance of initial capital
Develop the product
Provide administration systems
Meet regulations
Deal with mismatch of charges and expenses
Indicate financial strength to customers
Meet early claims
Smooth results on balance sheets
Act as a cushion against unexpected events
Define MCR
The threshold at which company would no longer be permitted to operate
Define SCR
The target level of capital below which companies may need to discuss remedies with the regulators
define economic capital
Amount of capital a provider determines is appropriate to hold in excess of liabilities to cover its risks under adverse outcomes, generally with a given degree of confidence over a given time horizon
Economic capital requirement will be determined upon:
Risk profile of assets and liabilities
Correlation between the risks
Business objectives of the provider
Level of credit deterioration a provider wishes to withstand
Why decide to use prescribed model?
Require less work
Does not have expertise
Does not have the data
Need to make sure model will be resilient over
Time delays could be high to approve internal models
Prescribed model fits risk profile
Address public’s concerns
Produces a lower capital requirement
What major development expenses will require initial capital
setting up suitable management systems
administration expenses
collecting premiums
investing expenses
paying commission to third parties
advertising and marketing expenses
How to manage existing capital by managing assets
asset-liability matching reduces volatility of results of mismatching and reduces solvency requirement
working capital management including banking products such as liquidity facilities
use of financial derivatives to reduce market risk and solvency capital requirement
cautious investing of assets backing solvency capital requirement
How to manage existing capital by managing liabilities
transfer risks via reinsurance or ART
consider level of prudence in the liabilties
reduce the level of guarantees
seek efficiencies in the business
actions other than raising new capital available to a product provider for capital management
managing new business strain - limiting volumes and re-designing to reduce strain
managing retained profits via appropriate distributions
regular monitoring of financial position
mitigating retained risks with cost constraint
Advantages and disadvantages of using internal model
Advantages:
might reduce level of SCR required
better reflect the exact risk profile and risk mitigation
provide richer management information
used to determine economic capital
automatically allow for correlations
Disadvantages:
might increase the level of SCR required
getting relevant data to calibrate the model may be difficult
costly to set up and maintain
onerous requirement for regulator approval
mght not get regulator approval
could be a complex model that’s time consuming to run
difficult to understand and audit
similarity and differences between standard formula and internal model
Similarities:
Both used to calculate SCR
both are risk-based capital assessments
Differences:
Standard: combination of factor-based charges and specified stress tests
Internal: complex cashflow model requiring probability distributions
standard: deterministic
internal: stochastic
standard: perscribed stresses and parameters on average insurer
internal: stresses and parameterisation are company-specific
standard: correlation matrix for aggregating risks
internal: possible use of copulas or other
standard: calculate overall SCR for insurer as a whole rather than unit level
internal: could calculate SCR bottom up per unit/segment
standard: give higher results than internal
internal: may give lower for example for sophisticated allowance for diversification
standard:may give lower results than internal
internal: may give higher results if include more risks or company is riskier
define new busienss strain
when the premiums paid at the start of a contract less the initial expenses including commission payments are not sufficient to cover the reserve that the company needs to set up at that point
name three types of life insurances that doesn’t have NBS
immediate annuity policies
single premium investment policies
unit-linked investment policies
how would NSB be recouped
thre premium received should be greater than the expenses that need paying
the capital released from reserves and solvency capital should be greater than the claim that is paid
because the sum of the reserves plus solvency capital will have been set at a prudently high level to increase the likelihood that the claims can be paid
