Ch 37: Capital requirements Flashcards
Regulatory capital
3
- Regulatory capital is capital required by the regulator to protect against the risk of statutory insolvency.
- Solvency II
- Basel Accords
List 3 types of liabilities covered by reserves
3
- Liabilities that have accrued but which have not yet been paid.
- Claims that have incurred but not yet settled.
- Future (unexpired) periods of insurance against which premiums have been received but where the risk event has not yet occurred.
Solvency Capital
Define the solvency capital requirement
3
- The solvency capital requirement is the total assets required to be held in excess of provisions that are calculated on a best estimate basis.
It therefore comprises:
- any excess of the provisions established on a regulatory basis over the best estimate valuation of the provisions
- any additional capital requirement in excess of the provisions established.
- These make up value of regulatory assets = BEL provisions+SCR+free assets
A more cautious basis can be used, this will increase Provisions and reduce additional capital required (SCR remains the same). Free assets remain the same
Outline the relationship between the provisions and the additional capital requirement
2
In some territories, or for some types of financial provider:
- the regulatory basis used for the provisions is best estimate
- and additional capital requirement is substantial
In other territories, or for other types of financial provider:
- the regulatory basis used for the provisions is significantly more prudent than best estimate
- the additional capital requirement is small (or zero)
Give 2 disadvantages of a regime where provisions are determined on a prudent basis and additional solvency capital requirements are based on simple formulae
2
- The levels of prudence within the provisions can vary between providers, making comparisons difficult.
- The solvency capital requirements are not risk-based, making it difficult to ensure that sufficient security is provided for policyholders
What is Solvency II and what are the three pillars on which it is based?
1,3
- Solvency II is a solvency regime for insurance companies. It requires an insurer to hold provisions on (BEL+risk margin) basis + risk based SCR
The three pillars are:
1. Quantification of risk exposures and capital requirements
Rules for valuing assets and provisions for liabilities MCR(Minimum Capital Requirement) and SCR
2. A supervisory regime : covers qualitative aspects such as risk management, internal controls
3. Disclosure requirements: Public and private
What are the 2 levels of capital requirements under Solvency II?
2
- The MCR (Minimum Capital Requirement) is the threshold at which companies will no longer be permitted to trade.
- The SCR (Solvency Capital Requirement) is the target level of capital below which companies may need to discuss remedies with their regulators.
Outline 2 methods that could be used to calculate the SCR.
2
- A standard formula prescribed by regulation
- A company’s own internal model (usually a stochastic model reflecting the company’s own business structure), which may be benchmarked against the standard formula output.
(An internal model is likely to be used by the largest companies who can afford the considerable extra work needed to justify using an internal model)
Outline how the standard formula determines the amount of capital to hold
3,4,1
The standard formula determines the capital requirement through a combination of:
- stress tests
- scenarios
- factor-based capital changes
It allows for the following types of risks:
- underwriting
- market
- credit/default
- operational
It aims to assess the net level of risk allowing for diversification and risk mitigation options.
Give one advantage and one disadvantage of using the standard formula to determine a provider’s capital requirements
1,1
Advantage:
- The SCR calculation is less complex and less time consuming
Disadvantage:
- It aims to capture the risk profile of an average company, and so it is not necessarily appropriate to the actual companies that need to use it.
Outline how the internal model works and state 4 uses of internal models
4
- Aim to create a stoch model that reflects business structure. Used to project bal sheet for large number of scenarios. Uses a risk measure ot determine Capital required eg VaR
Uses of internal models:
1. To calculate economic capital using different risk measures, such as VaR and TailVaR.
2. To calculate levels of confidence in the level of economic capital calculated.
3. To apply different time horizons to the assessment of solvency and risk.
4. To include other risk classes not covered in the standard formula.
What is the purpose of the Basel Accords?
3
- These accords set requirements for the amount of capital that banks need to hold to reflect the level of risk in the business that they write and manage. USe std formula
- 3 pillars I: Quantify the MCR for credit,ops risk using an internal model
Additional capital held: - Capital conservation buffer: extra layer above MCR
- Counter cyclical buffer: for systemic credit risk
- National regulator: req additional over SCR to be held
Define economic capital
1,3
- Economic capital is the amount of capital the provider determines it is appropriate to hold given its assets, liabilities and business objectives.
It is typically based on:
- the risk profile of the individual assets and liabilities in its portfolio
- the correlations of the risks
- the desired level of overall credit deterioration that the provider wishes to be able to withstand.
Usually quoted as a factor of required capital eg 1.5*SCR
What is an ORSA
1,2,4
- Own Risk and Solvency Assessment that assess ability of insurer to withstand stress events
Aims to provide info about:
1. Adequacy of risk management
2. Current and projected future solvency position
Requires:
1. Identification of risks, risk management process and controls
2. Quantify ability to continue to meet capital requirements
3. Analyze business strategy
4. projections of financial position over longer terms
Assessment of economic capital
What is the starting point in an economic capital assessment?
4
- The starting point is to produce an economic balance sheet to calculate how much capital is available on a market value basis.
- This will enable the provider to compare the economic capital requirement with that it has available - and hopefully the former will be less than the latter.
The available capital is calculated as:
- the market value of the provider’s assets (MVA) less
- the market value of the provider’s liabilities (MVL).
The economic capital requirement will then be assessed using a risk-based approach and the techniques described in the chapters on the risk management control cycle. Quantify the risks fexposed to
