Ch24: Supervisory reserves and capital requirements (2)

Question 1

How can supervisory authorities ensure insurance companies hold sufficient reserves to meet liabilities with a high degree of certainty?

Answer 1

• requiring insurance companies to hold reserves on a prudent basis
• requiring a minimum level of solvency capital to be held
• requiring a combination of prudent reserves and solvency capital to be held

Question 2

Cost of capital approach for determining the additional risk margin`

Answer 2

• firstly project the required capital at each future time period ( the amount required in excess of projected liabilities)
• multiply the projected capital amounts by the cost of capital
• discount using market-consistent discount rates to give the overall risk margin

Question 3

Passive valuation approach

Answer 3

• uses valuation methodology which is relatively insensitive to changes in the market conditions and a valuation basis which is updated infrequently
• e.g. net premium valuation approach for liabilities
• e.g. book value approach for assets
• the same valuation rate may be used throughout the term of the policy

Question 4

Advantages of passive valuation approach

Answer 4

• tend to be more straightforward to implement
• involve less subjectivity
• result in relatively stable emergence of profit

Question 5

Disadvantages of passive valuation approach

Answer 5

• risk of becoming out of date
• may provide a false sense of security

Question 6

Active valuation approach

Answer 6

• based more closely on market conditions, assumptions updated on a frequent basis

Question 7

Advantages of active approach

Answer 7

• more informative in terms of understanding the impact of market conditions on the company’s ability to meet obligations, particularly in relation to financial guarantees and options

Question 8

Disadvantages of active approach

Answer 8

• results are more volatile
• more complex