CH35 - Capital management

Question 1

Capital management of a financial benefit provider involves (2)

Answer 1

1. ensuring sufficient solvency and cashflow to meet:
   - existing liabilities
   - future growth aspirations
2. maximising the reported profits

Question 2

Capital needs - individuals (2)

Answer 2

Capital is needed by individuals to:

1. provide a cushion against unexpected events
2. save for the future

Question 3

Capital needs - companies (5)

Answer 3

Capital is needed by companies to:

1. deal with the financial consequences of adverse events
2. provide a cushion against fluctuating trading volumes
3. finance expansion
4. finance stock and work in progress
5. obtain premises, hire staff, purchase equipment (start-up capital)

Question 4

Capital needs - providers of financial services products (9)

Answer 4

A provider of financial services products has all the same needs for capital as other companies. However, the long-term nature of financial services products, and the associated uncertainty, gives rise to additional capital requirements to:

1. meet benefits before sufficient premiums / contributions are received
2. meet development expenses
3. hold a cushion against unexpected events
4. meet statutory / solvency requirements (fund new business strain, reflect risk)
5. invest more freely (mismatch)
6. sell products with guarantees
7. demonstrate financial strength to attract business
8. smooth reported profits
9. achieve strategic aims

Question 5

Capital needs - the State (3) + (2)

Answer 5

The State does not have the same capital needs as other providers as it can usually raise funds to meet its liabilities through:
1. taxation
2. borrowing
3. printing money
Nevertheless, the State will hold gold and foreign currency reserves to support:
1. fluctuations in the balance of payments and economic cycle
2. timing differences in income and outgo

Question 6

Meeting capital needs - proprietary insurer

Answer 6

A proprietary insurer is an insurance company owned by shareholders. A proprietary company may raise funds through the issue of shares or debt securities.

Question 7

Meeting capital needs - mutual insurer

Answer 7

A mutual insurer is one that is owned by policyholders, to whom all profits (ultimately) belong. A mutual has less access to the capital markets than a proprietary, but can use subordinated debt.

Question 8

Meeting capital needs - benefit scheme

Answer 8

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

Question 9

Meeting capital needs - microinsurance schemes

Answer 9

Microinsurance schemes may have capital support from the State.

Question 10

Capital management tools

Answer 10

There is a range of financial tools available to providers to help them with capital management. The effectiveness of any particular tool depends upon the regulatory tax environment within which the insurer operates. These tools include:

1. reinsurance - to reduce the amount of capital required
2. financial reinsurance(FinRe) - a reinsurance arrangement that provides capital, typically by exploiting some form of regulatory, solvency or tax arbitrage
3. securitisation - which in its most general form involves converting an illiquid asset into tradable instruements
4. subordinated debt
5. banking products - including liquidity facilities, contingent capital and senior unsecured financing
6. derivatives
7. equity capital
8. internal restructuring - including merging funds, changing assets, weakening the valuation basis, deferring surplus distribution and retaining profits