Chapter 36: Capital management

Question 1

Why is capital needed?

Individuals: CuS
Companies: CLOFFS
Providers of financial services and products: REG CUSHION M

Answer 1

Cushion against unexpected events. Car breakdown.
Saving for future

Cushion against fluctuation trade volumes and other events
Liquidity issues due to difference in timing of revenue and cost
Opportunities - mergers and acquisitions
Finance expansion
Finance work in progress and stock
Start-up capital

Regulatory requirement to demonstrate solvency - provision above best estimate
Expenses of new product launch (product development, administration systems)
Guarantees
Cashflows timing management
Unexpected experience cushion
Smooth accounts (e.g. catastrophe equalisation reserve, dividends distribution and bonuses)
Help demonstrate financial strength (and attract new business)
Investment and pricing freedom (mismatching reserve and loss leaders )
Opportunities; Mergers &Acquisitions, new ventures etc
Need to achieve strategic aims/ New business strain

Extra:
To fund maintenance expenses such as new It systems, Laptops, printers etc. until it can be recouped by the premium income

Question 2

Capital management tools include:

BRIDES CC BRB

Answer 2

Capital is managed by either:

• Increasing the level of available capital
• Reducing the level of capital required

Banking products (also Business written) FiCL
- Liquidity facilities
- Contingent capital, provided when needed - similar to
post loss funding
- Financing at group level: Distributing funds to products
Reinsurance (financial) to exploit capital/solvency/tax
regulation arbitrage
Internal restructuring: FAIR VaNCS
Derivatives - hedge risk
Equity capital - (parent, rights issue, new market issue)
Securitisation and subordinated debt

Other courses of action may include
- Closing to new business: which will reduce the level of new business strain on the capital because of a reduction in:
* initial expenses
* The need to establish cautious levels of
regulatory capital when new business is written
* will cause diseconomies of scale in long run
* will reduce future profits
- Change types of business underwritten

Run company in a more efficient way:

• Better expense control
  * Outsourcing
  * Cost effective distribution channels
  * Staff training
• Better Tax management policies
• Revise product pricing by either increasing or decreasing the price

Question 3

Internal restructuring FAIR VaNCS

Answer 3

Funds merged
Assets changed
Increase matching position
Replace admissible assets
Valuation rate of interest used to discount liabilities
could be based on assets. A switch in assets may
change the valuation rate of interest.
Valuation basis weakened -Not usually permitted by regulation
Nature of business change (less risky business written)
Change L valuation and nature of L
Surplus distribution deferred (less bonuses and dividends)

Question 4

Benefits of holding significant amounts of free capital:

FM PEER

Answer 4

Freedom: Investment, Strategic, pricing and from regulator
Can use as a Marketing advantage
Protects against volatility and allows you to take on more
Enables to write large amounts of new business
Enables to write more risky products
Reduces risk aversion

Question 5

Capital management definition

Answer 5

Capital management involves ensuring that a provider has sufficient solvency and cashflow to enable both its existing liabilities and future growth aspirations to be met in all reasonably foreseeable circumstances. It also often involves maximising the reported profits of the provider.