Chapter 37: Capital Requirements Flashcards
List 2 types of assessments of capital
- Regulatory capital
- Economic capital
Define regulatory capital
Regulatory capital is capital required by the regulator to protect against the risk of statutory insolvency.
List 3 types of liabilities a provider of financial benefits will need to hold provisions for
- Liabilities that have accrued but which have not yet been paid.
- Claims already 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.
Define the solvency capital requirement
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.
Outline the relationship between the provisions and the additional capital requirement
- The regulator may require a best estimate approach for the calculation of provisions.
- In addition, the provider will be required to hold significant further capital as a buffer for general adverse expenses
- Otherwise, the regulator may require provisions to be calculated on a significantly more prudent basis than best estimate. Only a much smaller (or zero) amount of capital would then be required compared with the above situation
Give 2 disadvantages of a regime where provisions are determined on a prudent basis and additional solvency capital requirements are based on simple formulae
- 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?
Solvency II is a solvency regime for insurance companies. It is a regulatory requirement for all EU states.
The three pillars are:
- Quantification of risk exposures and capital requirements
- A supervisory regime
- Disclosure requirements
What are the 2 levels of capital requirements under Solvency II?
- 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, such as closing to new business or moving to a better matched investment position
Outline 2 methods that could be used to calculate the SCR.
- 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 (WAAR’s DIE?)
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 (WAAR’s DIE?)
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.
Other than deriving Solvency II capital requirements, state 4 uses of internal models (WAAR’s DIE?)
- To calculate economic capital using different risk measures, such as VaR and TailVaR.
- To calculate levels of confidence in the level of economic capital calculated.
- To apply different time horizons to the assessment of solvency and risk.
- To include other risk classes not covered in the standard formula.
What is the purpose of the Basel Accords?
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.
3 Pillars the Basel framework is based on
- Minimum capital Requirements
- Risk Management and supervision
- Market Discipline and Disclosure
DOEN ORSA
DO IT