Chapter 37: Capital requirements Flashcards
Solvency requirements (Providers of financial benefits need to hold provisions for): AFCA
Providers of financial benefits need to hold provisions for:
- Accrued liabilities that have not yet been paid
- Future periods of insurance for which premiums have already been received
- Claims already incurred but not settled
- Additional capital to be held over and above the value provisions
The Basel Accord
Set requirements for the amount of capital banks need to hold to reflect the level of risk in the business that they write and manage
Solvency capital requirement:
SCR
Margin between best estimate and regulatory basis + the additional capital in excess of the provisions provided
Three pillars of Solvency II:
QSD
- A quantification of risk exposure and capital requirements
- A supervisory regime
- Disclosure requirements
Three pillars of Basel Accords: MCRDD / MRD
- The minimum capital requirement
- Risk management and supervision
- market discipline and disclosure
Economic capital:
The amount of capital that a provider determines is appropriate to hold given its assets, liabilities and business objectives which are calculated with an internal model, will depend on:
- The Risk profile of assets and liabilities
- The Correlation of Risks
- Desired level of credit deterioration the provider wishes to withstand
Economic balance sheet:
Market value of the Assets - Market value of the Liabilities
Where the liabilities are valued using a market consistent basis
Merits of a standard capital model
LLLEP USA / MECCAI USA
Less complex and time-consuming SCR calculations
Less costly because of less modeling requirements
Less risk of parameter/model error
Easier to monitor in the industry
Public confidence is higher
Updates of the factors need to be made regularly
Subjectivity introduced when choosing risk factors
Approximations of risks may not be suitable to non-standard companies
Manipulating of financial results cannot be done
Easier monitoring by regulator
Consistency between valuation of companies - makes financial position more comparable
Cheaper way of modelling requirements
Avoids complex and time consuming calcs
Increased confidence of the financial sector
Merits of a internal capital model SWUAR CATU
/ SWARt CARTHUN
Smaller capital requirements - might lead to smaller capital requirements
Wider range of economic scenarios tested
Unique risks of company considered
An internal model will reflect the insurers specific risk profile
Risk appetite of company allowed for
Relevant risk factors considered
Calculations will be complex and time consuming Approval needed from regulator - admin and time consuming
The internal model could be very costly to the company especially if stochastic modelling is used
Using standard model will help give financial sector confidence in the results
/
Smaller capital requirements potential
Wider range of economic scenarios tested
An internal model will reflect the insurers specific risk profile
Relevant risk factors considered
Calculations will be complex and time consuming
Approval needed from regulator
Regulator will pressure company to keep the model up to date
The internal model could be very costly to the company especially if stochastic modelling is used
Higher risk of model, parameter error due to complexity
Using standard model will help give public confidence in the results
No Guarantee of reduced capital requirements
Risk adjusted return on Capital (RAROC):
RAROC = Risk adjusted return/ Capital
Economic income created:
EIC
EIC = (RAROC-hurdle rate)* Capital
The notional risk capital allocated to each business unit will:
(PRAP)
- Determine the business unit’s Performance (With RAROC for example)
- Could affect directly or indirectly, the Remuneration of the unit’s managers and consequently, their level of motivation and behaviour
- Dictates the Amount of business the business unit can write
- Determines the Price at which business can be written
