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3. Exam 3.1 > Chapter 46: Capital Management > Flashcards

Chapter 46: Capital Management Flashcards

1
Q

Capital Management

A

Involves:

  • ensuring sufficient solvency and cashflow to meet
  • — (1) existing liabilities
  • — (2) future growth aspirations
  • maximising the reported profits
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2
Q

Capital needs - individuals

A
  • cushion against unexpected events

- save for the future

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3
Q

Capital needs:

Companies

A
  • cushion against fluctuating trade volumes
  • finance expansion
  • finance stock and work in progress
  • obtain premises, hire staff, purchase equipment (start-up capital)
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4
Q

Capital needs:

Providers of financial services

A
  • MEET BENEFITS before sufficient premiums / contributions are received
  • meet development expenses
  • cushion against UNEXPECTED EVENTS
  • meet STATUTORY requirements (fund new business strain)
  • INVEST more freely (mismatch)
  • achieve STRATEGIC AIMS
  • SMOOTH PROFITS (reported)
  • sell products with GUARANTEES
  • DEMONSTRATE FINANCIAL STRENGTH to customers and advisors.
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5
Q

Capital needs:

The State

A

State will hold gold and foreign currency reserves to support:

  • fluctuations in the balance of payments and economic cycle
  • timing differences in income and outgo
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6
Q

Methods through which the state can meet its liabilities

A
  • taxation
  • borrowing
  • printing money
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7
Q

Proprietary insurer

A

An insurance company owned by shareholders.

They may raise funds through the issue of shares or debt securities.

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8
Q

Mutual insurer

A

owned by policyholders to whom all profits belong.

A mutual has less access to the capital markets than a proprietary.

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9
Q

8 Capital Management tools

A
  • Reinsurance
  • Financial Reinsurance (FinRe)
  • Securitisation
  • Subordinated debt
  • Banking products
  • Derivatives
  • Equity capital
  • Internal restructuring
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10
Q

Capital Management:

Reinsurance

A

To reduce the amount of capital required

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11
Q

Capital Management:

Financial Reinsurance

A

A reinsurance arrangement that provides capital, typically by exploiting some form of regulatory, solvency, or tax arbitrage

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12
Q

Capital Management:

Securitisation

A

Involves converting an illiquid asset into tradeable instruments.

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13
Q

Capital Management:

4 Banking Products

A
  • Liquidity facilities
  • Contingent capital
  • Senior unsecured financing
  • Derivatives
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14
Q

Capital Management:

Internal resturcturing

A
  • Merging funds
  • Changing assets
  • Weakening the valuation basis
  • Deferring surplus distribution
  • Retaining profits
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15
Q

Capital Management:

Liquidity facilities

A

Used to provide short-term financing to companies facing rapid business growth.

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16
Q

Capital Management:

Contingent capital

A

A cost-effective method of protecting the capital base of an insurance company.
Capital would be provided as it was required following a deterioration of experience.

17
Q

Derivatives contracts can be used either:

A
  • to reduce risk (hedging), or

- to increase risk (speculation) in order to improve returns.

18
Q

3 Sources of equity capital

A
  • parent company
  • existing shareholder by a rights issue
  • directly from the market by a new placement of shares
19
Q

5 INTERNAL sources of capital

A
  • funds could be merged
  • assets could be changed
  • the valuation basis could be weakened
  • the distribution of surplus could be deferred
  • capital could be retained in the organisation possibly by not paying any dividends to any shareholders.
20
Q

Financial Reinsurance

A

to exploit some form of regulatory arbitrage
… in order to more efficiently manage the capital, solvency or tax position of a provider.

It relies on the regulatory, solvency or tax position of a reinsurer, which may be based in an overseas state, being different from that of the provider.

21
Q

capital

A

wealth or financial resources

22
Q

FSP capital needs:

Start-up capital and development expenses

A

There is a possibility that a claim event might arise before the provider has had time to accumulate sufficient funds from premiums.
They thus need start-up capital.

In addition there are initial costs:

  • setting up suitable management systems to administer the liabilities
  • collecting premiums / contributions
  • paying commission
  • investment expenses
  • administration expenses
23
Q

FSP capital needs:

Statutory requirements

A

Due to uncertainties (caused by the long-term nature of financial products), there is a requirement to
… hold a PROVISION for future liabilities
… in EXCESS OF THE BEST-ESTIMATE value of the future outgo.

24
Q

FSP capital needs:

Investment freedom

A

If a provider makes a decision not to hold a portfolio of assets that replicates its liabilities, its capital requirements will increase.

This is because there is a danger that movements in experience and in particular in interest rates, may result in the liabilities increasing by more than the assets.

25
Q

FSP capital needs:

Strategic aims

A

The level of a company’s capital will have a key role to play in achieving its overall strategic direction.

e.g. acquisitions, mergers, demutualisations, new ventures

26
Q

FSP capital needs:

Impact on the accounts

A 
Capital can be used to 
- smooth income statements 
-  and improve
---- the solvency 
---- and matching position 
   of the balance sheet
for a provider.
27
Q

FSP capital needs:

Products with guarantees

A

The levels of guarantees in a product impact the level of solvency margins a company has to hold and will therefore impact on capital requirements.

28
Q

FSP capital needs:

Financial strength

A

The financial strength of providers may be significant in determining new business levels.
Financial strength may be rated as one of the key determinants used by individuals and their advisers when deciding whether or not to place business with any particular provider.

29
Q

How might a reinsurer contribute to the initial new business strain?

A

by means of reinsurance commissions

30
Q

5 reasons for basing a reinsurance company in an overseas state

A
  • less conservative reserving assumptions
  • less onerous actuarial certification requirements
  • reduced income / capital gains and premiums taxes
  • fewer investment restrictions
  • lower initial capital requirements
31
Q

admissible assets

A

assets whose value can be included in the valuation of assets for the purpose of demonstrating statutory solvency

32
Q

Why might senior unsecured financing not have capital benefits for an insurer?

A

Since the loan would be treated as a liability on the company’s balance sheet

33
Q

When might “merging funds” help the solvency situation?

A

If, e.g., some of the regulatory liabilities or the solvency capital was calculated as a monetary / fixed amount per fund or had a fixed minimum.

3. Exam 3.1 (56 decks)

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