Chapter 46: Capital Management Flashcards
Capital Management
Involves:
- ensuring sufficient solvency and cashflow to meet
- — (1) existing liabilities
- — (2) future growth aspirations
- maximising the reported profits
Capital needs - individuals
- cushion against unexpected events
- save for the future
Capital needs:
Companies
- cushion against fluctuating trade volumes
- finance expansion
- finance stock and work in progress
- obtain premises, hire staff, purchase equipment (start-up capital)
Capital needs:
Providers of financial services
- 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.
Capital needs:
The State
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
Methods through which the state can meet its liabilities
- taxation
- borrowing
- printing money
Proprietary insurer
An insurance company owned by shareholders.
They may raise funds through the issue of shares or debt securities.
Mutual insurer
owned by policyholders to whom all profits belong.
A mutual has less access to the capital markets than a proprietary.
8 Capital Management tools
- Reinsurance
- Financial Reinsurance (FinRe)
- Securitisation
- Subordinated debt
- Banking products
- Derivatives
- Equity capital
- Internal restructuring
Capital Management:
Reinsurance
To reduce the amount of capital required
Capital Management:
Financial Reinsurance
A reinsurance arrangement that provides capital, typically by exploiting some form of regulatory, solvency, or tax arbitrage
Capital Management:
Securitisation
Involves converting an illiquid asset into tradeable instruments.
Capital Management:
4 Banking Products
- Liquidity facilities
- Contingent capital
- Senior unsecured financing
- Derivatives
Capital Management:
Internal restructuring
- Merging funds
- Changing assets
- Weakening the valuation basis
- Deferring surplus distribution
- Retaining profits
Capital Management:
Liquidity facilities
Used to provide short-term financing to companies facing rapid business growth.
Capital Management:
Contingent capital
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.
Derivatives contracts can be used either:
- to reduce risk (hedging), or
- to increase risk (speculation) in order to improve returns.
3 Sources of equity capital
- parent company
- existing shareholder by a rights issue
- directly from the market by a new placement of shares
5 INTERNAL sources of capital
- funds could be merged
- assets could be changed (switch one asset for another more admissible asset, take advantage of the regulatory valuation basis)
- 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.
Financial Reinsurance
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.
capital
wealth or financial resources
FSP capital needs:
Start-up capital and development expenses
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:
- administration expenses
- collecting premiums / contributions
- setting up suitable management systems to administer the liabilities (for data recording, accounting & auditing, monitoring of liabilities taken on, options and guarantees)
- paying commission
- investment expenses
FSP capital needs:
Statutory requirements
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.
FSP capital needs:
Investment freedom
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.
FSP capital needs:
Strategic aims
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
FSP capital needs:
Impact on the accounts
Capital can be used to - smooth income statements - and improve ---- the solvency ---- and matching position of the balance sheet for a provider.
FSP capital needs:
Products with guarantees
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.
FSP capital needs:
Financial strength
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.
How might a reinsurer contribute to the initial new business strain?
by means of reinsurance commissions
5 reasons for basing a reinsurance company in an overseas state
- less conservative reserving assumptions
- less onerous actuarial certification requirements
- reduced income / capital gains and premiums taxes
- fewer investment restrictions
- lower initial capital requirements
admissible assets
assets whose value can be included in the valuation of assets for the purpose of demonstrating statutory solvency
Why might senior unsecured financing not have capital benefits for an insurer?
Since the loan would be treated as a liability on the company’s balance sheet
When might “merging funds” help the solvency situation?
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.
