Chapter 47: Capital Management (2) Flashcards

1
Q

Regulatory solvency capital requirement

A

The total of:

  • the margins between the best estimate basis and the regulatory liability valuation basis
  • an amount of additional capital in excess of the regulatory provisions.
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2
Q

The Basel Accord

A

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.

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3
Q

3 Pillars of Solvency II

A
  • quantification of risk exposures and capital requirements
  • supervisory regime
  • disclosure requirements
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4
Q

2 levels of capital requirements for Solvency II

A
  • Minimum Capital Requirement

- Solvency Capital Requirement

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5
Q

Minimum Capital Requirement (MCR)

A

Threshold at which companies will no longer be permitted to trade

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6
Q

Solvency Capital Requirement (SCR)

A

The target level of capital below which companies may need to discuss remedies with their regulators.

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7
Q

Economic capital

A

The amount of capital that a provider determines is appropriate to hold given

  • its assets,
  • liabilities,
  • business objectives.
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8
Q

Economic Capital will be determined based upon:

A
  • risk profile of the individual assets and liabilities in its portfolio
  • correlation of the risks
  • desired level of overall credit deterioration that the provider wishes to be able to withstand
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9
Q

The economic balance sheet shows:

A
  • market values of a provider’s assets (MVA)
  • market values of a provider’s liabilities (MVL)
  • provider’s available capital, defined as MVA - MVL
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10
Q

Internal models

A

Used to calculate economic capital requirements and may be used to determine the Solvency II SCR.

Aim to create a stochastic model that reflects a company’s own business structure.

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11
Q

4 Uses for internal models

A
  • to calculate economic capital using different risk measures, eg VaR and Tail VaR
  • 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 risks not covered in the standard model.
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12
Q

A provider of financial benefits need to hold provisions for… (4)

A
  • liabilites that have been accrued but which have not yet been paid
  • future periods of insurance against which premiums have already been received
  • claims already incurred but which have yet to be settled.
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13
Q

How is the capital requirement determined (Solvency II)

A

Combination of

  • stress tests,
  • scenarios
  • factor-based capital charges
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14
Q

4 Risks that standard model allows for (Solvency II)

A
  • underwriting risk
  • market risk
  • credit / default risk
  • operational risk
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15
Q

Examples of Underwriting risk

A
premium, 
reserve, 
catastrophe, 
expenses 
and lapse risks.
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16
Q

Examples of Market risk

A
Equity, 
property, 
interest rate, 
credit spread, 
currency concentration 
and illiquidity risks.
17
Q

Advantage of the standard model (Solvency II)

A

Solvency Capital requirement calculation is

  • less complex
  • less time-consuming
18
Q

Disadvantage of the standard model (Solvency II)

A
  • It aims to capture the risk profile of an average company
  • Approximations made in modelling risks which mean that it is not necessarily appropriate to the actual companies that use it.
19
Q

Solvency II:

Pillar 1

A

includes

  • rules for VALUING both:
  • — assets
  • — provisions for liabilities
  • and also the determinations of two levels of capital requirement (MCR and SCR).
20
Q

Solvency II:

Pillar 2

A

Pillar 2 deals with qualitative aspects, eg a company’s internal controls and risk management process.
Includes monitoring visits to companies by the regulator.

21
Q

Solvency II:

Pillar 3

A

Disclosure requirements include both public disclosure and private disclosure by the company to the regulator.

22
Q

Suggest examples of remedies that may be required in the event of a company breaching the SCR.

A

Proposed remedies need to increase the amount of available capital, or reduce the company’s levels of risk.
E.g.:
- closing to new business
- moving to a more matched investment position

23
Q

To whom will the Solvency II Directive apply?

A

All insurance and reinsurance companies with

  • gross premium income exceeding €5 million, or
  • gross technical provisions in excess of €25 million
24
Q

By whom are the Basel Accords issued?

A

The Committee on Banking Regulations and Supervisory Practices of the Bank for International Settlements (BIS)

25
Q

What factors might the regulator take into account when assessing a bank’s risk profile / management systems? (6)

A
  • reviews of the work of internal and external AUDITORS
  • the bank’s risk appetite and its TRACK RECORD in managing risk
  • the NATURE OF THE MARKETS in which the bank operates
  • the quality, reliability and VOLATILITY OF ITS EARNINGS
  • the bank’s ADHERENCE to sound valuation and accounting standards
  • the bank’s DIVERSIFICATION of activities
26
Q

To which banks does the Basel accord apply?

A

All internationally active banks.

27
Q

First stage in a risk-based capital assessment for a provider

A

to produce an economic balance sheet

28
Q

2 Possible forms of factor-based capital charges

A

• factor x sum at risk
to determine a capital requirement in relation to mortality risk

• factor x reserves
to determine a capital requirement in relation to inadequate reserves

29
Q

4 Disadvantages of factor-based capital charges

A
  • the large number of factors required to capture all the risks insurance companies may face
  • the factors may be chosen to be appropriate for a typical insurance company with typical risks (and might be unsuitable for all companies)
  • the simple calculation may not be appropriate to deal with some types of risk, eg catastrophes
  • to retain an appropriately stringent capital requirement in different conditions, the factors would need to be updated in the light of changing conditions.