Chapter 47 - Capital Management (2) Flashcards
For what would a provider of financial benefits need to hold provisions?
- Accrued liabilities which have not been paid yet
- Future insurance cover for which premiums have already been received
- Claims which have been incurred but not settled
What is a solvency capital requirement?
It is the excess capital over provisions plus the margin between the best estimate and regulatory valuation basis.
It is also the target level of capital below which a company needs to discuss remedies with the regulator (e.g. match better or stop selling new business)
Discuss the background of the Solvency II framework.
- It is a capital adequacy regime
- It has been in operation since 1 Jan 2016
- It governs the capital requirements for insurance companies in the EU
- It applies to insurers and reinsurers who
- Earn a gross premium of > 5 Euro
- Hold a technical reserve of > 25 Euro
- It is wider than solvency I
1. How to value assets
2. How to set up provisions -> best estimate + risk-based capital requirement
3. Assess risk management systems
Describe the 3 pillars of Solvency II.
- Quantification of risk exposure and capital requirement
- Valuation of A and L
- MCR = Threshold at which the company will no longer be permitted to trade
- SCR = Target level of capital below which a company needs to discuss remedies with the regulator (close to new business, more matched position)
- Prescribed formula (Standard model) or Internal model can be used
- Risk and risk measures
- Allowance for diversification - Supervisory regime (qualitative aspects)
- Internal systems
- Risk management systems
- Corporate governance
- Monitoring visits by the regulator - Disclosure of information
- Public
- Privately to the regulator
What is the Basel Accords and what does it take into account?
- It governs the capital requirements of banks and credit institutions
- The amount of capital must reflect the amount of risk
- Set up by a committee of the Bank of International Settlement (BIS)
It considers:
- Nature of the market the bank or credit institution operates in
- Quality, volatility and reliability of earnings
- Review of internal and external auditors
- Risk appetite and track record of risk management systems
- Diversification activities
- Adherence to sound valuation and accounting standards
What is regulatory capital used for?
To demonstrate solvency to the regulator.
Define economic capital.
Economic capital is the amount of capital a company determined is appropriate to hold, given its A, L and business objectives.
Determined based on
- Risk profiles of the individual A and L in the portfolio
- Correlation between risks
- The level of credit deteriorisation that the company wishes to be able to withstand
-> risk-based capital assessment using an internal model
What can economic capital be used for?
- Business opportunities
- New products
- New distribution channels
- New markets
- M&A
- Offer options and guarantees
- Financial management
- Demonstrate financial strength
- Reduce reliance on external financing
- Flexible dividend policy
What is the solvency ratio?
Available capital (A-L)/Required capital
When will an asset be inadmissable?
- Low or 0 value on wind-up
- Subjective to calculate the value
- Value decrease significantly over time
What is goodwill?
It is an intangible asset.
It is the value above NAV for which a company can be sold due to
- Reputation
- Human capital
- Relationship with customers and suppliers
- Brand name
What is deferred acquisition costs?
It is a prepaid expense.
What is unearned premium?
It is an income received in advance.
What will happen if the ruin probability is changed from 1/200 to 1/500?
- Providers of capital will take their money elsewhere since ROC will be lower
- Charge higher premiums
- Change benefit designs to reduce risk -> need to hold less capital
How does the standard model work under solvency II?
- Combination of stress tests, scenarios and risk-based factor charges.
- Aims to assess the capital required after allowance for risk management systems.
Accounts for
1. Underwriting risk = risk associated with the perils undertaken and the process of conducting the business e.g. longevity, mortality, annuity rates, premium, reserve, catastrophe, expenses, withdrawals, disability
2. Market risk e.g. equity, property, interest rates, illiquidity, credit spread, currency, concentration
3. Operational risk e.g. reputational risk
4. Credit risk e.g. reinsurer default
Factor-based charges
SCR is less than sum of individual parts due to diversification
