Chapter 47: Capital Management II

Question 1

2 Main types of capital

Answer 1

• solvency capital

- economic capital

Question 2

Solvency capital

Answer 2

Solvency capital is
… the required ADDITIONAL capital that the provider must demonstrate that it is holding
… OVER AND ABOVE an estimate of PROVISIONS on a best-estimate basis.

Question 3

Economic capital

Answer 3

The amount of capital that the provider determines is appropriate to hold, given:

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

Typically it will be determined based upon

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

Question 4

How might a provider calculate the market value of its liabilities?

Answer 4

Calculate the present values of the liabilities using a best-estimate basis and then add a risk margin.

Question 5

2 Approaches used to calculate the RISK MARGIN

when valuing the present value of the liabilities?

Answer 5

• cost of capital approach

- option pricing theory

Question 6

What capital adequacy regimes apply to banks?

Answer 6

The Basel Accords set requirements for the levels of capital that banks need to hold to reflect the levels of risk in the business that they write and manage.

Question 7

What are the 3 pillars of Solvency II

Answer 7

• quantification of risk exposure and capital requirements
• supervisory regime
• disclosure requirements

Question 8

2 levels of capital requirement under Solvency II

Answer 8

MINIMUM CAPITAL REQUIREMENT:
- the threshold under which companies will no longer be permitted to trade.

SOLVENCY CAPITAL REQUIREMENT:
- the target level of capital below which companies may need to discuss remedies with their regulators.

Question 9

2 Options for calculating the SCR

Answer 9

Using:

• a prescribed standard model
• a company’s internal model

The use of an internal model will need to be justified to the regulator, but may lead to a reduction in capital requirements.
However, only large companies may feel that the reduction in capital requirements is sufficient to warrant the extra work.

Smaller companies may therefore opt for the standard model approach. The model used is also likely to depend on the president set in the country concerned.

Question 10

4 Things an internal model of capital might be used for

Answer 10

• to calculate the economic capital using different risk measures (Eg VAR, or tailVAR)
• to calculate the 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 risk classes, not included in the standard risk model