Chapter37-Capital requirement

Question 1

Framework

Answer 1

1 Types of assessments of capital
2 Regulatory capital
3 Liabilities covered by provisions
4 Solvency capital requirement
5 Provisions vs additional capital requirement
6 Disadvantages of calculating a prudent provision and using simplistic form of solvency capital requirement
7 Solvency II and pillars
8 Levels of capital requirement under solvency II
9 Ways to calculate SCR
10 Calculating standard formula SCR
11 Advantages and disadvantages of SCR standard form
12 Other uses of internal model either than SCR
13 Purpose of the Basel accord
14 Economic capital
15 Starting point for assessing economic capital
16 Market value of assets and liabilities
17 Components of profit for a provider
18 Meaning of cost of capital

Question 2

Regulatory capital

Answer 2

Regulatory capital is capital required by the regulator to protect against the risk of statutory insolvency.

Question 3

Solvency II and pillars

Answer 3

Solvency II is a solvency regime for insurance companies. It is a regulatory requirement for all EU states.

The three pillars are:

1. quantification of risk exposures and capital requirements
2. a supervisory regime
3. disclosure requirements.

Question 4

Ways to calculate SCR

Answer 4

1. A standard formula prescribed by regulation
2. A company’s internal model (usually a stochastic model reflecting the company’s own business structure), which may be benchmarked against the standard formula output

(An internal model is likely to be used only by the largest companies who can afford the considerable extra work needed to justify using an internal model.)

Question 5

Advantages and disadvantages of SCR standard form

Answer 5

+ The Solvency Capital Requirement (SCR) calculation is less complex and less time-consuming

– It aims to capture the risk profile of an average company, and so it is not necessarily appropriate to the actual companies that need to use it

Question 6

Economic capital

Answer 6

Economic capital is the amount of capital the provider determines it is appropriate to hold given its assets, liabilities and business objectives.

It is typically based on:

 the risk profile of the individual assets and liabilities in its portfolio

 the correlation of the risks

 the desired level of overall credit deterioration that the provider wishes to be able to withstand.