CHP 36: Capital Management

Question 1

List 10 reasons why providers of financial services need capital

Answer 1

REG CUSHION

• Regulatory requirement to demonstrate solvency
• Expenses of launching a new product / starting a new operation
• Guarantees can be offered (higher solvency capital requirement)
• Cashflow timing management (mismatch benefits vs premiums / contributions)
• Unexpected events cushion, e.g. adverse experience, fines
• Smooth profit
• Helps demonstrate financial strength / attract new business / obtain a good credit rating
• Investment freedom to mismatch in pursuit of higher returns
• Opportunities, e.g. mergers and acquisitions, new ventures
• New business strain financing

Question 2

List 8 capital management tools available to financial providers

Answer 2

1. Reinsurance
2. Financial resources
3. Securitization
4. Subordinated debt
5. Banking products
6. Derivatives
7. Equity
8. Internal sources of capital

Question 3

Outline the internal sources of capital available to a financial provider

Answer 3

1. Restructuring the merging funds
2. Changing assets:
   - inadmissible to admissible
   - matching more closely to reduce the mismatching reserve
   - to influence the valuation of interest rates used for the liabilities
3. Weakening the valuation basis
4. Deferring the disruption of surplus (e.g. bonuses)
5. Not paying dividends, i.e. retaining profits within the provider
6. Issuing script dividends