D.1 Multi-Stakeholder Approach to Capital Adequacy

Question 1

Weaknesses of EC models

Answer 1

1. Produces a single financial measure of required capital
2. No external consequences/penalties for failing
3. inflexible in terms of time horizon - ignores changing risks over time
4. risk thresholds are arbitrary, parameter risk in extreme tail is significant

Question 2

capital adequacy for each stakeholders

Answer 2

want higher capital:

1. Policyholders - want enough capital to protect them in loss events
2. Regulators - concerned with protecting policyholders
3. Debt holders - want the company to maximize capital held to minimize chance of default
4. Rating Agencies - more capital = higher ratings

want lower capital:

5. shareholders
   - want to maximize the return on capital
   - want enough capital to absorb unexpected risks
   - have enough capital for growth
6. company mgmt
   - wants more capital than shareholders
   - however also wants to satisfy shareholder interests

Question 3

Multi-Objective approach to capital adequacy

Answer 3

multi-objective approach tries to find a single capital adequacy target across 3 dimensions:

1. Financial Variables
   - return on capital
   - Rating agencies
   - regulatory measures (RBC
   - EC measures
2. Time Horizon
   - risks interact differently over time
   - current capital supports future growth
   - company has to assess ability to raise capital in the future
3. Risk Threshold
   - 1-in-1000 events are unknowable - cannot quantify extreme tail events
   - failure to meet obligations vs. failure to thrive

benefits:

1. incorporates unique objective of all stakeholders
2. aligned with real world decision making processes
3. produces multiple estimates of capital adequacy
4. goes beyond solvency analysis
5. Consistent evaluation of all measures
6. multiple risk thresholds and sensitivity testing
7. multi year time horizon
8. appropriately represents risk diversification and aggregation over time
9. Risk thresholds calibrated to observable info

Question 4

financial rating risk replication techniques

Answer 4

revisit this

Question 5

Rating transition matrix

Answer 5

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Question 6

How to calculate capital available to release

Answer 6

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Question 7

Considerations in setting a capital target

Answer 7

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Question 8

Measure Capital Adequacy

Answer 8

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