FSI 3-Calculation of Minimum Capital Requirements

Question 1

Describe the roles and responsibilities regarding the calculation and disclosure of MCR? (6)

Answer 1

• The ultimate responsibility of prudential management and financial soundness lies with the board of directors

• The board needs to ensure that eligible own funds are sufficient to cover MCR as well as ensuring that there are systems in place to ensure the requirement is met on an on-going basis

• The MCR needs to be calculated quarterly and reported to the PA

• The HAF needs to express an opinion on the accuracy and adequacy of the MCR calculation

• The insurer’s auditors must audit financial soundness of insurer within its duties are obligations

• The PA may direct the insurer to rectify a breach of MCR and suspend or with the insurer’s licence

Question 2

Outline the principles underlying the MCR calculation? (6)

Answer 2

• The financial soundness framework requires two measures of required capital for regulatory purposes:
o MCR which is a relatively simple measure and the absolute minimum eligible own funds to ensure the policyholder is not exposed to unacceptable amount of risk
o SCR which is a risk based measure that is also forward looking. It is calculated as the capital required to remain solvency (value of assets exceed technical provisions) given a 99.5% confidence level over a one year time horizon

• The breach of MCR is likely to result in the strongest form of regulatory intervention

• MCR is calculated using a simple linear formula linked to the scale of the insurers business with an upper and lower bound linked to SCR

• MCR is also subject to an absolute floor expressed in rand amounts

• The MCR calculation is performed using a linear formula unless one of the boundary conditions applies

• MCR has a general structure that is consistent between different types of insur

Question 3

Describe the general structure of MCR? (3)

Answer 3

• A “liner formula” that is a factor based combination of basic volume measures-the linear formula is calibrated to the VaR of basic own fund subject to a confidence level of 85% over a period of 1 year

• A cap of 45% and a floor of 25% of the SCR (calculated using standardised formula or internal model) –collectively referred to as the corridor

• An absolute minimum floor denoted AMCR is set to the higher of R15 million and 25% of annualised operating expenses for the preceding 12 months

Any capital add-ons by the prudential authority on SCR will influence the corridor of MCR

Question 4

Outline the definition of gross operating expenses used in the calculation of MCR? (7)

Answer 4

• Operating expense are calculated gross annualised expenses involved in day-to-day operations including claims handling, management expenses, asset management and fund management fees excluding:
o Acquisition expenses in writing new business
o Depreciation
o Costs of restructuring
o Disposal of property, plant and equipment
o Realisation of long-term investments
o Gains and losses linked to natural disasters
o Asset management fees and fund management fees directly linked to polices

Question 5

Outline key elements of the linear formula? (4)

Answer 5

• The liner formula is calculated separately for life and non-life business

• The volume measures should be allocated to each type of business without double counting

• The MCR calculation must be segmented according to lines/sub-lines business specified in FSI 2.2.

• The volume measures used is to proxy the risk of the insurer. Life obligations use
o Technical provisions (net of reinsurance and excluding the risk margin)
o Capital at risk (cover amount less net technical provisions less recoverable)

Question 6

Describe the linear formula calculation in the determination of MCR? (8)

Answer 6

• Separate components are calculated for polices
o Including discretionary participation features
o Excluding discretionary participation features

• Policies with discretionary participation features component is calculated as the maximum of
o 2% of minimum liability BEL_min (FSI 4.1)
o Sum over the various product groups the max of
 BEL_min 6.2%-(loss absorbing capacity of technical provisions)(BEL- BEL_min)6.7%
 Zero

• Policies without discretionary participation features component is calculated as sum of
o 0.5% of technical provisions where policyholder bears the investment risk without guarantees

o 1.8% of technical provisions where policyholder bears the investment risk with guarantees

o 2.9% of technical provisions without profit participation

o 0.1% of the capital at risk for polices with death, disability or health benefits
 Excess value of benefit payable less net technical provisions less reinsurance recoveries

Question 7

Outline the MCR calculation for composite reinsurers? (3)

Answer 7

• The MCR linear components for each type of insurance business is first calculated based on above

• The SCR corridor is calculated for each type of business separately by portioning the total SCR based on relative size of each MCR linear components and applied to respective linear components

• A total AMCR is calculated for the reinsurer as the max of R30 million and 25% of gross operating expenses and applied as before