Prudential Standard FSI 4.1 (Market Risk Capital Requirement)

Question 1

Prudential Standard FSI 4.1 sets out …

Answer 1

the details for calculating the market risk capital requirement for insurers using the Standardised Formula to calculate the Solvency Capital Requirement (SCR).

Question 2

Who is ultimately responsible for the prudent management of the financial soundness of an insurer?

Answer 2

Board of directors,
who need to ensure that the insurer has systems and controls in place to adequately calculate its market risk capital requirement according to the Financial Soundness Standards for Insurers.

Question 3

Who is ultimately responsible for the prudent management of the financial soundness of an insurer?

Answer 3

Board of directors,
who need to ensure that the insurer has systems and controls in place to adequately calculate its market risk capital requirement according to the Financial Soundness Standards for Insurers.

Question 4

To whom does Prudential Standard FSI 4.1 apply?

Answer 4

All insurers (life insurers, non-life insurers, reinsurers) licenced under the Insurance Act (2016),

other than microinsurers, Lloyd’s and branches of foreign reinsurers.

Question 5

Define market risk

Answer 5

The risk of loss arising from movements in market prices on the value of an insurer’s assets and liabilities or of loss arising from the default of the insurer’s counterparties.

Question 6

How is exposure to market risk measured?

Answer 6

By the impact of movements in financial variables such as stock prices, interest rates, real estate prices and exchange rates.

Question 7

How is exposure to market risk measured?

Answer 7

By the impact of movements in financial variables such as stock prices, interest rates, real estate prices and exchange rates.

Question 8

What should be included in the calculation of interest rate risk capital requirement?

Answer 8

All assets and liabilities that are sensitive to changes in the yield curve.

• fixed-income securities
• financing instruments
• policy loans
• interest rate derivatives
• other items included in the valuation of technical provisions

Question 9

Capital requirement for:

the nominal interest rate CURVE risk

Answer 9

The capital requirement for the nominal interest rate curve risk captures the risk arising from changes in the nominal yield curve.

Question 10

Upwards nominal shock

Answer 10

An instantaneous increase in the nominal interest rate term structure used to value nominal interest rate sensitive items.

Question 11

Downwards nominal shock

Answer 11

An instantaneous decrease in the nominal interest rate term structure used to value nominal interest rate sensitive items.

Question 12

Capital requirement for:

the real interest rate CURVE risk

Answer 12

Captures the risk arising from changes in the real yield curve.

Question 13

Upwards real shock

Answer 13

An instantaneous increase in the real interest rate term structure used to value real interest rate sensitive items.

Question 14

Downwards real shock

Answer 14

An instantaneous decrease in the real interest rate term structure used to value real interest rate sensitive items.

Question 15

Interest rate volatility risk

Answer 15

Arises when the market value of assets and liabilities are sensitive to changes in the expected future volatility of market yield curves.

Question 16

Equity risk

Answer 16

Arises when the market value of assets and liabilities are sensitive to changes in the market prices for equities or their volatilities.

Question 17

3 categories into which equities must be split when determining the capital requirement for equity price risk

Answer 17

GLOBAL EQUITY
Covering equities listed in regulated markets in the countries which are members of the European Economic Area (EEA) or the Organisation for Economic Co-operation and Development (OECD)

SA EQUITY
Covering equities listed on the JSE

OTHER EQUITY
Covering all other equities not included in the Global and SA categories, including equities listed in emerging markets, unlisted equity, hedge funds and other investments with equity risk exposure.

Question 18

Equity volatility risk

Answer 18

Relates to the sensitivities of the market value of assets and liabilities to changes in the expected future volatility of equities.

Question 19

Property risk

Answer 19

Arises when the market value of assets and liabilities are sensitive to changes in the level of market prices of property.

Question 20

Assets & Liabilities that should be included in the calculation of the property risk capital requirement (2)

Answer 20

a) Land, buildings and immovable-property rights

b) Property investment for the own use of the insurer.

Question 21

Currency risk

Answer 21

Arises when the market value of assets and liabilities are sensitive to changes in currency exchange rates.

Question 22

Spread risk

Answer 22

Arises when the market value of assets and liabilities are sensitive to changes in credit spreads over the risk-free interest rate term structure.

Question 23

Default risk

Answer 23

Default risk arises from potential losses due to credit default events, such as the default of the counterparty or issuer of a financial instrument held by an insurer.

Question 24

9.2. on asset sets covered by default risk and spread risk

Answer 24

The two credit risk components (ie spread risk and default risk) should cover mutually exclusive sets of assets.

I.e. assets that are included in the calculation of the spread risk capital requirement should be excluded from the default risk capital requirement, and vice versa.

Question 25

Assets and liabilities that are subject to credit spreads include: (9)

Answer 25

• Government and corporate bonds
• Subordinated debt instruments
• All other debt and fixed-income securities, including hybrid debt instruments
• Asset-backed securities
• Structured credit products such as collateralised debt obligations
• Credit derivatives, including credit default swaps, total return swaps, and credit-linked notes
• Participating interests
• Loans
• Participation in investment pools

Question 26

Type 1 exposures

Answer 26

Exposures where the counterparty or issuer of the instrument may be rated, and consist of exposures in relation to:

a) Deposits with ceding institutions, if the number of independent counterparties does not exceed 15;
b) Capital, initial funds, letters of credit as well as any other commitments received by the insurer which have been called up but are unpaid, if the number of independent counterparties does not exceed 15;
c) Guarantees, letters of credit, letters of comfort which the insurer has provided, as well as any other commitments which the insurer has provided and which depend on the credit standing of the counterparty;
d) Recoverables from eligible risk mitigation instruments; and
e) Assets not captured elsewhere in the calculation of the market risk capital requirement.

Question 27

Type 2 exposures

Answer 27

Cover exposures where the counterparty or issuer of the instrument is likely to be unrated, and consist of exposures in relation to:

a) Receivables from intermediaries;
b) Policyholder debtors, including mortgage loans;
c) Deposits with ceding institutions, if the number of independent counterparties exceeds 15; and
d) Capital, initial funds, letters of credit as well as any other commitments received by the insurer which have been called up but are unpaid, if the number of independent counterparties exceeds 15

Question 28

Type 3 exposures

Answer 28

Cash held at banking institutions

Question 29

Concentration risk

Answer 29

Refers to the risk of potential losses on investments over and above the systematic risks arising from the portfolio of investments when the portfolio of investments is not sufficiently diversified.

Question 30

Scope of concentration risk

Answer 30

For the purposes of this Standard, the scope of concentration risk is restricted to the risk related to the accumulation of exposures with the same counterparty, or group of related counterparties (i.e. exposures related to the same corporate group).

The scope does not include other types of concentrations such as geographic or industry concentrations.

Question 31

3 Steps for the calculation of the concentration risk capital requirement

Answer 31

a) Calculation of excess exposures per counterparty
b) Determination of concentration risk capital requirements per counterparty
c) Aggregation of concentration risk capital requirements across all counterparties.

Question 32

Illiquidity premium risk

Answer 32

Refers to the risk of a change in Basic Own Funds resulting from a decrease in the illiquidity premium used in the valuation of technical provisions.