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Flashcards in 15 Capital Management Deck (18)
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1
Q

Define Required Capital (2)

A

It is the excess of assets over liabilities required such that policyholder claims can be met with a high degree of certainty when they fall due.

2
Q

Describe the three measures of required capital. (3)

A
  1. Economic Capital. This is the internal determination of capital required, based on a company’s own risk profile, risk appetite and ongoing business strategy.
  2. Regulatory Capital. Capital based on valuation rules for assets and liabilities prescribed by the regulator.
  3. Rating Agency Capital. The view of rating agencies. Important if you need to maintain a certain credit rating.
3
Q

List six categories of risk to which a life insurance company is exposed. (6)

A
  1. Market risk
  2. Credit risk
  3. Insurance risk
  4. Operational risk
  5. Liquidity risk
  6. Group risk
4
Q

State 3 reasons why life insurance companies require working capital. (3)

A
  1. To fund new business, including attracting support from intermediaries.
  2. To fund overheads and the development costs of organic expansion.
  3. To acquire other companies or blocks of business.
5
Q

List seven reasons why life insurance companies need for capital has increased in recent years. (7)

A
  1. The costs of mis-selling compensation.
  2. Enforced flat charging structures (e.g. stakeholder pensions).
  3. Lower investment returns in a low inflation environment.
  4. Improving annuitant longevity.
  5. Implications of TCF.
  6. Increasing competition from fund management groups.
  7. Changing distribution patterns.
6
Q

State four sources of a proprietary life insurance company’s required capital. (4)

A
  1. The initial capital from the first shareholders.
  2. Additional amounts subsequently subscribed by shareholders or raised through subordinated loan stock.
  3. Profits retained within the company.
  4. Consistent under-distribution of surplus in respect of past generations of with profits policyholders.
7
Q

State three reasons why the amount of capital available to a proprietary life insurance company may have been depleted over the years. (3)

A
  1. Distribution of capital to shareholders as dividends.
  2. Losses on without-profit business to which shareholders are exposed to 100% of profit or loss.
  3. Consistent over-distribution of surplus in respect of past generations of with profit policyholders.
8
Q

Describe what is meant by the inherited estate in a with profits fund. (5)

A
  1. It is the realistic value of the assets held in a with profits fund less the realistic value of the liabilities (taking into account PRE).
  2. In most with profit companies the estate has built up over many years.
  3. A company may have decided to retain this capital for commercial reasons (e.g. to attract new business or fund expansion).
  4. Ownership of the inherited estate and its uses are the subject of much debate.
  5. A company’s PPFM covers the intended management of its estate, its intended uses and target size.
9
Q

List five possible uses of the inherited estate in a with profits fund. (5)

A
  1. Aiding investment flexibility in a with profits fund.
  2. Helping to meet regulatory capital requirements.
  3. Paying tax incurred by the fund on distributions to shareholders.
  4. Covering over-runs on existing and new business expenses.
  5. Helping to support smoothing flexibility.
10
Q

State the two sources of capital available to a mutual life assurance company. (2)

A
  1. The initial or subsequent capital injected into the company.
  2. Any consistent under-distribution of surplus in respect of past generations of policyholders.
11
Q

Describe the entity approach to running a mutual. (2)

A
  1. It assumes the available capital is there to support the company.
  2. The available capital does not belong to any particular generation of policyholders. In particular, not the current generation.
12
Q

State six reasons a life insurance company might perform solvency projections. (6)

A
  1. To allow it to understand the evolution of its risk profile.
  2. To allow the impact of key business strategy decisions to be assessed.
  3. To help in preparing run-off plans for any with-profit funds that are closed or in decline.
  4. To estimate the pattern of capital releases and assess whether the company is achieving a suitable return on capital.
  5. To meet Solvency 2 requirements, e.g. for the pillar 2 ORSA. Projections of solvency capital are also required to calculate the risk margin component of technical provisions.
  6. To play a role in risk measurement and risk management.
13
Q

Describe the two approaches to calculating economic capital. (2)

A
  1. Stochastic modelling. Used to assess market and credit risks using a large number of real world scenarios.
  2. Stress tests. Used when the distribution of a particular risk is less well understood.
14
Q

When might different time horizons be suitable when assessing economic capital requirements? (2)

A
  1. A one-year time horizon may be suitable if the company’s risks can be hedged through the capital markets.
  2. A full run-off may be suitable if the risks cannot be hedged.
15
Q

Outline the steps in using a proxy model. (5)

A
  1. Choose the type of proxy model, the key risk factors and their dependencies.
  2. Generate fitting scenarios using expert judgement and run the heavy model under these scenarios.
  3. Calibrate the proxy model to provide an acceptable fit in these scenarios, e.g. by using the least squares regression approach.
  4. Validate by using a set of out of sample scenarios and compare the results of the heavy model and proxy model.
  5. Re-calibrate the proxy model periodically.
16
Q

Describe how capital, risk and value are inextricably linked. (4)

A
  1. Risk drives the amount of required capital and policyholders willingness to do business with a company.
  2. Risk also drives shareholder value as the market price of financial risk is a core driver of shareholders required return.
  3. The amount of capital held drives the shareholder value through the frictional cost of holding capital.
  4. For example, from a shareholder perspective a life company might not be the most tax efficient place to have capital locked in.
17
Q

List six methods by which life assurance companies may be able to increase available capital. (6)

A
  1. Equity
  2. Subordinated debt
  3. Securitisation
  4. Reinsurance
  5. Derivatives
  6. Review the asset-liability matching position.
18
Q

List possible proxy model approaches. (5)

A
  1. Polynomial
  2. Curve fitting
  3. Kriging
  4. Replicating portfolio
  5. Closed form solutions