C35 : Capital Management Flashcards
(18 cards)
Define the term ‘Capital Management’
- Capital Management involves ensuring that a provider has sufficient solvency and liquidity to enable both its existing liabilities and future growth aspirations to be met in all reasonably foreseeable future circumstances
- It also involves maximising the reported profits of the provider
Explain why individuals need capital
Why individuals they need capital:
1. Provide a cushion against future unexpected events
2. Overcome timing differences between income and outgo
3. Save for large future expenses such as a holiday or buying a house, child’s marriage/education
Explain why companies need capital
Why trading companies need capital:
1. Provide a cushion against fluctuating trade volumes
2. Build up funds for a planned expansion
3. Fund the cashflow strain arising from the need to pay suppliers, fund work in progress and finance stock before the finished good is sold
4. Provide start-up capital e.g. hire premises, staff
5. Deal with financial consequences of adverse events
Explain why financial providers need capital
Why the capital needs of a financial provider are more onerous than than those for non-financial companies
Why providers of finance need capital: HUGER COINS
- Helps demonstrate financial strength to e.g. Brokers, credit rating agencies
- Unexpected events e.g. adverse experience, fines
- Guarantees (write business containing) as higher solvency margin required.
- Expenses of launching a new product/starting a new operation
- Regulatory requirement to demonstrate solvency
- Cashflow timing mismatch, benefits v premiums / contributions
- Objectives/opportunities e.g. mergers and acquisitions
- Investment freedom e.g. to mismatch in pursuit of higher returns
- New business strain financing
- Smooth profit and loss accounts and improve balance sheet solvency
Discuss the capital needs of the State
- For the most part the State does not need to build up free capital because it can raise taxes, issue bonds or print money if it requires funds.
- However, the State does tend to build up working capital (using gold and foreign currency reserves) to support fluctuations in the economic cycle and in the balance of payments, and to manage timing difference in income and outgo.
How providers meet, manage and match capital needs
- Proprietary companies
Issue shares to existing shareholders e.g. rights issues
Issues of shares to new shareholders e.g. tender offers
Issues of debt
Securitisation
Reinsurance
How providers meet, manage and match capital needs
- Mutual companies
- Initially capital is raised through an altruistic gesture (someone lending money but with no requirement for it to be repaid, unless profits emerge)
- Issues of subordinated debt
- Securitisation
- Reinsurance
How providers meet, manage and match capital needs
- Sponsors of benefit schemes
The sponsor of a benefit scheme may be prepared to put up the initial capital for the arrangements, particularly those required to cover the expenses of setting up the scheme.
Why micro-insurance may have support from State
- Microinsurance is the provision of low-cost insurance products and benefits to those on low incomes.
- Microinsurance schemes may have capital support from the State, given their usual purpose of supporting individuals on low incomes.
Describe the role of Reinsurance in capital management
Reinsurance as a provider of financial assistance:
- If an insurer has reinsurance, the regulator may not require as large a solvency margin as it would without reinsurance
- Reinsurance can help with liquidity issues. The cedant is swapping the need to find big lump sums to pay claims with smaller reinsurance premiums
- Proportional reinsurance can help manage a cedant’s NB strain by means of reinsurance commissions paid at the start of the arrangement. This is an example of financial reinsurance
- Financial reinsurance aims to exploit some form of regulatory arbitrage
- One type of FinRe, often associated with proportional reinsurance, is a loan dressed up as reinsurance commission. If the loan repayments are made contingent on future profits being made, the direct writer may not need to reserve for them on a regulatory basis
Outline the process of matching and managing capital requirements
- model both the existing business and the
projected new business. - The model can generate the amount of capital needed for the provider’s business plans to be achieved at a given ruin probability
- A sophisticated model will also consider any statutory or regulatory minimum capital requirements for the business throughout its lifetime.
List two external factors that may determine the effectiveness of different capital management tools
- regulatory and tax environment
- effectiveness of a given approach to managing an insurer’s capital may change over time if the regulatory / tax environment changes.
List capital management tools
BED RIFSS
- Banking products – including liquidity facilities, contingent capital and senior unsecured financing
- Equity capital
- Derivatives (used to protect the value of existing capital by hedging)
- Reinsurance – to reduce the amount of capital required
- Internal restructuring – including merging funds, changing assets, weakening the valuation basis, deferring surplus distribution and retaining profits.
- Financial reinsurance (FinRe) – a reinsurance arrangement that provides capital, typically by exploiting some form of regulatory, solvency or tax arbitrage
- Securitisation – which in its most general form involves converting an illiquid asset into tradable instruments
- Subordinated debt
Use of Banking products in capital management
- Liquidity facilities (makes existing capital more liquid)
- Contingent capital (similar to post loss funding)
- Senior unsecured financing (money raised by a parent company and distributed to improve the capital position of certain subsidiaries)
- Derivatives (used to protect the value of existing capital by hedging)
List Sources of equity capital
Sources:
1. Parent company
2. Existing S/H via rights issue
3. New S/H via placement of new shares
List internal sources of capital management
1) Restructuring by merging funds
2) Changing assets:
- inadmissible to admissible
- matching more closely to reduce mismatching reserve
- to influence the valuation interest rate used for liabilities
3) Weakening the valuation basis
4) Deferring the distribution of surplus (e.g. bonuses)
5) Not paying dividends i.e. retaining profits within the provider
Describe securitisation as a tool of capital management
- Involves turning illiquid assets into tradable instruments
- Primary motivation is often to achieve regulatory arbitrage, e.g. by turning an inadmissible asset into an admissible one
- Typically an element of risk transfer involved in the transaction
- Securitisation often involves the issuance of a bond where the interest and/or capital payments are contingent on some factor, e.g.:
a) Future profits emerging on a block of insurance business
b) Repayment of mortgages or loans
Describe Subordinated Debt as a tool of capital management
- Ranks behind all other liabilities, including meeting PRE
- Debt repayments may not need to be shown as liabilities in regulatory accounts
- Debt can be dated or undated – this affects the amount that can be shown as an admissible asset and may impact tax implications
