CH:37 Capital requirements

Question 1

A provider of financial benefits will need to hold provisions for?

Answer 1

• liabilities that have accrued but which have not yet been paid
• future periods of insurance against which premiums have already been received
• claims already incurred but which have yet to be settled.

Question 2

What are the 3 pillars for Solvency II

Answer 2

1. quantification of risk exposures and capital requirements
2. a supervisory regime
3. disclosure

Question 3

What are the 2 levels of capital requirement under Solvency II

Answer 3

• Minimum Capital Requirement (MCR) – the threshold at which companies will no longer be permitted to trade
• Solvency Capital Requirement (SCR) – the target level of capital below which companies may need to discuss remedies with their regulators.

Question 4

How is SCR calculated

Answer 4

SCR is a risk-based capital requirement, hence

Assesing the capital required for each risk against a 0.5% ruin probability in 1 year

Question 5

Suggest factors that the regulator could take into account in assessing a bank’s risk profile and risk management systems

Answer 5

• reviews of the work of internal and external auditors
• banks’s risk appetite and its track record in managing risks
• nature of the markets in which the bank operates
• quality, reliability and volatility of its earnings
• banks adherence to sound valuation and account standards
• banks diversification of activities

Question 6

What is the purpose of ORSA (Own Risk and Solvency Assessment)

Under Solvency Pillar 2

Answer 6

Provide the board and senior management with an assessment of:
* adequacy of its risk management
* current, and unlikely future, solvency position

Question 7

What are the requirements of ORSA

Answer 7

• identify risks to which it is exposed
• identify risk management processes and controls in place
• quantify its ongoing ability to continue to meet its solvency capital requirements
• analyse quantitative and qualitative elements of its business strategy
• identify the relationship between risk management and level and quality of financial resources needed and available

Question 8

What is economic capital

Answer 8

Economic capital is the amount of capital that a provider determines is appropriate to hold (in excess of liabilities) to cover its risks under adverse outcomes, generally with a given degree of confidence and over a given time horizon

Question 9

How will economic capital be determined?

Answer 9

• risk profile of the individual assets and liabilities in its portfolio
• correlation of the risks
• business objectives of the provider
• desired level of overall credit deterioration that it wishes to be able to withstand

Question 10

How can companies use internal models to calculate economic capital

Answer 10

• calculate economic capital using different risk measures eg. VaR
• calculate confidence levels in economic capital calculated
• apply different time horizons to the assessment of solvency and risk
• include other risk classes not covered in the standard formula