Chapter 13 - Ongoing Solvency

Question 1

A life insurer will need capital for: (8)

Answer 1

1. Providing protection against adverse experience
2. Funding new business
3. Supporting a riskier investment strategy
4. Funding overhead and developmental costs
5. Acquiring other companies, ir block of business
6. Satisfying solvency valuation requirements
7. Supporting with-profits bonuses and their smoothing
8. Providing day to day working capital

Question 2

Reasons for projecting solvency: (4)

Answer 2

1. It will allow the impact of key business strategy decisions to be assessed and, in particular, will show the amount of new business strain, and hence the volume of new business, that can be supported by the available capital. They will also allow the company to put in place funding plans where available capital is insufficient
2. For with-profits funds that are close, or in decline, solvency projections are important in preparing run-off plans for the fund
3. Can also be used to estimate the pattern of capital releases to shareholders. Can be used to assess the cost of capital on calculating EV of the company
4. It plays a role in successful risk measurement and risk management within the company. In particular, under SAM solvency projections are required as part of the ORSA process

Question 3

Definition of Required Economic Capital:

Answer 3

The capital required for supporting a business with a certain probability of default.

This capital is required from an economic point of view rather than from a regulatory point of view

Question 4

Definition of Available Economic Capital:

Answer 4

The excess of the value of the company’s assets over the value of its liabilities on a realistic or market consistent basis

Question 5

Main features of the standardised formula to calculate SCR: (4)

Answer 5

1. It is a forward-looking, risk based measure that addresses the key risks faced by insurers
2. Measures risks primarily through the application of stress scenarios to an insurer’s assets and liabilities
3. Is proportionate in that it allows for the use of simplified calculations under certain conditions
4. Makes allowance for the risk-reducing impact of diversification benefits between risks, and also for risk mitigation instruments, changes to PH behaviour and future management action

Question 6

Insurers can use an internal model to calculate SCR if they satisfy the following key requirements: (5)

Answer 6

1. Insurers must have an effective system of governance for the internal model, including the requirement to develop and maintain a model change policy that sets out the processes and controls that they will adhere to when implementing changes to the internal model
2. Insurers must demonstrate via the Use Test that the model is widely-used in risk management and decision-making, and plays an important role in their system of governance
3. Insurers must meet requirements relating to statistical quality, data quality, model calibration, and validation
4. Partial models may be approved provided they are sufficiently justified and integrated into the remaining standardised formula

Question 7

Definition of own funds:

Answer 7

The excess of assets over liabilities, plus subordinated liabilities, less any regulatory adjustments (basic own funds), plus off balance sheet capital resources that can be caled upon to absorb losses (ancillary own funds)

Question 8

Regulatory adjustments that are made on Basic Own Funds: (7)

Answer 8

1. Certain ineligible assets
2. Holdings in own shared
3. Holdings in own holding company shares
4. Cash and deposits at a bank in the same financial conglomerate
5. Restricted reserves
6. Participations in financial and credit institutions
7. For any ring fenced funds

Question 9

Definition of ancillary own funds:

Answer 9

It is off balance sheet capital resources that can be called to absorb losses. Would include letters of credit and guarantees

Question 10

Shortcomings of standard model to calculate SCR: (7)

Answer 10

1. The use of multiple correlation matrices is theoretically invalid and can result in inaccuracies in the correlations between risks
2. It may not be accurate for fast growing or closed books
3. It does not allow for non-linearity between risks. Refers to situations where the capital required for 2 risks occurring simultaneously is greater than the sum of the capital required for each risk individually
4. Operational risk is modelled at a very high level with no link to the insurer’s actual risk management framework
5. Complex risk management techniques such as dynamic hedging and certain reinsurance structures can not be allowed for
6. It only adjusts for double counting for potential double counting of the loss abaorbing capacity of technical provisions in the market risk module. For policies where the insurer is able to vary future bonus rates or alter prms and charges in response to non-market shocks, there is a risk of double counting that is not captured in the standardised formula
7. The allowance for risk sharing inherent in cell captive business between 3rd party cells and promoter cell is allowed for on an approximate basis, which may overstate the SCR for the business

Question 11

The minimum for MCR: (2)

Answer 11

Minimum overall value of:
1. R15 million
2. Or 15% of gross annualised operational expenses

Question 12

Define the loss absorbing capacity of liabilities:

Answer 12

It refers to the ability of an insirer to vary its future bonus rates or alter premiums and charges in response to the shock being tested