Chapter-19 Page-2

[nluashok]

Hi,

Regarding economic capital it is given;

"the amount of capital that a provider determines is appropriate to hold given its
assets, its liabilities, and its business objectives – this is known as economic
capital and will be higher than the minimum regulatory capital."

If economic capital is higher than regulatory capital than why will company go for economic capital?

Regards,
Ashok

 

[maz1987]

Because there are many more objectives for an insurer than to simply satisfy the regulator's requirement for capital.

As an extreme (simplified) example, one objective may be to ensure their capital levels do not fall below the regulator's threshold. Therefore if they hold exactly the regulatory requirement then a single dollar deterioration of reserves would put them under the threshold. As such they would opt to hold more capital than the statutory requirement.

Other objectives also include maintaining a certain credit rating, which often demands much more capital than the regulator may require.

It also may want to hold capital to take advantage of M&A opportunities as they arise, or to demonstrate its strength to the market and to policyholders.

Of course it will have to make important decisions about at what point is it holding too much capital. So conversely it's not simply a case of an insurer holding as much capital as it can get its hands on!