Capital Requirements - Ch14

Discussion in 'SA2' started by Studystuff, Feb 17, 2022.

  1. Studystuff

    Studystuff Very Active Member

    Hello Students/Tutors,

    I was hoping someone may be able to help some queries I have regarding this chapter.

    Topic 1: The term "inherited estate" is described as "The existence of capital within a with-profits fund that has arisen from under distribution to past generations of policyholders" and then it is also defined as "broadly the amount of assets over and above the realistic liabilities"..

    Question 1 - However, what I am confused about here is where the PV of future shareholder transfers comes into play? We saw in an earlier chapter that this should be included in Own Funds and not as a liability in the SII balance sheet. Therefore A-L would include some PV of future shareholder transfers and not explicitly be "existence of capital within a with-profits fund that has arisen from under distribution to past generations of policyholders"

    I saw on the FCA website (https://www.handbook.fca.org.uk/handbook/glossary/G3488.html) that they include PV of future transfers as an 'other liability' and therefore Realisitc A-L in that case would give you a true "inherited estate"... But I'm not so sure how this looks from a SII POV? Is it more correct to say that PV of future transfers are included within the inherited estate or in addition to the inherited estate?



    Topic 2. I understand that we can value our (i) Assets (ii) Liabilities and (iii) Capital requirements on an economic, regulatory or ratings agency basis...
    A regulatory basis is likely to include prescribed rules from the regulator but the economic basis will be an internal determination of capital required based on companies risk profile, risk appetite and the needs of its ongoing business. In addition to this, the company will be able to set its own rules about valuing assets and liabilites.

    My confusion comes from section 3.2 which is specifically to do with assessing the value of Assets and Liabilities. Core reading states that MV(A) - MV(L) is equal to "realistic available capital".

    Question 1
    - Does this mean by extension that a "market value" of assets and "market value" of liabilities are "realistic" assessments of assets and liabilites? IN CP1/SP2 I think we used the term 'realisitic' for Best estimate rather than market consistent but maybe it can be used for both? So when we see the term 'Realistic Liabilities" used can we replace with with MV of Liabilities?

    Question 2 - Is there only 1 true 'Realistic Capital' amount? Because on a SII basis we look at the (Market value of assets) less (market value of liabilities (TP)) but on an economic basis we also take MV(A) - MV(L), but this market value of liabilites may be different because we include cashflows beyond a contract boundary. This looks like we could get 2 different versions of "Realisitic Capital" as both are based on Market Value but are likely to have different exact values (Due to extra cashflows for example)

    Am I picking that up correct? That you could have some slightly deviating "Realisitic Capital" values between the SII approach and an economic basis approach? but that both could in fact be considered "Realisitic Capital"?
     
  2. Em Francis

    Em Francis ActEd Tutor Staff Member

    Hi,I will have a go at answering your queries:
    Companies may define their inherited estate in different ways, there is no universally agreed definition.
    You may find the following thread useful:
    https://www.acted.co.uk/forums/inde...-vs-inherited-estate-same-or-different.15983/

    If it is realistic value of assets over liabilities then we could think of the inherited estate as Solvency II own funds and that means that it would include the PV shareholder transfers. However companies may choose to record the latter under 'other liabilities' and define the estate as assets in excess of technical provisions and capital requirements and PVST.

    If we think about the general definition of the inherited estate - 'broadly that part of the with-profits fund over and above that which is required to meet the realistic liabilities, and which the company has decided to retain – perhaps for commercial reasons.'
    and the fact that it is there to provide working capital for the with-profits fund will mean that it is up to the shareholders whether they want to include their future shareholders transfers in such a fund as 'retained capital'.

    However, remember that Solvency II is a regulatory requirement. The calculation of the inherited estate will be an internal requirement.
     
  3. Em Francis

    Em Francis ActEd Tutor Staff Member

    In SA2, you can think about think about realistic valuations on a market-consistent basis made up of best estimate assumptions plus an allowance for risk. But if they are used in a non-market consistent basis then you would need to allow for the risk somewhere.
    A realistic value of a liability can be the market value for those risks where a deep and liquid market exists (the hedgeable risks).
    Market valuations will be based on best estimate assumptions but will also allow for risk in their valuations.
    If we consider SII's balance sheet: The technical provisions are made up of:
    1) a best estimate liability valuation plus a risk margin for those risks where a reliable market value is unobtainable (ie unhedgeable risks) and
    2) a market value for those hedgeable risks where the market has allowed for the risk.

    Yes, it will depend on how the company has defined realistic. Note however that 'realistic capital' is not a regulatory term.
    The more prudent and restrictive the regulatory requirement, the less realistic the capital - in this situation, a company would likely take realistic capital to refer to their own valuation, ie based on the economic balance sheet. However, under SII the two balance sheets should be similar so there shouldn't be much difference between the realistic capital derived from each.

    Hope this helps.
     
  4. studentactuary15

    studentactuary15 Active Member

    Hi I thought I would use this thread because I have a question on Capital Management chapter.

    This is in the solutions on ASET April 2016, 1iii:

    "Raising capital by financial reinsurance, securitisation or the issue of subordinated loan stock may be difficult for with-profits business.
    Plus, they would not directly improve / increase available capital on a realistic economic basis...

    ... and would only reduce the required economic capital if the company can default on the loan or interest repayments under extreme adverse scenarios, ie under the 1-in-200 year equity fall scenario."

    I just don't understand the bold part. Why is it difficult to raise capital through these methods for WP business? And why would they not directly improve capital on a realistic basis? Is it because they would increase both assets and liabilities due to it being methods which you need to pay back the capital?

    Thank you in advance.
     
  5. Em Francis

    Em Francis ActEd Tutor Staff Member

    Hi
    The first part is just referring to the challenges for with-profits business around the repayment from the future profits and how there may be constraints due to the with-profit policyholder's entitlement.
    The second part is referring to the fact that on a realistic basis a company will need to take account of the future profit repayment within its liabilities. So yes, as you say, there will be an increase in both the assets (via the loan amount) and the liabilities (via the repayment).

    Hope this makes sense.
    Thanks
    Em

    Hope this makes sense.
     
    studentactuary15 likes this.
  6. studentactuary15

    studentactuary15 Active Member

    Makes perfect sense - thank you!
     
  7. User 1234

    User 1234 Active Member

    Hi Em,

    I got confused by the point around whether there is a need to reserve the repayments i.e. increase liabilities under the Securitisation. In the Securitisation section of Chapter 14 core reading, it says that insurers do not need to reserve for the future repayments prior to S2. Is it that insurers need to reserve repayment under S2 (realistic basis) but do not need to reserve repayment prior to S2 (prudent basis)? If so, what is the rationale of such different treatment? Some numbers below to illustrate my interpretation, is it correct?

    Prior to S2:
    Without the securitisation: assets =100, statutory reserves = 80 (= 20 PVIF + 60 BEL), NAV = 20
    With the securitisation: assets = 100 + 20 = 120, statutory reserves = 80 (no need to reserve the repayment), NAV = 40
    Overall, NAV is improved by 20.

    Post to S2:
    Without the securitisation: assets =100, liabilities = realistic reserves 60, NAV = 40
    With the securitisation: assets = 100 + 20 = 120, liabilities = realistic reserves 60 + repayment 20 , NAV = 40
    Overall, NAV is improved by 0.

    Therefore, securitisation is less effective under S2.

    Thanks a lot for your help!
    Cheers
     
    studentactuary15 likes this.
  8. Em Francis

    Em Francis ActEd Tutor Staff Member

    Hi

    Yes, you have summarised well. The rationale is that you are recognising those future payments when calculating the BEL (ie BEL is 60 not 80) and so you should then also recognise that there is a repayment of 20, as part of your future liabilities.
     
    User 1234 likes this.

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