April 2013 Q 2 vi (Solvency II)

Does this 10% assumption pertain to the capital charge for the 'reserve risk module' as per the Solvency std formula? I presume that this has got nothing to do with the 'risk margin' that is added to the 'Best estimate liability' (BEL).

I think the 10% is a discount rate assumption that the examiner came up with. There is nothing in the question to lead us there, but the examiner would have accepted any assumption. the fact that the question said "undiscounted" reserves was a clue that we had to look at the impact of discounting under Solvency II. once discounted, the reserves would fall. If we assume average term 1 year, and rate 10% then they would fall be £37.5million.


As I understand, this undiscounted 375 m should ideally be discounted and then a risk margin would be added. Say, this BEL+risk margin amounts to 360 m. Then this 360 will be reflected as 'technical provisions' in the balance sheet and a capital charge of 10% of this amount would be the capital backing this technical provision. Am I correct


It will be discounted under Solvency II. As you say, there will be a best estimate and a risk margin, but I dont think the examiner has gone into this. He has just assumed that the 375 is at face value, and when discounted it would fall - any assumed fall would gain marks.

If the technical provisions (BEL + risk margin) was 360m, then this would be a drop of 15m from the existing technical provisions of £375m. I dont think there is a 10% capital charge in Solvency II against technical provisions. This sounds like the 8% charge in the Basel banking regulations, which isnt replicated in the Solvency II system.

 

I did not quite understand the idea. Why has discounting "consumed" the prevailing capital? It would be a lesser number as compared to the undiscounted reserves.

The idea is that the technical reserves are at the moment undiscounted. Assets of 375m will be held to cover these liabilities. If discounting is used, the 375m liability will fall by 37.5m. The assets required to cover this liability will also fall, and the released assets will count as capital for the company.




Also, You mean to say that he has assumed that the discounted reserves would be 37.5 million lesser and deducted this amount from the capital? What does this operation mean

I hope the above explains this concept.

 

I think the exminer is deducting it from "capital required", rather than actual capital. the conclusion is that the company has loads of capital under Solvency II, so the likelihood is that the deductions are to find the new (reduced) capital required under Solvency II.

 

I agree it is written odly, but it makes no sense the way you have suggested - namely that the 10% reduction in the reserves through discounting will be deducted from the 400 capital. Rather I suspect what the examiner is saying is that discounting will automatically free up 37.5m of the capital. So 37.5 of the 400, which was there against those undiscounted reserves, can be released. (part xii discusses the release of up to 125m capital to reduce the purchase price of the acquisition). Assuming this capital is paid out to the acquirer, that leaves 362.5m left. He then goes on to suggest that even this is too great given the level of risk in the business, and that more capital could be released - up to 125m in total. So my thinking is that the falling 400m, is the examiner "releasing" the capital into an acquisition pot.

 

This was one of these SA5 questions where the examiner made a lot of assumptions in his/her calculations. The calculations are to indicate the type of analysis that the examiner was looking for. In particular, the assumed £125m of surplus capital that could be removed from the business is very hard to justify mathematically. So long as students established that the business does look over-capitalised, and assumed that some capital could be removed, they would have achieved the marks available in (xii)