Hi, Available capital= own funds= SCR + free surplus Also, available capital = assets- TP Now, if the SCR increases, using first equation, would it imply that available capital increases?
No: being required to put a higher amount of capital aside to cover adverse events doesn't mean that the company has managed to generate more capital for itself to use! Available capital is defined as value of assets minus value of liabilities. So, under Solvency II, we have available capital = own funds (OF) = assets - TP. Free surplus is defined as the excess of own funds over the SCR, ie free surplus = OF - SCR So if all that happens is that the SCR increases, there is no change to assets or to TP and hence OF (= assets - TP) is also unchanged. But the amount of free surplus (= OF - SCR) will reduce. In other words, if the company has to put aside more of its available capital to meet a higher required capital, it will have less free capital available to do other things with.
Yes. In one of the past year questions, there was a discussion around how can we reduce available capital. In the solution, we have considered actions which will increased required capital. This will reduce free surplus but available capital would still remain same given available capital = required capital + free surplus? Is there anything which I am not able to interpret mathematically?
Hi - can you give me the reference for that past paper question? It sounds like it was actually asking about actions that would reduce free capital.
Ah yes, I can see why there might be some confusion here. This solution isn't saying that you would reduce the absolute amount of available capital by increasing required capital. The question states that the company 'sets a target level of available capital'. It wouldn't make sense to do this in absolute terms, but rather the target should be expressed as a % of required capital (since the primary purpose of available capital is to cover required capital). As we explain in ASET, suppose that the target level of available capital is 150% of required capital, and the actual level is much higher at 200%. Increasing the required capital would mean that the ratio of available to required capital falls, moving towards the target level of 150%. So the question is effectively asking about how the ratio of available to required might be reduced (from its current very high position, to be nearer to its target level). This can be done either by reducing the available capital, or by increasing the required capital. Hope that makes a bit more sense now.
Alright. Yes surely! However, I am concerned that this is not as intuitive- the fact that target level of available capital is a percentage of required capital. If questioned under exam conditions, how to arrive at such conclusions?
Well it wouldn't really make sense to just say 'our target level of available capital is $Xm' because that doesn't take into consideration changes in the size of business or in its risk exposure, so that should be pushing towards thinking about it slightly differently. However, I completely take your point and it's very easy to say this when not actually having to answer the question in the exam! So what I would say is not to worry about it: it was perfectly possible to score very well in this question without realising this.
