Hi Ch 11 Questions 1. What does the CR mean by ‘apply 1 in 200 shocks to all risk factors’ at the bottom of p21? 2. What are captive reinsurers – last sentence p34? 3. Please explain the first market risk scenario – ie fall in equity values on p17. The CR is a bit confusing. Ch 12 Questions 1. What is the definition of an impaired bond? (p19 under balance sheet) Thanks SV001
Hi Ch 11. 1. For each of the risk categories, you would try to quantify the effect of the worst 1-in-200 year risks actually applying in the following year, and calculate the capital required if these all did happen. However, as the CR on the following page points out, credit is often taken for diversification benefits between the risks, depending on to the degree of correlation between them, rather than assuming that they will all apply at the same time. For some risk categories (such as insurance risk and market risk) the 1-in-200 year impact is often ascertained using stochastic modelling – ie to assess the impact at the 99.5% confidence level. For other risks (such as operational risk), detailed consideration of various scenarios is likely to be used. 2. The FSA definition of a captive reinsurer is: “a pure reinsurer owned by: (a) a financial undertaking other than an insurance undertaking or a reinsurance undertaking; or (b) a group of insurance undertakings or reinsurance undertakings to which the Insurance Groups Directive applies; or (c) a non-financial undertaking, the purpose of which is to provide reinsurance cover exclusively for the risks of the undertaking or undertakings to which it belongs or of an undertaking or undertakings of the group of which that pure reinsurer is a member.” So, this will be where a (non-insurance) company sets up a subsidiary with the primary purpose of insuring the risks of a parent or associated group companies. The company could set up a captive insurer or a captive reinsurer. If it is a captive insurer, it would receive premiums directly from the group companies. However, if it is a captive reinsurance, insurance companies are involved. The group companies will pay premiums to its insurers who will then pass them straight on to the captive reinsurer. The insurers are effectively acting as “fronting” insurers, as the risk is borne by the captive. Depending on where the captive reinsurer is based, there will usually be tax or regulatory benefits to doing this. In addition, creating a separate captive (insurer or reinsurer) allows the company to find insurance that may not be available elsewhere and focus management efforts on managing the companies’ risks better. 3. The precise scenario is set out in INSPRU 3.16 to 3.18. http://fsahandbook.info/FSA/html/handbook/INSPRU/3/1 It’s a bit complex! For the fall in equities, two calculations are made: (a) calculate the % fall in market values that would produce an earnings yield on the FTSE Actuaries All Share Index (FTASI) equal to 4/3rds of the yield on 15 year UK government fixed-interest securities index (b) calculate (25%-X) where X is the % fall (if any) in the current value of the (FTASI) compared to the average over the previous 90 days, capped at 25%; i.e. calculate how much future the index has to fall for there to be a total fall of 25% You take the lower of these two calculations (which will be less than 25%) and take the greater of this and 10%. For the scenario, you consider a fall in equity values of this percentage. Ch 12. 1. An impaired loan is one that is issued to a credit-impaired borrower, so we reckon an impaired bond in this context is one where the creditworthiness of the issuer is "impaired" in some way, i.e. below some threshold level. Hope this is of some help. All the best Steve
