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Debt as Capital

A

Actuary_1234

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Hello,
This is a capital (ch 4) question. I wasn't quite sure of how some aspects tied together so it would be good for someone to confirm/answer the below.

I can understand capital being defined as “assets minus liabilities”.
What is confusing for me though is we start defining the components of this capital in terms of debt issued and use the language of debt for the tiering (“redeemable”, “maturity”, etc.).
An example was given of subordinated debt issued by the company for basic tiers two and three.

1. Would an example of this be corporate bonds issued by the company?

2.When the company issues this debt, it would receive a principal in cash to go on the asset side of its balance sheet and then, it would seem, the requirement to pay back this principal and any coupons would go on the liability side.
Why therefore is this not listed as a “hedgeable liability” in the balance sheet but rather “capital”?

3. Or is the point rather about being “subordinated”. I.e. the whole definition of capital here is, in the event of an SCR breach or needs-must situation, what financial instruments have I used to generate funds available in my business which can then be used to pay the claims of policyholders above all others?
 
Your 'point 3' is nearer to the mark.

Capital is not necessarily defined as assets minus liabilities - I'd normally call that free assets, shareholders' funds, or free reserves. Capital for the purposes of tiering is more likely to be referring to total assets (investments).
So, a company will have all sorts of investments/assets - equities, debts, property etc. But the amount these assets can be used to cover statutory solvency requirements depends on, for example, their security and flexibility. Subordinated debts are lower down the pecking order, and hence normally count as Tier 2, which isn't as 'good' as Tier 1 capital. There are plenty of background reading papers that talk in more detail about the tiering of capital - but they get rather technical from an investment point of view - and I'd suspect go well beyond the relevance for SA3 (which is more interested in the liabilities side of the balance sheet).

Hope that helps.
Ian
 
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