Difference between global provisions and required capital

Hello Amarnath

You are right that for some risks we might set a global reserve, or we might set additional solvency capital. The approach used in practice depends on the regulations of the country.

For many risks we might calculate reserves on a policy by policy basis, eg the risk of a claim being made.

For other risks that apply to a group of policies we might instead calculate a global reserve. So we look at the portfolio of policies, rather than considering each policy one at a time.

In addition (or alternatively) we might calculate the required capital to cover a risk. For example, we might calculate the capital required to cover losses 99.5% of the time.

Different approaches exist, and different names are given to the components, but the end result is that the insurer is required to hold assets to cover the sum of the various reserves and required capital. Some countries require large reserves and little capital. Other countries require smaller reserves but have much larger required capital. In a sense, it doesn't matter how big a particular component is, as long as the sum of all the solvency components is large enough to give good security to policyholders.

I hope this helps.

Best wishes

Mark

 

Hello Adithyan

I think most regulators require only one of a global reserve or solvency capital. However, in theory the insurer could be required to hold both at the same time.

Yes, there is a danger of double counting where insurers hold a reserve and solvency capital. However, that need not be the case. The reserve might be to cover the best estimate of the operational risk say, while the required capital is there to cover the possibility that the risk is worse than expected. This might give exactly the same total requirement as a prudent reserve for operational risk and no solvency capital.

Best wishes

Mark