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Capital management (Why providers of financial services need capital (REG…
Capital management
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Capital management tools
Subordinated debt
Payments only made if regulatory solvency capital requirement will continue to be met and, possibly, if authorised by the regulator.
Therefore, debt repayments may not need to be shown as liabilities in the regulatory balance sheet
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Securitisation
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The primary motivation is often to achieve regulatory arbitrage, e.g. by turning an inadmissible asset into an admissible one.
Often involves the issuance of a bond where the interest and/ or the capital payments are contingent on some factor
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Less effective in regimes which take credit for future profits in the regulatory balance sheet, e.g. Solvency II
Derivatives
e,g, enter into a contract to protect its equity portfolio falling below a certain level
Financial reinsurance
Aims to exploit some form of regulatory arbitrage. The extent to which it can help depends upon the regulatory regime in place
Historically, such arrangements have been used to crystallise the value of future expected profits in the balance sheet. The arrangement takes the form of a loan, where the repayments are made contingent on future profits being made so that the direct writing company may not need to reserve for them on a regulatory basis. However, such methods are not viable under regulatory regimes which already take credit for future profits (e.g. Solvency II)
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Reinsurance
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Can help with liquidity issues. The cedant is swapping the need to find big lump sums to pay claims with smaller reinsurance premiums
Proportional reinsurance can help with managing a cedant's new business strain by means of reinsurance commissions paid at outset.
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Admissible asset
One that is permitted by the regulators to be included in the valuation of assets for the assessment of supervisory solvency, i.e. it can be used to back the provisions and solvency margin.
E.g. there may be restrictions on the type of an asset that can be used or on the amount of a particular asset than can be included in the assessment.
Examples of inadmissible assets might include works of art and derivatives held for speculative purposes.
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Capital management
Involves ensuring that a provider has sufficient solvency and liquidity to enable both its existing liabilities and future growth aspirations to be met in all reasonable foreseeable circumstances. It also often involves maximising the reported profits of the provider.
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