REGULATORS
1. the 'solvency capital' is required for various reasons from the regulatory point of view.
2. To reduce the likelihood of the insurer not meeting liabilities when they fall due
3. To provide a cushion to limit the losses, in the event of insolvency
4. To provide an early warning system for regulatory intervention and early corrective action
5. To promote the confidence of the general public
SOLVENCY ASSESSMENT
1. It is the ability of an insurer to meet all its liabilities whenever they fall due. Simplistically, it is represented by the excess of an insurer's assets over its liabilities.
2. From the management's point of view, having identified the total capital requirements from the risk management process, the capital representing the 'tail' events.
3. Given that there may be various approximations used in the estimation of the total capital and that the model & the parameters used may always have an element of error, in practice, the desired level of solvency may be higher than that represented by the 'tail' events.
4. In the absence of any regulatory requirement, the capital actually held by the company to support these 'tail' events may then depend upon the risk taking appetite of the shareholders and the cost of capital.
COMMON METHODS TO DETERMINE "SOLVENCY CAPITAL"
1. Absolute Amount - A certain minimum amount. Such an approach obviously does not allow for the amount of risks undertaken by a life insurance company and hence is usually used only as a starting requirement.
2. Fixed Factors - A certain minimum amount arrived at by using fixed factors that are applied to various items of an insurer's balance sheet or financial statements. (e.g. x% of mathematical reserves + y% of net amount at risk + z% of assets).
3. Absolute Amount with Fixed Factors - A combination of the above two forms
4. Dynamic Solvency Analysis – Under this approach, insurers may be required to test their solvency against a range of adverse conditions in the form of prescribed scenarios. These scenarios may include 'shocks' or 'tail' events and the insurers need to hold solvency capital to withstand these 'shocks' or 'tail' events with an acceptable probability of ruin over a prescribed time period.
5. Internal Risk Management Model - A certain minimum amount arrived at by using company specific internal risk management models to assess their unique solvency capital needs.
OPINIONS
1. Scenarios dynamic solvency analysis may apply to either in-force business or only include new business. The inclusion of new business may indirectly allow for the risks involved in some insurance processes.
2. For Internal models, regulators like a solvency capital requirement that are objective, comparable between insurers and easily verifiable.
3. Given the merits of the risk management model approach, a hybrid method could be developed which combines the risk management approach and the traditionally used factors approach.
