ActEd Acronym App Question 3
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Subject CA1 Paper 1 September 2007 Question 4 (i)
Question
Outline the reasons why a general insurance company holds capital.
[5]
Solution
Overview
This question on the reasons why capital is needed is covered in the chapter on Capital
management. There is a useful acronym to help you remember the main uses of capital
(REG CUSHION):
Regulatory solvency purposes
Expenses of developing new business
Guarantees and options
Cashflow mismatching
Unexpected events and adverse experience
Smooth results
Help demonstrate financial strength and attract business
Investment freedom
Opportunities
New business strain
However, be aware of acronym abuse! A poor student would just list this acronym. A
good student would note that the question asks for outlines not lists, and that the answer
should therefore contain more detail, including some examples.
You need to tailor the answer to a general insurance company. Important ideas to
associate with general insurance companies are: volatile and unpredictable claim
experience, new business strain, mainly short-term contracts, and onerous regulatory
solvency requirements.
The Actuarial Education Company
© IFE: 2015 Examinations
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ActEd Acronym App Question 3
A general insurance company needs capital:
•
to demonstrate regulatory solvency
•
to meet the liabilities arising on unexpected events, for example:
–
adverse claims experience over time
–
a catastrophe resulting in multiple claims on a portfolio of business
–
a regulatory fine for mis-selling
–
operational risks such as fraud
Note that in questions like this, one example will often suffice.
•
to meet unexpected timings of the liabilities
•
to cover the one-off expenses of developing new general insurance products,
including marketing costs
•
to demonstrate financial strength to credit rating agencies and to customers and
intermediaries, which in turn should help attract new business
•
to smooth fluctuations in claims costs in the accounts
•
to smooth profit distributions to shareholders
•
to take advantage of opportunities, eg:
–
mergers and acquisitions
–
introducing new sales channels
–
projects to create a more efficient and profitable business
•
to demonstrate financial strength to customers and intermediaries, which in turn
should help attract new business
•
to enable greater investment freedom, ie to mismatch in pursuit of higher
investment returns – this may be significant for longer-tailed business such as
liability business
•
to enable greater pricing freedom, eg to sell business as a loss leader
•
to cover new business strain, ie the shortfall that often occurs on general
insurance contracts. For example, if it is a regular premium contract and the
initial premium is less than the initial expenses plus commission plus a (typically
prudent) statutory reserving requirement.
© IFE: 2015 Examinations
The Actuarial Education Company