As actuaries continue to prepare for the challenges of Solvency II and the increased emphasis on the efficient use of capital, a workshop at the Actuarial Profession’s life conference, which took place in Birmingham from 7 to 9 November 2010, examined the potential use of contingent capital in a post Solvency II world.
Cormac Galvin and Richard Baddon began by explaining how many contingent capital structures aim to align regulatory with economic capital, their current treatment under Solvency I before going on to examine how transactions may be structured under Solvency II.
Cormac said: “A significant change from the current framework is that, the emergence of expected profits in future premiums (EPIFP), which is analogous to Value of In-Force (VIF), will automatically count as tier 1 capital under Solvency II. This may mean that the most common trades of recognising VIF through the use of financial reinsurance or contingent loans will no longer be needed.”
The discussion also examined the nature of the structures practitioners can expect to see in the post Solvency II landscape. Richard said: “We are already seeing transactions being structured that provide contingent capital in new and innovative ways. The closer alignment of economic and regulatory capital under Solvency II is moving towards contingent capital transactions that give an real economic benefit in extreme events delivered in a cost effective way.”
Cormac and Richard outlined structures that could manage insurers’ Solvency II liabilities, capital requirements and tiering of own funds along with fungibility across complex groups. Richard said: “An example of where the Solvency II may cause challenges for insurers is in relation to the liquidity premium and contingent capital structures may be used to bridge this gap.”
Cormac said: “These structures should not be thought of a way for insurers to avoid prudent capital provision. In our view, these structures are not regulatory arbitrage as they are often labelled, the transactions transfer risk and therefore can form an important part of sensible risk management.”
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