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Provisioning and Solvency Capital

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asked Mar 29 in BUS 4027W - Actuarial Risk Management by Faith (580 points)

What is the difference between holding provisions and required solvency capital? 


I am aware that both are required by regulation and that provisions are needed to meet future liabilities. In my mind, that also implies ensuring solvency to an extent. 

Why do we need to mention both when answering questions ? 

Please help! 


Thank you in advance xx

1 Answer

+1 vote
answered Mar 29 by A.mabaso (520 points)
selected Mar 30 by Faith
 
Best answer
 From what I understand, provisions (or more formally 'technical provisions’) speak to monies that are held to ensure that a provider can keep its promise to pay future benefits when they fall due. So the amount of provisions that one keeps is directly linked to the nature of benefits that one promises. 
According to SAM, technical provisions "should be calculated on a best estimate basis and should reflect the probability-weighted average of future cash flows, having regard to the time value of money." 

Solvency capital requirements (SCR) are mainly focused on the minimum amount of own-capital that you have to hold in order to be able to meet your liabilities in a worst case scenario (1 in every 200 years). Regulation also requires a company to calculate a minimum capital requirement (MCR) which is basically the same but for instead of a 99.5% confidence level it is calculated at 85%. 
The thing about SCR is that it is held with respect to the level of your liabilities independent of when they are likely to be paid. What SCR is, is essentially a risk-constraint on the free capital of the business. But if your business is operating with capital close to the SCR then this should be a warning sign that the business is at risk.

In terms of questions, I can't speak too much to that but I can say that SCR/capital adequacy should always be considered when writing new business. Will the business have enough capital to meet these requirements? When modelling, (let's say for a pricing model) one could run stress tests to help calculate their minimum capital requirement levels.  
With provisions, this should mainly be used when referring to specific classes of business or specific types of products, schemes, contracts and transactions.     

The image attached gives an idea of how regulation in SA wants your balance sheet to look like.
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