Minimum regulatory capital requirements are determined by pillar 1.

There are 3 main components of capital requirements:

  • Technical Provisions
  • Minimum Capital Requirement
  • Solvency Captial Requirement

The regulatory supervisor may determine that an additional capital add-on may need to be added for risks not adequately modelled by the SCR.  (not shown in diagram)

Asset Valuations

Assets fall into two broad categories:

  • those with readily available market prices
  • those without

Those without can be valued using market consistent mark-to-model techniques.

 

There is inherent uncertainty in the valuation of any asset and this uncertaintly is most material for asset where no quoted market prices are available. The less deep, liquid and transparent the market for a particular asset, the greater reliance a firm will have to place on modelled values, and hence the greater the valuation uncertainty. <fn>https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss120.pdf#page=13</fn>

Valuation uncertainty introduces valuation uncertainty risk.  The PRA expects firms to have systems and controls to limit and manage exposure to valuation uncertainty. This demands a framework for quantifying or grading exposure to this risk, to enable them to define appropriate internal investment limits in respective assets. <fn>https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss120.pdf#page=13</fn>

Prudent Person Principle

Solvency II introduces the Prudent Person Principle (‘PPP’) to insurance investment.

The Prudent Person Principle gives insurers greater investment freedom providing a ‘prudent person’ benchmark standard is met.<fn>https://www.hymans.co.uk/media/uploads/Hymans_Robertson_Solvency_II_Newsflash_-_PRA_CP22-19.pdf</fn>

A breach of the prudent person principle may lead to a capital add on.  https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/supervisory-statement/2020/ss120.pdf#page=6

Liabilities

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Bibliography