Reserving, Capital and Solvency for Life Insurance Business
Reserving and capital
This domain tests the difference between reserves, technical provisions and capital. A reserve is held for expected future obligations under a contract. Technical provisions are best-estimate liabilities plus a risk margin. Capital is additional resources held to absorb adverse deviations and meet regulatory requirements. Solvency capital is often expressed as a required amount, such as a solvency capital requirement, with a minimum capital requirement below it. Eligible own funds divided by the required capital gives a solvency coverage ratio.
Valuation issues
Liabilities should be valued on a consistent basis, allowing for future premiums, claims, expenses and options. Gross reserves include expense and profit loadings; net premium reserves use benefits only. A prudent reserve uses conservative assumptions, while a best-estimate reserve uses expected assumptions. Capital models consider risks including mortality, longevity, persistency, expense, interest and asset risk.
Worked example
A life insurer has best-estimate liabilities of 800, a risk margin of 100, and a solvency capital requirement of 150. Technical provisions are 800+100=900. Eligible own funds are 1,100. The solvency coverage ratio is 1,100/150=733%. The excess over the SCR is 950. If eligible own funds fell to 120, the ratio would be 80%, below 100%, indicating a capital shortfall even if technical provisions were still covered.
Traps
Treating the risk margin as available capital; comparing own funds with technical provisions instead of the capital requirement; ignoring expense reserves; and assuming a reserve calculated on best-estimate assumptions is automatically prudent.