Odomirok - Financial Regulations

Question 1

What are the objectives of SAP and GAAP?

Answer 1

SAP: measure ability to pay claims
GAAP: measurements of earnings

Question 2

Who are the intended users of SAP and GAAP?

Answer 2

SAP: regulators
GAAP: general audience (policyholders, investors, public)

Question 3

When are the assets recognized in SAP and GAAP?

Answer 3

SAP: asset recognized when expense incurred
GAAP: may defer recognition of asset for asset/revenue matching with expenses (eg: DPEA)

Question 4

How do SAP and GAAP treat reinsurance in loss reserves?

Answer 4

SAP: loss reserves NET of reinsurance
GAAP: loss reserves GROSS of reinsurance

Question 5

Do SAP and GAAP defer income taxes?

Answer 5

SAP: no, they are not deferred
GAAP: yes, they are deferred

Question 6

Contrast liquidation vs going concern.

Answer 6

LIQUIDATION: sees assets/liabilities as runoffs - of interest to REGULATORS (for satisfying policyholder obligations)
GOING-CONCERN: sees assets/liabilities as continued normal operations - of interest to INVESTORS

Question 7

Contrast fair value vs historical cost.

Answer 7

FAIR VALUE: Value in open market - more accurate

HISTORICAL COST: original cost MINUS depreciation - easier to calculate

Question 8

Contrast principle-based vs rule-based.

Answer 8

PRINCIPLE-BASED: accounting approach requiring interpretation to apply (more flexible)
RULE-BASED: specific guidance (easier, but less flexible)

Question 9

What is Solvency 2?

Answer 9

It is a principle-based insurance regulatory system TO DETERMINE the required capital levels of insurance companies IN the European Union.

Question 10

What are the 3 pillars of Solvency 2?

Answer 10

1) quantitative
2) governance
3) transparency

Question 11

Describe the QUANTITATIVE pillar of Solvency 2. (3)

Answer 11

Sets the SCR (Solvency Capital Requirement) and the MCR (Minimal Capital Requirement):

• uses total balance sheet approach
• SCR is defined as 99.5% VaR meaning that the probability of ruin is <0.5%

Question 12

Describe the GOVERNANCE pillar of Solvency 2. (4)

Answer 12

• supervisory activities
• requires adequate governance for the functions of internal auditing, actuarial, risk management and compliance
• supervisor identifies high risk companies and may intervene
• note that companies are required to perform ORSA

Question 13

Describe the TRANSPARENCY pillar of Solvency 2. (3)

Answer 13

• supervisor reporting & public disclosure
• information from pillars 1 & 2 is given to the supervisor & financial markets
• purpose is to increase market discipline because companies know their decisions are public.

Question 14

Quantitative pillar: what happens if total capital falls below SCR; below MCR?

Answer 14

• if total capital < SCR -> regulatory intervention

- if total capital < MCR -> company not permitted to operate

Question 15

Quantitative pillar: method for calculating SCR.

Answer 15

SCR is set using a total balance sheet approach
METHODS:
- standard/regulator model
- approved internal model (more costly than standard model but gives lower capital requirements)

Question 16

Governance pillar: Identify CONDITIONS that must be addressed. (3)

Answer 16

• fitness & propriety
• outsourcing
• internal control

Question 17

Governance pillar: Identify FUNCTIONS that must be addressed. (4)

Answer 17

• internal audit (annual report to BoD on deficiencies)
• actuarial (reasonability of methods & assumptions)
• risk management (monitor)
• compliance (with law)

Question 18

Briefly describe the “Windows & Walls” approach of the U.S. Solvency Modernization Initiative as it applies to Solvency 2.

Answer 18

Gives Windows for state insurance regulators to look into group wide operations:

• enhanced communication between state and group regulators
• enforcement tools if violations occur

But, maintains the Walls at the statutory legal entity level
- capital cannot be shared between legal entities