Economic Capital

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EconomicThis document has been made available on www.actuaries.org.uk with the permission of the Society of Actuaries, Schaumburg, Illinois. Copyright 2008.

Specialty Guide on Economic Capital

Version 1.5 March 2004

Specialty Guide on Economic Capital

Section
I. II.

Page

FOREWORD...................................................................................................................1 INTRODUCTION AND OVERVIEW ...............................................................................2

III. EXECUTIVE SUMMARY ................................................................................................3 IV. HOW DO WE DEFINE ECONOMIC CAPITAL? ............................................................5 V. USES OF ECONOMIC CAPITAL.................................................................................10

VI. TIE-IN OF ECONOMIC CAPITAL TO REGULATORY/RATING AGENCY CAPITAL 21 VII. CURRENT APPROACHES TO CALCULATING ECONOMIC CAPITAL....................23 VIII. CURRENT APPROACHES TO ALLOCATION OF ECONOMIC CAPITAL ................37 APPENDICES Appendix 1: A Theoretical Method of Calculating EC Appendix 2: Industry Survey on EC Appendix 3: Review of Literature

Specialty Guide on Economic Capital

1

I.

Foreword

This Specialty Guide on Economic Capital is a work in progress. It was made available in June of 2003 by members of the Economic Capital (EC) Subgroup of the Society of Actuaries Risk Management Task Force (RMTF) as an indication of the Subgroup’s progress since its formation in the Spring of 2002, and to stimulate wider discussion of the issues raised in the report. Acknowledgments go to the following members of the EC subgroup for their active contributions in completing this report: Jenny Bowen Kitty Ching Nathan Greenlee Gary Hatfield David Ingram Patricia Matson Hubert Mueller Terry Owens Kamran Quavi Kevin Reimer Brett Roush Jose Siberon Erik Von Schilling Ali Zaker-Shahrak

This update reflects a few corrections discovered since the original release of the Guide. We would like to point out that this document will continue to be updated periodically, as new experience emerges. Please direct any comments to Hubert.Mueller@towersperrin.com. We welcome your feedback. Finally, special thanks go to Valentina Isakina (SOA Liaison) and Julie Young (SOA Support) for their assistance in coordinating the efforts of our subgroup. Hubert Mueller March 10, 2004

Specialty Guide on Economic Capital

2

II.

Introduction and Overview

This Specialty Guide is designed to be a source of information for practitioners interested in: Learning more about the subject of Economic Capital (EC), Finding out about current market practices in this area, and Getting acquainted with available literature on this topic. The Specialty Guide has been put together by members of the Economic Capital subgroup of the Risk Management Task Force, using the results of a 2002 Survey on Economic Capital conducted by the subgroup, and their experiences with Economic Capital. We would like to point out that this Specialty Guide is not intended to represent only Best Practices in the marketplace, but rather to outline current practices commonly in use. Best Practices will be described in a subsequent paper on this topic (yet to be developed). The Specialty Guide addresses the following topics: Definition of Economic Capital, Uses of Economic Capital in the current marketplace, Tie-in of Economic Capital to Regulatory / Rating Agency Capital, Current approaches to calculating Economic Capital, and Current approaches to allocating Economic Capital. A summary of the answers obtained from the industry survey, as well as a review and discussion of available literature is provided in two separate Appendices. We would like to point out that the EC subgroup maintains an updated version of this Specialty Guide on its website, which is available by going to the RMTF page on the SOA’s website...
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