Wednesday, February 9, 2011

Basics of Solvency II (Part 1)

To understand better about Solvency II, lets start with solvency concept.
What is Solvency Margin?
Solvency Margin: In a simple word to describe solvency margin of an (re)insurance Inc is when the assets exceed the liabilities.
How to calculate Solvency Margin Ratio?
Solvency Margin Ratio: It is solvency margin divided by written premium, not the solvency margin divided by total assets.
Balance sheet of any organization is a snapshot of its financial capability at the stated date of balance sheet. Therefore balance sheet of any (re)insurance company would tell you the summary of its financial status at particular instant. So to understand solvency of an insurance company it’s better to start with reviewing its balance sheet.
Balance sheet of any (re)insurance company looks like this:
Free reserves: It is a balancing piece which equal to the excess of assets over insurance liabilities.
Technical reserves: These are the amounts set aside in respect of expected payments to or on behalf of policyholders.
Investments: These might be bonds, equities, cash, property etc.
Fixed assets: For example, office building and equipment.
Net current assets: Excess of current assets over current liabilities, e.g. money due from brokers.

SCR (Solvency capital requirement): This fund is used to settle significant losses from uncertainly and provide assurance to policyholders and stakeholders that payment will be made. If the insurer did not have an adequate level of solvency reserve, policyholders would have no reason to believe that the insurer would be able to meet claims in the event of disaster.

MCR (Minimum capital requirement): Legislative requirement which says financial resources should not fall from this level.

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