EPR and the deduction for Capital Available Deduction
Is EPR an asset or liability? why do we deduct from capital available when we have too much?
In the case where EPR is not used as part of financial resources to cover the earthquake risk exposure, i.e. the company has enough financial resources to cover its earthquake risk exposure without the voluntary reserve, the EPR can be deducted from capital available instead of being added to total capital requirements.
Why book excess EPR if it is just deducted from Capital Available? (EPR seems like a good thing - deduction from Cap Available seems like a bad thing).
I also was wondering why the Earthquake Reserves were ADDED to capital Available & Added to Capital Required. (The P&C-1 suggests that the balance sheet reserves figure does not get the 1.25x multiplier whereas the capital required for earthquake reserves does).
Capital Available:
Category A: Earthquake, nuclear and general contingency reserves; and (p 20.45 line 90 - 98)
Capital Required:
Earthquake Reserves = (EPR + ERC) x 1.25
The amount of earthquake reserves includes Earthquake Premium Reserve (EPR) and Earthquake Reserve Component (ERC) and is added to total capital requirements for the purposes of the MCT/BAAT as capital/margin required at the target level.
Comments
So I reviewed the actual P&C-1 filings for several companies who are actually using catastrophe reserves. It appears the instructions are being follows as described. I think seeing how they all happen simultaneously will help some people understand the concept.
I still don't understand why OSFI would want to deduct the EPR from Capital Available. Only 1 insurer is really doing this anyway. There are virtually no companies using the ERC with any regularity. The balance sheet results suggest there may be some confusion how it should work as well.
Equity: Reserves (20.20 Line 45): = SUM(Actual Reserves)
Catastrophe Capital Required (30.61 Line 24) = 1.25 x SUM(Actual Reserves)
EPR is used as a deduction from Capital Available. - reduced capital / required reduced capital available. - see Co-operators.
iN ($000s)
Line 11 of 30.62 is a deduction from Capital Available. I forgot to include Line 13 for the co-operators in the MCT (it is also 8,015). Co-operators have excess EPR as a result they have a lower Capital Required, but also lower Capital Available. The EPR for the Co-operators is 0.09% of Total Assets.
In terms % of assets the amounts listed for reserves are VERY small as a percentage of Assets (<1.00%). Wawanesa is larges at 0.76% of total assets.
It's also curious to see some insurer's not using their catastrophe reserves in their Capital Available (LLoyd's).
Just letting you know that I don't have a definite answer to this just yet (after looking through the material) but I'll still attempt to provide some thoughts hopefully tomorrow.
Ok, let's take some scenarios:
EPR used as part of financial resources
With respect to capital required:
where
Substituting the ERC expression into the Earthquake Reserves expression, we have
Implications:
1. Capital requirement does not depend on EPR, and the 1.25 multiplier applies
2. Capital available still includes EPR.
EPR not used as part of financial resources
EPR appears to be counted in both capital available and capital required:
1. It is counted in capital available through the Category A Capital/Common Equity.
2. It is counted in capital required with the 1.25 multiplier
Furthermore:
The above item is not clear-cut in my opinion but I'll try to express my thoughts still. Suppose prior to applying the deduction, we had capital available as 4 and capital required as 3. MCT = 1.33. If EPR = 1 and we apply the deduction, then capital available = 4 - 1 = 3, and capital required = 3 - 1 = 2, so MCT = 1.5 (I'm just ignoring the 1.25 multiplier for illustrative purposes). So this deduction could be beneficial from the perspective of inflating the MCT.
Definitely this is digging deep into the material, which is good, but I'm not sure how likely this is to be tested.
@javid - thanks this makes more sense.