Capital Base and Prescribed Capital Amount (PCA)

Notes

Purpose
To demonstrate calculation of the capital base and prescribed capital amount (PCA) in accordance with APRA's prudential standards for a st

Author / Source
This exercise has been adapted from the Life 2B course materials

Creation date
29/5/2014

Review date
13/1/2020

Key inputs
See assumptions tab

Description
Assumptions Provides a summary of all assumptions used in the spreadsheet
CB Calculation of the capital base in accordance with LPS 112
IRC Calculation of the insurance risk capital charge in accordance with LPS 115
ARC Calculation of the asset risk capital charge in accordance with LPS 114
AB Calculation of the aggregation benefit in accordance with LPS 110
CSS Calculation of the combined stress scenario adjustment in accordance with LPS 110
ORC Calculation of the operational risk capital charge in accordance with LPS 118
PCR Calculation of the prescribed capital amount and prescribed capital requirement in accorda
 Life Insurance Applications
Module 7: The Valuation Cycle

A's prudential standards for a statutory fund containing only term insurance

ce with LPS 115

ccordance with LPS 110

ance with LPS 118
d capital requirement in accordance with LPS 110
Capital Base and Prescribed Capital Amount (PCA)

Assumptions

Risk free discount rate 5%

Claims 80% % of premiums
Expenses 5% % of premiums
Lapse rate 10% % of premiums
IBNR 200 Present value, payable at the end of year 1.

Taxation Nil
Reinsurance Nil

Premiums are paid at the beginning of the year

Expenses and claims are paid at the end of the year
Capital Base and Prescribed Capital Amount (PCA)

Capital Base
This tab demonstrates the calculation of the capital base in accordance with LPS 112.

The capital base of a life company includes an allowance for regulatory adjustments.

This example focuses on one regulatory adjustment - the change from the policy liability to the adjusted policy liability. It does not
consider others adjustments such as the deferred tax asset or liability adjustment. Also the regulatory adjustments in respect to moving
from the policy liability to adjusted policy liability need to allow for tax. However in this example tax is ignored.

Statutory Accounts

Assets

Australian listed equities 200 dividend yield ASX 200 4%

Overseas listed equities 100
Properties 100 rental yield 7%
Corporate bonds 800 zero coupon, rated AA, yield 7%, maturing in 3 years
Total assets 1,200

Liabilities

Policy liabilities -400

Other liabilities 100
Total liabilities -300

Net assets 1,500

Adjusted Policy Liabilities

Risk free discount rate 5%

Claims (% of premiums) 80%
Expenses (% of premiums) 5%
Lapse rate 10%
IBNR 200

Best estimate projection

Year Premiums Claims Expenses
1 1,000 800 50
2 900 720 RFBEL includes45the IBNR
3 810 648 41
4 729 583 36
Termination values equal the
5 656 525 33
IBNR in this example.
6 590 472 30 are zero.
Surrender values
7 531 425 27
8 478 383 24
9 430 344 22
 Termination values equal the
IBNR in this example.
Surrender values are zero.

10 387 310 19

IBNR 200
RFBEL -848
Termination values 200
Adjusted policy liabilities 200

Capital Base

Net assets 1,500

Regulatory adjustments:
Adjusted policy liabilities less policy liabilities 600

Capital Base 900

ed policy liability. It does not
adjustments in respect to moving
is ignored.
Capital Base and Prescribed Capital Amount (PCA)

Insurance Risk Charge

This example relates to term insurance only and as such only the mortality stress is applicable. Tax is ignored in this example. In pract

Risk free discount rate 5%

Claims (% of premiums) 80%
Expenses (% of premiums) 5%
Lapse rate 10%
IBNR 200 present value, payable at the end of year 1

Best estimate projection

Year Premiums Claims Expenses
1 1,000 800 50
2 900 720 45
3 810 648 41
4 729 583 36
5 656 525 33
6 590 472 30
7 531 425 27
8 478 383 24
9 430 344 22
10 387 310 19

IBNR 200
RFBEL -848
Termination values 200
Adjusted policy liabilities 200

Insurance Risk Charge

Random stress 30% Event stress

Year Premiums Claims Expenses Premiums
1 1,000 1,040 50 1,000
2 900 720 45 900
3 810 648 41 810
4 729 583 36 729
5 656 525 33 656
6 590 472 30 590
7 531 425 27 531
8 478 383 24 478
9 430 344 22 430
10 387 310 19 387

IBNR 260 IBNR

RFBEL -559 RFBEL
Impact of stress 289 Impact of stress
Diversification factor
Combined impact 1,480
Sum of impacts 2,030
Factor 73%
The lapse stress has no
impact in this example as
the adjusted liability at the
end of year 1 is the
Combined stress with lapse and expense stresses termination value and the
Lapse stress -50% year 1 cash flows are not
affected by lapses.
Expense stress 10%

Year Premiums Claims Expenses

1 1,000 1,646 55
2 950 1,397 52
3 903 801 50
4 857 686 43
5 815 652 41
6 774 619 39
7 735 588 37
8 698 559 35
9 663 531 33
The cashflow projection
10 630 504 32 claims
assumes that
incurred in year 1 are paid
immediately. Hence IBNR
IBNR 266 at duration 1 is assumed
RFBEL (1) -441 to be zero.
Adjusted Liab (1) 0
Stressed Policy Liabilities 886

Insurance Risk Charge 686

icable. Tax is ignored in this example. In practice the insurance risk capital charge would be calculated net of tax.

Assume the best estimate

mortality rate is 0.5 per
thousand. The event stress
doubles the claims cost in
years 1 and 2.

100% Future stress 15%

Claims Expenses Premiums Claims Assume repricing in
1,600 50 1,000 920 response to the futur
stress occurs in year
1,440 45 900 828 Allow for the impact
648 41 810 745 repricing by keeping
premiums unchange
583 36 729 583 returning claims to th
525 33 656 525 best estimate.
472 30 590 472
425 27 531 425
383 24 478 383
344 22 430 344
310 19 387 310

200 IBNR 230

567 RFBEL -522
1,415 Impact of stress 326
 Correlation Matrix
lapse stress has no
act in this example as Mortality future
adjusted liability at the Mortality future 1
of year 1 is the
mination value and the Mortality random 0
r 1 cash flows are not Morbidity Future 0.25
cted by lapses.
Morbidity random 0
Event 0
Longevity -0.25

Aggregation formula

Mortality future
Mortality future 106413
Mortality random 0
Morbidity Future 0
Morbidity random 0
Event 0
Longevity 0
ted net of tax.

Expenses Assume repricing in

response to50the future
stress occurs in year 4.
45impact of
Allow for the
repricing by
41keeping
premiums unchanged and
36
returning claims to the
33
best estimate.
30
27
24
22
19
Mortality random Morbidity future Morbidity random Event
0 0.25 0 0
1 0 0 0
0 1 0 0
0 0 1 0
0 0 0 1
0 0 0 0

Mortality random Morbidity future Morbidity random Event

0 0 0 0
83273 0 0 0
0 0 0 0
0 0 0 0
0 0 0 2002129
0 0 0 0
Longevity
-0.25
0
0
0
0
1

Longevity
0
0
0
0
0
0
Capital Base and Prescribed Capital Amount (PCA)

Asset Risk Charge

The underlying cashflows are not subject to inflation. Typically for death products the sum insured is indexed at CPI (subject to a maxim
would not tend to impact the underlying cashflows.

Again the calculation ignores tax.

Adjusted
balance
sheet Real interest rates Expected inflation Currency
pre-stress Up Down Up Down Up

Australian listed equities 200 200 200 200 200 200

Overseas listed equities 100 100 100 100 100 80
Properties 100 100 100 100 100 100
Corporate bonds 800 712 879 712 879 800
Total assets 1,200 1,112 1,279 1,112 1,279 1,180

IBNR 200 198 202 198 202 200

RFBEL -848 -861 -836 -861 -836 -848
Termination values 200 198 202 198 202 200
Adjusted policy liabilities 200 198 202 198 202 200

Other liabilities 100 100 100 100 100 100

Total liabilities 300 298 302 298 302 300

Capital Base 900 815 977 815 977 880

Fall in Capital Base 85 0 85 0 20

Real interest rates

Risk free discount rate 5.0% Fall in capital base with sign
Stressed risk free discount rate (up) 6.3%
Stressed risk free discount rate (down) 4.0%

Expected inflation sign

Stressed risk free discount rate (up) 6.3%
Stressed risk free discount rate (down) 4.0% Correlation matrix

Currency RIR
Currency stress 25% INF
CUR
Equity EQY
ASX200 dividend yield 4.0% PROP
Stressed dividend yield 6.5% CSP
Fall in equity values 38.5%
Aggregation formula
Property
Rental yield 7.0%
Stressed rental yield 9.8% The bonds are assumed to -1 85
Fall in property values 28.2% be zero coupon in this -1 85
example.
-1 20
 The bonds are assumed to
be zero coupon in this
example.

Credit spreads 1 115

Term to maturity of bonds 10 1 28
Yield to maturity of bonds 7.0% 1 62
Credit spread 2.0%
Increase in spread (grade 2, AA rated) 0.8%
Default factor (grade 2, AA rated) 0.6% Asset risk charge
xed at CPI (subject to a maximum of 5%) and as a result the inflation stress

Credit
Currency Equity Property spreads Default
Down

200 123 200 200 200

133 62 100 100 100
100 100 72 100 100
800 800 800 738 800
1,233 1,085 1,172 1,138 1,200

200 200 200 200 200

-848 -848 -848 -848 -848
200 200 200 200 200
200 200 200 200 200

100 100 100 100 100

300 300 300 300 300

933 785 872 838 900

0 115 28 62 0

tal base with sign

RIR INF CUR EQY PROP CSP

85 85 20 115 28 62
-1 -1 -1 1 1 1

RIR INF CUR EQY PROP CSP

1 0.2 0.2 0.2 0.2 0.2
0.2 1 0.2 0.4 0.4 0.2
0.2 0.2 1 0.6 0.2 0.4
0.2 0.4 0.6 1 0.4 0.8
0.2 0.4 0.2 0.4 1 0.4
0.2 0.2 0.4 0.8 0.4 1

-1 -1 -1 1 1 1
85 85 20 115 28 62
7288 1458 341 0 0 0
1458 7288 341 0 0 0
341 341 400 0 0 0
 0 0 0 13314 1302 5712
0 0 0 1302 796 698
0 0 0 5712 698 3829

229
Capital Base and Prescribed Capital Amount (PCA)

Aggregation Benefit
Insurance risk charge 686
Asset risk charge 229
Correlation 20%

Aggregation benefit 150

Capital Base and Prescribed Capital Amount (PCA)

Combined Stress Scenario Adjustment

Typically a key part of the CSSA is the tax that has been assumed in the ARC, IRC
and AB.

Tax is ignored in this example.

Insurance risk charge 686

Asset risk charge 229
Aggregation benefit 150

Aggregation diversification factor 84%

Sum of capital charges for asset risks 396

Asset risk diversification factor 58%
The stress for equities and
Assets Pre-stress Post-stress properties is the percentage
fall in value, not the increase
in dividend or rental yield.
Australian listed equities 200 163 The result of this calculation
will change if diversification
Overseas listed equities 100 73 factors are applied to yield
Properties 100 86 increases.
Corporate bonds 800 688
Total assets 1,200 1,009

Liabilities

Stressed policy liabilities 200 722

Other liabilities 100 100
Total liabilities 300 822

Capital Base 900 187

Capital charge for combined stress scenario 713

Combined stress scenario adjustment 0

Corporate bonds
Term 10
Yield to maturity 7.0% 8.6%

Adjusted policy liabilities

Risk free discount rate 5.0% 6.2%
Claims year 1 80% 150.8% The cashflow projection
assumes that claims
Claims year 2 80% 136.1% incurred in year 1 are paid
Claims year 3 80% 87.3% immediately. Hence IBNR
at duration 1 is assumed
Claims year 4+ 80% 80.0% to be zero.
Lapse rate 10% 5.8%
Expenses 5% 5.4%
IBNR 200 252
 at duration 1 is assumed
to be zero.

RFBEL (1) -536

Adjusted Liab (1) 0
Stressed Policy Liabilities 722

Year Premiums Claims Expenses

1 1,000 1,508 54
2 942 1,282 51
3 887 775 48
4 835 668 42
5 787 629 39
6 741 593 37
7 698 558 35
8 657 526 33
9 619 495 31
10 583 466 29
 or equities and
s the percentage
, not the increase
or rental yield.
of this calculation
if diversification
applied to yield
Capital Base and Prescribed Capital Amount (PCA)

Operational risk charge

Inputs
GP1 900 premium income (gross of reinsurance) for the 12 months ending on the reporting date
GP0 800 premium income (gross of reinsurance) for the 12 months ending on the date 12 months prior to the re
NL1 200 adjusted policy liabilities (net of reinsurance) at the reporting date
A 3%

Operational risk charge 27

e 12 months prior to the reporting date
Capital Base and Prescribed Capital Amount (PCA)

Prudential Capital Requirement

Insurance Risk Charge 686

Asset Risk Charge + 229
Asset Concentration Risk Charge + 0
Operational Risk Charge + 27
Aggregation Benefit - 150
Combined Stress Scenario Adjustment + 0

Prescribed Capital Amount 792

APRA Supervisory Adjustment 0
Prudential Capital Requirement 792

Capital Base 900

Surplus Capital 108