Blog 56: Risk Based Capital: Part 1 by Xavier Lo, FIA, FRM, MBA

Risk Based Capital [風險資本] is quite a hot topic [熱門話題] in Hong Kong during the recent few years. The reason for this is because there will be regulatory changes [制度改變] to how any insurer calculates the amount of capital that they have to hold.

Historically, when we think about any insurance company, the local regulator will definitely ask them to set aside a bit of money in case a lot of claims are made against the insurer. This money is called required capital [監管資本] and is ultimately decided by the regulator [監管局]. It could be as simple as just asking each company to hold HKD 1m. However, I’m sure you can see the problem: what if I am a massive multinational insurer [跨國保險公司], would HKD 1m be enough? On the flip side, if I was just starting up a micro insurance company, maybe I don’t actually have enough money to set HKD 1m aside. Hence capital is usually linked to the size of the insurance company (perhaps through the volume of business written [業務量]).

This wasn’t enough though, as it does not differentiate between the riskiness [風險] of business activities. For example, what if one insurer wrote purely chemical plants insurance [化學廠保險]? This would be more risky than another company that was a similar size but wrote maybe 10 different types of insurance business: risks are diversified [多樣化]. The next evolutionary step for capital setting is Risk Based Capital. Depending on what risks you have, the regulator would determine how much capital you need to hold. Intuitively, the more diversified your company is, and the less risks you have, the less capital you will need to hold.

At the end of the day, this greatly impacts the business direction of any insurer. If it costs me so much capital to write insurance for a power plant, maybe I will decide not to concentrate so much of my efforts there. Ultimately this is a very complicated topic – I’ll touch more on this in a later blog!

Qualified fellow actuary (in UK and Hong Kong), Financial Risk Manager, and MBA graduate (listed on the Dean's List) with a passion for insurance, data science, and analytics. Experienced in a broad range of insurance roles (pricing, capital modelling, reserving, ERM), along with a touch of knowledge in banking. Member of the General Insurance Committee (2021), Actuarial Innovation Committee (2019 - 2021) in ASHK.

    2 Comments

  1. September 28, 2021
    Reply

    Great piece Xavier. Looking forward to reading more.

  2. Xavier Lo, FIA, FRM, MBA
    September 28, 2021
    Reply

    Thanks Alexander – feel free to follow my Instagram page too, there is a bit of content which only appear on Instagram!

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