PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

RISKINESS LEVERAGE MODELS 71a maximum amount of rating agency required capital. For givenreserve levels, this implies a limit to premium capital and thusto how much business can be written. Mango summarizes bystating that an insurer’s actual capital creates underwriting capacity,while underwriting activity (either past or present) usesup underwriting capacity.Mango notes that the generation of required capital, whetherby premiums or reserves, temporarily reduces the amount ofcapacity available for other underwriting. Being temporary, itis similar to capacity occupancy, a non-consumptive use of theshared asset. Capacity consumption occurs when reserves mustbe increased beyond planned levels. Mango points out that thisinvolves a transfer of funds from the capital account to the reserveaccount, and eventually out of the firm. Mango recaps bystating that the two distinct impacts of underwriting an insuranceportfolio are as follows:1. Certain occupation of underwriting capacity for a periodof time.2. Possible consumption of capital.He notes that this “bi-polar” capital usage is structurally similarto a bank issuing a letter of credit (LOC). The dual impactsof a bank issuing a LOC are as follows:1. Certain occupation of capacity to issue LOCs, for theterm of the LOC.2. Possible loan to the LOC holder.Mango notes that banks receive income for the issuance ofLOCs in two ways:1. An access fee (i.e., option fee) for the right to draw uponthe credit line.2. Loan payback with interest.