Capital and solvency margin

Magazine Issue:

The new trends [3]

Magazine date:

Jun 2004

Share Capital

Definition

Share capital is the amount of money invested in a permanent way in the company by the owners or partners as a property or cash contribution either upon the creation of the firm or on capital increase.
Share capital may be increased through the inclusion of reserves or profits or decreased by the refund of contributions or following losses.

Role of capital	Capital Evolution
Share capital assumes three functions: The source of funding: share capital contributions (cash or in kind) represent a source of funding: it is a decisive commitment on part of the partners to assume losses that are related to the fluctuations of the company's economic operations. Keys to the distribution of partners' rights: In principle it is the amount of holding of a partner in the share capital that defines the sum of rights he or she is entitled to. The protection of creditors: Share capital stands as a security for creditors. It is a current asset that corresponds to tangible wealth.	The shareholders' Extraordinary General Assembly shall decide the capital increase. Such an increase cannot occur unless the initial capital is entirely liberated. The share capital increase may be achieved through: Cash contribution Contribution in kind The inclusion of the reserves or the not-yet distributed profits (retained profits) The conversion of the company's debts into shares The partial or total takeover of a company (it is the case of a merger, partial contribution,…) The conversion of founders or beneficiaries' stakes into shares

Role of capital

Capital Evolution

Share capital assumes three functions:

The source of funding: share capital contributions (cash or in kind) represent a source of funding: it is a decisive commitment on part of the partners to assume losses that are related to the fluctuations of the company's economic operations.
Keys to the distribution of partners' rights: In principle it is the amount of holding of a partner in the share capital that defines the sum of rights he or she is entitled to.
The protection of creditors: Share capital stands as a security for creditors. It is a current asset that corresponds to tangible wealth.

The shareholders' Extraordinary General Assembly shall decide the capital increase. Such an increase cannot occur unless the initial capital is entirely liberated.
The share capital increase may be achieved through:

Cash contribution
Contribution in kind
The inclusion of the reserves or the not-yet distributed profits (retained profits)
The conversion of the company's debts into shares
The partial or total takeover of a company (it is the case of a merger, partial contribution,…)
The conversion of founders or beneficiaries' stakes into shares

Shareholders' equity

Definition

Used with permission from Microsoft Shareholders equity may be defined as the difference between the elements of the firms' assets (all that the firm owns) and those pertaining to external liabilities (all that the company owes).
Shareholders' equity stands for the company's property or for the capital amounts that belong to the firm as its equity. It is the shareholders' wealth.

Shareholders' equity may also be defined as financial resources, which contribute along with borrowed capital in the funding of the company.

Shareholders' equity is the sum of a set of calculations:

Shareholders' equity = share capital (companies' contributions) + reevaluation gaps + non-distributed profits or reserves – losses (negative carry or loss of the financial year) + investment grants + mandatory provisions

Shareholder's equity stands on the balance sheet liabilities as non-payable debts.

The Role of Shareholders' Equity

Within a company, shareholders' equity :

Represents a protection for the company's creditors: a guarantee function which is of great importance to companies rights.
Represents a financial resource which is essential in defining the capability of funding and forming the company's share capital.
Insures risk taking pertaining to the company's economic operations.

The Difference between Share Capital and Shareholder's Equity

Share capital must not be confused with shareholders' equity for the following reasons:

A differentiation exists at the legal, financial levels as well as accountancy wise.
The share capital is a component of shareholders' equity.
The amount of share capital does not depend on the results achieved by the company, whereas that of shareholders' equity varies according to the profits made or the losses incurred by the company.

Share Capital in the Insurance Sector

Minimum Capital Importance and fixing in Insurance Company

One of insurance's characteristics is minimum capital constraint: it corresponds to the required level for a company to be able to operate. This minimum capital is, in fact, set by legislation.

Upon the creation of the firm, minimum capital enables the company to face management fees and other miscellaneous charges pertaining to establishment along with start-up operations.

During operational stage, minimum capital is assessed in relation to the calculation of solvency margin. Being a component of equity funds, it is used to guarantee the commitments made by the insurers toward their clients.
Minimum capital is placed in the risk-free assets in order to avoid any invested-capital-related loss.

Solvency Margin

Definition

It is a regulatory constraint that defines the minimum amount of the resources required for the practice of insurance operations.
The solvency margin is defined as the minimum relation between equity funds and the company's activity. Any shortage in the solvency margin could trigger the dissolution of the company.

Method of calculating solvency margin

The amount of solvency margin depends on the regulations of each country. The calculation of solvency margin applied to Life business is different from that of Non-life. For the Non-Life, the solvency margin is often reckoned in relation to two criteria: premiums and losses.

Solvency Margin Insufficiency

In case of a shortage in the solvency margin, the supervising authority could:

Require a long-term recovery plan.
Require a short-term funding plan that enables the company to pick up equity funds.
Finally, in case the recovery or funding plans have not been carried out, the supervising authorities could withdraw the company's license, which means that the company is put into receivership.

Examples: fixing minimum capital and method of calculating solvency margin in certain countries

Minimum share capital	Solvency margin (non life)
Algeria
Cash contribution is : 450 000 000 DZD (6.36 million USD) ¹. Each shareholder must pay at least one quarter of the capital in cash upon the creation of the firm. The payment of the not-yet-issued remainder (3/4) must follow within the next 5 years.	15% of technical debts. 20% of the turnover all taxes comprised, free of annulment and reinsurance.
Tunisia
The amount of minimum capital is 10 000 000 TND (7.85 million USD) wholly issued upon the creation of the firm.	20% of the total premiums issued and accepted, multiplied by the ratio existing between retained premiums and issued and accepted premiums. 25% of the average annual losses charge for the last 3 financial years, multiplied by the ratio existing between the amount of losses still borne by the firm and the amount of gross losses entrusted to reinsurance.
Morocco
50 000 000 MAD (5.58 million USD): totally issued in cash upon the creation of the firm.	Calculations in relation to premiums The amount of issued net premiums free of annulment and acceptance of the last financial year. The calculation is made by applying a percentage to premiums as follows: Amount issued and accepted premiums inferior to 120 000 000 MAD (13.38 million USD): 20%. Fraction of premiums superior to 120 000 000 MAD: 18%. Calculations in relation to losses the referred to period corresponds to the last three financial years. the losses reserve to pay for last financial year. the losses reserve to pay for N-3 financial year. (A) + (B) - (C). (D) / 3 The calculation is made by applying a percentage to the amount (E) as follows: Amount inferior to 90 000 000 MAD (10.03 million USD): 27%. Amount superior to 90 000 000 MAD: 24%.
Countries of the CIMA area*
The amount of share capital must be at least equal to 500 million of FCFA (916 000 USD), (not including contributions in property). Each shareholder must pay at least half the amount of his or her subscribed shares in cash before definitive creation of the company. The payment of the remainder must follow within a three-year period	20% of direct premiums or premiums accepted in reinsurance during the course of the financial year. 25% of the average annual losses charge of the last three years

¹ For firms operating all insurance and reinsurance classes including reinsurance transfer abroad. * Senegal, Mali, Niger, Chad, Cameroon, Congo, Gabon, Côte d'Ivoire, Burkina Faso, Benin, Togo, Centrafrica, Guinea Bissau, Equatorial Guinea.