Embedding Free Capital Generation (FCG) in the insurer’s strategy requires FCG to be measurable and actively deployed as a metric. Although capital generation is becoming the leading metric for strategic decision making across the insurance industry, the industry lacks a common view on how to define and measure FCG. This is illustrated by the large number of FCG definitions used by insurance companies: operating capital generation, normalized capital generation and organic capital generation to name a few.
Effective use of capital generation
As was described in our previous blog, an effective use of capital generation as a metric consists of four pillars, which are visualized in the picture above. This blog focuses on the first pillar – Measurement.
To achieve proper measurement of capital generation, a robust definition is key. In the past years, we have seen alignment in capital generation definitions among the larger insurance companies in the Netherlands, but differences in definition remain.
Reason for different definitions
There are two main reasons for the fuzziness around definitions. Firstly, the lack of a common standard. The industry, at the hands of the CFO forum, did not manage to come to a single (European) definition and methodology on capital generation disclosures. In the Netherlands, the Dutch Association of Insurers (‘Verbond van Verzekeraars’) did publish a standard, but it only described the general, high-level principles, whilst still allowing for major discrepancies in the implementation and interpretation of that standard. Secondly, the objectives of measuring and disclosing capital generation figures vary among companies. Some insurers intend to either inform investors on the expected capital generation for the next reporting period, or show the company's performance in the past period, excluding (external) market influences. Other insurers use capital generation figures for internal balance sheet management only.
Using a different FCG definition than your peers is not necessarily a problem, as long as it is aligned with your company's objectives and applied consistently. Without consistency, the metric could allow for subjectivity, may lead to volatility and misinterpretation by its stakeholders, and cannot be fully adopted for monitoring & steering on the realization of your strategic ambitions.
How to come to a definition that works for you?
To achieve this alignment, insurers need to start with defining their objectives: what do you want your capital generation figures to reflect, who is your audience, how do you want to use it in managing your company, and how will you communicate on the performance of your company? In the end, the objective of FCG is long-term optimization of the balance sheet, using all (strategic) levers available to the board. To be able to understand these levers and steer on them, proper measurement is essential.
With KPMG's experience in capital generation, we can help in defining FCG objectives, and translating them into a methodology that gives a useful metric for internal and external disclosures for your organization.