Background to Insurance (1-6) Flashcards
State the criteria that a risk must meet to be insurable
- the policyholder must have an interest in the risk being insured, to distinguish between insurance and gambling
- a risk must be of a financial and quantifiable nature
- the amount payable must bear some relationship to the financial loss incurred
State additional criteria that a risk should ideally meet to be insurable
- individual risk events should be independent of each other
- the probability of the event should be relatively small
- large number of similar risks should be pooled
- there should be an overall limit on the liability undertaken by the insurer
- moral hazards should be eliminated as far as possible
- there should be sufficient statistical data/info to accurately estimate the size and likelihood of a loss occuring
Explain why the policy document is important
The policy document sets out the T&Cs under which an insurer is liable to pay insurance claims in specific circumstances and must therefore be carefully worded to cover all possible circumstances under which payment will (and will not) be made.
Explain the difference between the policy form and the schedule
Policy forms are normally standard for all personal lines business and small commercial policies, in the sense that an insurer will issue the same wording to all policyholders. Items that vary between policyholders will be included in a schedule.
List items that might be included in a policy schedule
- details of vehicle/property/people covered
- excess applied
- any limits to the cover
- exclusions
- time limits
- whether or not any optional covers have been taken
- details of insurance premium paid
Outline how policies for large commercial risks differ from those for small commercial risks and personal lines business
Large commercial and London Market risks tend to have policies that are individually made for the particular policyholder, possibly assembled from a library of standard clauses.
Explain what exclusions are and why they are applied to insurance policies
Exclusions are clauses in a policy that limit the circumstances in which a claim may be made. Exclusions are used to avoid payment by the insurer in situations where the:
- policyholder is at an advantage through possessing greater personal information about the likelihood of the claim
- claim event is largely under the control of the policyholder
- claim event would be very difficult to verify
- loss occurs as part of the normal course of events (could be considered depreciation)
- probability of a claim is very high
- risk cannot be reasonably estimated
Exclusions are also used where the risk is covered by a third party such as the government (e.g. Terrorism in the UK). Exclusions can be used to reduce the premium for competitive reasons or to make it more appropriate to an individual.
List the four general classifications of insurance cover
Liability, property damage, financial loss, fixed benefits.
Explain how comprehensive motor insurance policies and household contents insurance policies combine insurance cover types
A typical comprehensive motor insurance policy will provide cover for:
- compensation for personal injury to third parties and damage to their property
- compensation for loss of or damage to the insured’s vehicle
- fixed benefits in the event of defined categories of personal accident to the insured
A typical policy covering household contents will provide cover for the financial loss, property damage and liability of the insured to third parties.
Explain what package policies are
Policies for businesses often include all types of cover that the business needs appropriately called package policies.
State the typical aim of an insurance policy
Typically, the intention is to provide the insured with money to cover his or her financial loss as a result of an insured event, although policies that provide benefits in kind are also possible.
Explain why there is often a degree of choice in determining the exposure measure
In some types of insurance there is a degree of choice as to the measure of exposure, as it will not be immediately obvious which reliable and measurable factor bears the closest relationship to the expected claim amounts.
Give four key characteristics of claims
As well as the amount that becomes payable, the claim characteristics refer to the ways in which and speed with which the claims:
- originate
- are notifed
- are settled and paid
- are, on occasion, reopened
Explain what rating factors are
Rating factors will be either objectively measurable risk factors or other factors that can be used as reliable proxies for the risk factors.
Where credible exposure and claims data exist, experience rating can be used to take account of residual risk factors.
Explain, using examples, how non-independence of exposures leads to risk and how this varies between classes
Some classes of business cause insurers more risk and uncertainty than others because of the nature of the risks involved and the claims that can arise from those risks.
Even within a given rating factor category, exposures can be very variable and dissimilar. The variability is increased where exposures are not independent, as this can lead to an accumulation of risk. For example, if the majority of policyholders in a household insurance portfolio live in a certain area of the country, there will be a disproportionate claim cost if there is a local catastrophe. Motor insurance lends itself to having a reasonable spread of exposures whereas creditor insurance will be heavily linked to the state of the economy and unemployment.
Give three examples of how the nature of a risk may change over a policy year
1) Change of fire precautions within a building
2) Change of drivers or location under a motor policy
3) A change in economic conditions under a mortgage indemnity policy
Give an example of a situation in which changes in the underlying risk would need to be reported to the insurer and an example in which they would not
In some cases a change in the underlying risk would need to be reported to the insurer by the policyholder. For example, a motor policyholder should inform the insurer if he or she moves house; this is a rating factor. In extreme cases, failure to notify the insurer could make the cover void. Changes in background conditions, such as economic conditions, would not normally need to be notified.
Discuss how the cost of claim varies for different classes of business
The cost of claim from any given policy cannot be predetermined (except fixed benefit) and is often very variable. While there will often be a maximum sum insured stated, relatively few claims will be settled for that maximum. For most classes, a large proportion of claims will be for small amounts and there will only be a small number of large claims. The precise distribution will vary greatly between class, in particular between property and bodily injury claims, and also year by year.
State the types of probability distribution conventionally used to model the sizes of individual claims in a class of business
Highly skewed distributions with no theoretical upper limit (e.g. lognormal or Pareto distributions)
State how the parameters may be derived for the probability distributions applied to claim size and what broad factors affect their shape
Exposures are often too small to yield useful information individually so their experience is aggregated to derive parameters of the claim cost distributions when the risks are homogeneous enough and attritional. The shape of these claim cost distributions depend on risk characteristics demonstrated by different classes of business and the insured’s risk profile, among other factors.
Give examples illustrating how different classes of business are affected by inflation in different ways
1) Property insurance responds mostly to the cost of property, and claims will tend to increase in line with general inflation, although repair costs can be linked to earnings.
2) A large proportion of motor claims cost is for the repair of the vehicle and will be affected by the level of earnings since these determine labour costs.
3) Liability classes are often subject to higher levels of inflation, especially on personal injury claims, as there is a trend of more generous compensation in many markets. However, this may arise in steps rather than as a continuous process of inflation, as landmark legal judgments are handed down or legal reform comes into effect.
Discuss why there may be delays between the date a claim occurs and the date it is settled and how the extent of such delays varies between bodily injury and property damage claims
Claim delays can arise for various reasons. for example:
- a delay between the incident occurring and the policyholder becoming aware of it
- a delay between the insured becoming aware of the loss and reporting it
- a delay before sufficient details of the incident can be gathered to assess the value of the claim
- a delay until an injured party’s condition stabilises to the extent that assessment of damages is appropriate
- a delay in agreeing the actual value at which the claim is to be settled, and the payment of this amount to the insured
Bodily injury cases tend to have the longest delay tails, owing to the continuous issues of many of the claims involved, often with the need for legal proceedings. This may be worsened by the greater likelihood of latent claims or claims from industrial disease where the delay from event to reporting can be considerable.
By contrast, property damage classes have a much shorter delay tail, and hence in this respect a lower degree of risk, since the losses are more immediately apparent and can usually be valued reasonably accurately by a competent assessor.
Explain how accumulations of risk might arise in property and liability [2]
Some classes of business are prone to accumulations of risk. Property classes are prone to catastrophes giving rise to a large aggregate total loss for the insurer. However, such accumulations need not be single incidents (e.g. dry summer may lead to a large number of subsistence claims).
Liability insurance is less susceptible to large single-incident accumulation losses, but a single cause may give rise to a large number of claims. The most obvious example is exposure to asbestos, which has given rise to claims under liability policies that are expected to exceed any single event catastrophes.
Explain how fraud affects insurers [2]
Certain classes are more exposed than others to the risk that the insured will make false or invalid claims, or exaggerate the amount claimed following a loss. Often, it will be difficult or uneconomical to check whether the claims are genuine or not. At the extreme, such false claims could include arson and embezzlement. The rate of fraudulent claims has been observed to increase in times of economic stringency.
Outline how minimum solvency requirements affect insurers and the purpose of such requirements [2]
General insurers require resources beyond those needed to cover their technical liabilities in respect of the business they have written. The excess of the value of the assets over the value of the liabilities is subject to minimum requirements if a company is to be allowed to continue to trade.
The methodology for calculating this minimum is laid down in legislation that varies from one country to another. General insurers regulated in the UK and the EU have the option to calculate the required minimum of excess of assets over liabilities (SCR) using a standard formula or their own internal model. This requirement provides a safety margin against the uncertainty surrounding the ultimate future cost of liabilities and the value of the assets supporting them.
Outline the key factors that determine the capital needed by the insurer [2]
The longer the tail of the business written the greater the uncertainty and hence, the more capital that will be required. In setting its capital requirements, beyond those specified by law, the general insurer will need to take into account the uncertainty and variability of the business it writes. For an individual CoB, the greater the uncertainty and variability in the future claims experience and run-off of reserves of a class, the larger the capital requirement for that class per unit of premium or reserves. An insurer that writes a variety of classes of business with a good spread of risks is likely to be exposed to less overall volatility than one that writes limited classes of business in limited markets.
Describe the essential characteristics of liability insurance [1]
The essential characteristics of liability insurance is providing indemnity where the insured, owing to some form of tort (private or civil wrong, such as negligence), is legally liable to pay compensation to a third party.
List the main types of liability insurance [3]
- employers liability
- third party motor liability
- marine and aviation liability
- public liability
- product liability
- professional indemnity / errors and omissions (E&O) liability
- directors’ and officers’ (D&O) liability
- environmental liability
State how the benefit under liability insurance may be restricted [2]
The extent of any legal liability may depend on prevailing legislation. For marine and aviation liability, international law prevails, depending on which jurisdiction applies and how the contract is worded. For classes such as motor and employers’ liability, national laws are likely to apply.
The benefit may be restricted by:
- a maximum indemnity per claim or per event (this may involve more than one claim), or aggregate maximum per year
- an excess
Describe the benefits provided by employers’ liability insurance [3]
EL insurance indemnifies the insured against the legal liability to compensate an employee or his or her estate for bodily injury, disease or death suffered, owing to the negligence of the employer, in the course of employment. Loss of or damage to employees’ property is usually also covered.
The benefit can be in the form of regular payments to compensate for disabilities that reduce the employee’s ability to work, lump sum payments to compensate for permanent injuries to the employee and benefits under the legal framework.
Legal costs will also be covered. Other costs such as care costs can also be included.
State how insurance products to compensate employees for incidents occurring in the course of their employment may differ between countries [1]
The most important distinction is between countries that have a system of employers’ liability (in which losses must arise from the employers’ negligence if they are to form the basis of compensation, e.g. in the UK) and workers’ compensation (in which losses merely have to be suffered in the course of employment. e.g. in the US).
Describe the benefits provided by motor third party liability insurance [2]
This insurance indemnifies the owner of a motor vehicle against compensation payable to third parties for personal injury or damage to their property. The benefits will include compensation for loss of earnings, hospital costs and damage to property costs, and can be paid in a lump sum or periodically to the injured party. In most countries such cover is compulsory, although precise rules vary, for example in the amount of cover required. The cover provided may or may not be limited to that required by legislation.
State the requirements in the UK relating to motor third party liability insurance [2]
Third-party liability cover is required for all motor vehicles in the UK, under the Road Traffic Act 1972. The cover must be unlimited in relation to third party injury claims. For third party property damage claims a minimum level of cover is set out in law.
Describe the benefits provided by marine and aviation liability insurance policies [1]
The insured is indemnified against the legal liability to compensate a third party for bodily injury, death or damage to property arising out of operation of the vessel or aircraft. Third parties include, but are not limited to, passengers.
Describe the benefits provided under public liability insurance [2]
The insured is indemnified against legal liability for the death or a bodily injury to a third party or for damage to property belonging to a third party, other than those liabilities covered by other liability insurance. There are two main types of cover, namely:
- the risk at an insured’s own premises (e.g. warehouses)
- the risk when work is carried out by the insured away from their own premises (e.g. on a building site)
Describe the benefits provided under product liability insurance [1]
This insurance indemnifies the insured against the legal liability for the death or bodily injury to a third party, or for damage to property belonging to a third party, that results from a product fault. This policy will usually also cover legal costs. Some policies will include the cost of recalling faulty products that have not actually caused damage.
Describe the benefits provided under professional indemnity insurance [2]
This insurance indemnifies the insured against legal liability for losses resulting from negligence in the provision of a service, for example unsatisfactory medical treatment or incorrect advice from an actuary or solicitor. The insured will be a professional person or firm. Holding professional indemnity insurance is often a legal or regulatory condition of being allowed to practice a profession or may be imposed as a condition by a governing body.
Describe the cover provided under D&O liability insurance [1]
D&O insurance indemnifies the insured against the legal liability to compensate third parties owing to any wrongful act of the insured in his or her capacity as a director or officer of a company. The insurance is personal to the director or officer, but is usually bought for him or her by the company.
Describe the cover provided under environmental environmental liability insurance [2]
The insured is indemnified against the legal liability to compensate third parties as a result of bodily injury, death and damage to property as a result of unintentional pollution for which the insured is deemed responsible. The cost of cleaning up the pollution and regulatory fines may also be covered. Gradual and sudden environmental pollution will generally both be covered.
List the insured perils under employers’ liability insurance [2]
- accidents caused by negligence of the employer or by other employees
- exposure to harmful substances (e.g. chemicals, coal dust, asbestos)
- exposure to harmful working conditions (e.g. loud noises or repetitive strain)
Describe the insured perils under marine and aviation liability insurance [2]
- loss of, or damage to, passengers’ property, including luggage
- bodily injury or death of passengers either while on board the vessel or aircraft or when boarding or leaving the aircraft
- bodily injury caused by the vessel or aircraft
- damage to property caused by the vessel or aircraft
(There will likely be several exclusions including terrorism/war although extensions may be in place to cover these)
Describe the insured perils under public liability insurance [1]
Depends on the type of policy. For example, a dog bite may be covered by a household policy, while compensation for injury from a falling object may be covered by a commercial policy held by a builder.
In general, the policy will not be restricted to named perils, although some perils may be excluded.
Describe the insured perils under product liability insurance [1]
Here the perils depend greatly on the nature of the product being produced, but include:
- faulty design
- faulty manufacture
- faulty packaging
- incorrect or misleading instructions
Describe the insured perils under professional indemnity insurance [1]
The perils here depend on the profession being insured, for example:
- wrong medical diagnosis
- error in medical operation
- error in actuarial report
Describe the insured perils under D&O liability insurance [1]
- allowing a company to continue operating in circumstances when it should have been declared insolvent
- any act resulting in the insured being declared unfit for his or her role
- allowing false financial statements to be published
Describe the insured perils under environmental liability insurance [1]
Any incident causing gradual or sudden environmental pollution
State the basis of cover for each of motor third party liability, marine and aviation liability, product liability, professional indemnity, D&O liability and environmental liability [3]
- Motor third party liability - cover is usually provided on a loss-occurring basis.
- Marine and aviation liability - policies are likely to be written on a loss-occurring basis.
- Product liability - policies are likely to be written on a claims-made basis.
- Professional indemnity - usually written on a claims-made basis.
- D&O - usually written on a claims-made basis.
- Environmental liability - likely to be written on a claims-made basis.
State the main measure of exposure used for each of employers’ liability and motor third party liability [2]
The main measure of exposure for employers’ liability is payroll, or total wage and salary costs. The premium rate for an employer will be agreed when a policy is taken out and a premium will be paid on the basis of the estimated payroll for the year. At the end, an adjustment premium will be paid or refunded.
For motor third party liability the measure of exposure is the vehicle-year. In other words, an agreed monetary premium is charged for the insurance of a single car for a year.
Discuss possible measure of exposure for marine and aviation liability [2]
- passenger kilometres
- passenger voyages
- in-service seats
- in-service vessels/aircraft
- under marine insurance, sum insured, feet drilled and turnover are used when suitable
State the most commonly used measure of exposure for each of public liability, product liability, professional indemnity and environmental liability [2]
- Public liability - turnover
- Product liability - turnover
- Professional indemnity - turnover (or sometimes funds under management)
- Environmental liability - number of power stations/amount of energy generated/value of the land
Explain why there can be long settlement delays in liability classes [2]
Several issues need to be resolved before a liability can be settled:
1) whether or not there has been a loss
2) whether or not the insured is liable
3) the quantum (amount) of the loss
The loss may also be reduced if there is contributory negligence on the part of the victim. If the loss is personal injury, it may take several years before the victim’s condition has stabilised and can be assessed for damages. Claim settlement will involve litigation for any claim of significant size, even though most cases are resolved out of court before they go to trial.
Describe, using examples, how long reporting delays can arise in liability classes and why it might be unclear which insurer is liable for a given claim [3]
Some liable claims remain undetected for many years and are often referred to as ‘latent claims’. This means that a loss may not become evident until many years after it was caused (e.g. mesothelioma from exposure to asbestos where symptoms are usually not evident for at least 20 years).
A further complication is that claims may arise over a long period. For example, a storage tank may leak contents into the ground causing pollution for some years before the damage is discovered (or those with mesothelioma were exposed to asbestos for many years before their condition manifested). This means that it may not always be clear which insurer is liable for the loss and often some form of allocation is necessary.
Explain why claim development patterns for similar classes can differ significantly between countries [1]
The legal environment has a significant effect on the settlement of claims, and this varies from country to country. Therefore, claims development patterns for similar classes of business may vary significantly between countries.
Outline how claim cost distributions for liability classes differ from those for property classes [1]
Claim cost distributions tend to be more widely spread for property classes, and there can be some extremely large individual claims that take many years to settle.
Outline how the characteristics of motor liability claims differ from those of other types of liability claims and other types of motor claims [2]
Motor liability claims tend to be more frequent and usually smaller than claims on other liability policies, both for property damage and for bodily injury to third parties. Settlement is often faster than for other types of liability claims, although claims arising from serious bodily injury do typically take several years to settle. Even so, motor liability claims, and particularly bodily injury claims, are significantly longer-tailed than other motor claims. In some jurisdictions, bodily injury claims can be settled as regular payments for life to the victim, rather than lump sum payments.
State the underwriting factors considered in assessing an appropriate premium for employers’ liability and public liability insurance [3]
For EL and PL, the main factor influencing the risk is the type of industry or the occupation of the insured. The underwriting factors are as follows: - type of industry or occupation - exposure and claims experience - location of the workforce - frequency of visitors to the site - the materials handled - the processes involved - safety precautions in place, for example sprinklers in a factory or office - turnover - size of deductible In addition, underwriters should vary the premium according to a general assessment of the risk management standards of the insured.
State rating factors used for marine and aviation liability insurance [3]
- loss history
- type of craft or vessel (as accident rates and types/sizes of claims will vary) for example, jets/turboprop/rotor wing for aircraft
- commercial category (commercial/private/military)
- satellites and missiles
- use of craft or vessel (passenger/cargo/leisure/business)
- geographic region (jurisdiction of litigation)
State factors affecting the assessment of an appropriate premium for product liability insurance [2]
- the nature of the products produced by the insured
- the distribution channel of the product
- how much US exposure the product has (in general, product sold in the US show a different (higher) claims distribution and more claims are likely to be made)
- its usage
Each policy will be underwritten individually, and the underwriter will need to assess the risks arising from a policy subjectively.
