CH 23 (WM)

Question 1

What are the main reasons for calculating the reserves of a health and care insurer? [4]

Answer 1

• To determine the liabilities to be shown in the insurer’s published accounts.✓✓
• If separate accounts have to be prepared for the purpose of supervision of solvency✓, to determine the liabilities to be shown in those supervisory accounts.✓✓
• To determine the liabilities to be shown in the internal management accounts of the insurer.✓✓
• To estimate the cost of claims incurred in recent periods✓ and hence provide a base for estimating the future premiums required to attain a given level of profitability.✓✓
• To value the insurer for merger or acquisition.✓✓
• To influence the investment strategy.✓✓
• To assist with the assessment of reinsurance agreements.✓✓

Question 2

List the reserves that healthcare insurers might hold i.r.o. long-term insurance contracts. [2.25]

Answer 2

• Reserves for IF policies✓
• IBNR ✓
• RBNFS ✓
• Option Reserves ✓
• UPR & URR for group contracts ✓✓✓
• Investment mismatching reserve in some territories ✓✓

Question 3

Define an option reserve, together with an example. [2]

Answer 3

Additional provisions that need to be set aside for the eventuality that a particular option “comes into the money”✓✓
– ie becomes more valuable in its exercise than in its discard.✓✓

For example there may be a guaranteed conversion options on CI policies.✓✓

This reserve is held in order to fund the value of those guarantees.✓✓

Question 4

What are the policy reserves and the claims reserves also referred to? [0.75]

Answer 4

Policy reserves – active life reserves or prospective premium reserves ✓✓

Claims reserves – disabled life reserves ✓

Question 5

Provide two practical examples of where reserves are required i.r.o. claims that have been reported and not yet fully settled. [1]

Answer 5

LTCI claims that are currently in payment.✓✓

CI claims that are still in their assessment period.✓✓

Question 6

Ignoring the investment mismatch reserve, describe the reserves that need to be held for an individual LTCI policy where the PH is currently:

(a) Fully capacitated
(b) Incapacitated, but has not yet informed the insurer
(c) Incapacitated and claiming
[3.5]

Answer 6

)a) Active life reserve will be required.✓ Typically this will be:
The discounted value of expected future claim inceptions✓
Plus✓ the disc value of expected future expenses✓ (both regular and claim)✓
Less✓ the disc value of the expected future premiums.✓

(b) IBNR✓ – expected cost of claims✓ (and claim expenses)✓ that have been incurred but not reported.✓

(c) RBNS✓ – current claim annuity value✓ of the benefits in payment✓ plus the EPV of the associated future claim expenses.✓

Question 7

Define an Unearned Premium Reserve (UPR). And also explain the details of the UPR calculation via an appropriate example of how it works i.r.o. a single policy where the UPR is calculated at the year end. [6.5]

Answer 7

The UPR is the balance of premiums received iro periods of insurance not yet expired.✓✓ This is effective a retrospective approach✓, ie how much of the premium that were charged should be held i.r.o. the unexpired risk.✓✓

Workings: We need to determine
what the premium is supposed to cover✓✓, and
when precisely the premium is earned.✓✓

The premium covers claim payments ✓, initial expenses, eg commission, and other expenses eg claims expenses [1], as well as profit.✓

Apart from the initial expenses✓, all the elements of the premiums may be assumed to be earned with the incidence of the risk.✓✓ Collectively, these elements make-up the risk-related premium.✓✓ If the policy under consideration has m% of the risk before the year-end, and (100-m)% of the risk after the year-end then (100-m)% of the risk-related premium is unearned at the year-end.✓✓
The UPR for this policy could be calculated as (100-m)% X risk-related premium.✓✓

For the whole portfolio, the UPR is the sum of these amounts over all policies.✓✓

Question 8

Define an Unearned Risk Reserve (URR).
[3]

Answer 8

The reserve i.r.o. the unexpired insurance premium✓ (per UPR calculation )✓ where it is felt that the premium basis is inadequate to meet future claims and expenses.✓✓
This is effectively a prospective approach✓: how much is needed now to cover the expected claims and expenses from the unexpired risk period?✓✓
If the UPR is inadequate to cover the claims and expenses for unexpired risk due to insufficient premiums then more will be needed.✓✓
The URR is an estimate of what is actually needed to provide for the unexpired risk, rather than simply taking a proportion of premium.✓✓
The URR would typically be calculated by estimating the future loss ratio and applying it to the proportion of premium unexpired.✓✓

                  Don’t use the word “future” but rather “unexpired risk”.

Question 9

Describe EQUALISATION and CATASTROPHE reserves. [3.5]

Answer 9

Equalisation or CAT reserves are required where it is felt that the current year is atypical and amounts will have to be held back for abnormal events.✓✓
Equalisation reserves are amounts held back generally from profitable years.✓✓ In the less profitable (or loss-making) years, amounts may be drawn from the reserve to boost the results for that year.✓✓
There may be legislation controlling the amounts that can be passed to and taken from the reserves.✓✓ The primary purpose of equalisation reserves is to smooth profits.✓✓

CAT reserves are funds held aside in case a future catastrophe happens.✓✓

The regulation of both equalisation and CAT reserves varies from country to country.✓✓ They may/may not be allowable, and may/may not receive favourable tax treatment.✓✓

Question 10

Describe the circumstances under which an insurer will be required to hold reserves for long-term insurance contract where the claims have been reported but not settled yet. Also, explain how the actuary will determine the amount of the reserves that should be held. [5]

Answer 10

For most long-term insurance contracts that pays a lump sum benefit, the amount of the benefit is known once a claim is submitted.✓✓However, for contracts that pay an income, the duration for which benefits will be paid will generally not be known at the point a claim is submitted.✓✓

The insurer will hold a reserve for claims that have been notified but not yet settled ✓✓, using the amounts in the policy document✓, increased where appropriate by relevant inflationary indices or other increments.✓✓

Where benefits are paid as an income (LTCI for example)✓✓ the actuary will normally use statistical methods.✓ Case estimation would only be used for very small volume of claims, where the reserves can be determined by asking the claims manager to estimate the likely duration of each claim.✓✓

Most of the long-term insurance provisions held are i.r.o. future claims✓✓, acknowledging that a level premium (or one increasing at a similar rate to the benefit)✓✓ is being paid to cover an increasing probability of claim.✓

The actuary may utilize deterministic or stochastic models in order to estimate potential future claims outgo and thus set current provisions.✓✓

Question 11

Define the following types of reserves i.r.o. short-term insurance contracts.

a) IBNR
b) Claims in-transit [1.75]

Answer 11

a) Reserves i.r.o. claims that have arisen but that have yet to be notified to the insurer.✓✓

b) Reserves i.r.o. claims reported but NOT assessed or NOT recorded. ✓✓✓ These are reserves held aside for claims that are “in the pipeline”.✓✓

Question 12

Describe the principles for setting statutory or solvency reserves. [9]

Answer 12

• The amount of the reserves should be such that all liab’s arising out of insurance contracts can be met by the insurance company.✓✓
• The amount of the reserves should be calculated by a suitable prudent VAL of all future liab’s for all existing policies✓✓, incl. guar’d benefits, options available to PH, expenses, incl. comm and premiums contractually due. (1.25)
• The VAL basis should be prudent✓, ie BE + appropriate margin for adverse deviation of relevant factors.✓✓
• The VAL should take account of the nature, term and method of VAL of the corresponding assets, depending on the type of policy. (1)
• The use of approximations and generalisations should be allowed.✓✓
• The VAL rate of interest should be taken prudently having regard to the yields on the corresponding existing assets and to the yield that is expected will be obtained on sums to be invested in the future. (1)
• The elements of the statistical basis, that is the demographic and persistency assumptions, and the allowance for expenses used in the calculation of the reserves should be chosen prudently, having regard to the type of insurance, the territory of the persons insured, and the administrative costs and commission expected to be incurred. (2)
• If a VAL method defines in advance the amount of expenses to be used in the VAL, the amount so defined should not be less than a prudent estimate of the relevant future expenses.✓✓
• The method of calculation of the reserves from year to year should be such as to recognise profit in an appropriate way over the duration of each policy and should not be subject to discontinuities arising from arbitrary changes to the VAL basis. (1)
• Each insurance company should disclose the methods and basis used in the VAL.✓✓

Question 13

State the factors that will be taken into account when assessing the reserves on an individual claim using the case estimate approach.
[2.5]

Answer 13

• Procedure type ✓
• Hospital ✓
• Surgeon/Consultant ✓✓
• Policy Coverage ✓
• Age, Gender and Past Claims History ✓✓✓
• Current level of medical inflation ✓✓

Question 14

Define the following types of reserves i.r.o. short-term insurance contracts.

Outstanding Claims Reserve
IBNER [2.5]

Answer 14

OCR - reserves i.r.o. claims notified to the insurer but not yet fully settled. ✓✓ This is a reserve for claims that are currently known about✓ (and maybe some claim payments have already been made) ✓, but have yet to be fully settled.✓

IBNER – as above✓ ,but where it is felt that not all detail has yet been submitted and a provision needs to be established for the remainder.✓✓ It is therefore an adjustment, either positive or negative, to the OCR.✓✓✓

Question 15

What are the two primary methods used to calculate the reserves for health and care products? And also explain what factors will be considered to determine the method to be employed. [1]

Answer 15

The two methods are case estimates and statistical estimates.✓✓

The method used will depend heavily on the characteristics of the product and the purpose of the calculation.✓✓

Question 16

Why will an actuary define the IBNER separately from the OCR? [1.5]

Answer 16

It may give more information to management in order that they can make better-informed decisions.✓✓

There may be different trends in IBNER reserves, which are best modelled separately.✓✓

IBNER may receive different tax treatment from other reserves.✓✓

Question 17

Describe the approach an insurer will follow to set reserves for short-term (PMI) insurance contracts. [2]

Answer 17

PMI is typically an indemnity cover✓, ie. the amount payable on claim is determined by the costs incurred by the claimant✓ and is thus not known with certainty✓ until the particular course of treatment is complete.✓

The approach that is usually adopted to estimate the amount of claim is one of statistical estimation✓, though certain large✓ or unusual claims✓ will warrant reserves on a case-by-case basis.✓

Question 18

What is a passive valuation approach? [1]

Answer 18

Valuation approach that is relatively insensitive to changes in market conditions✓✓ and
has a valuation basis that is updated relatively infrequently✓✓.

Question 19

(Question 4.29) A health and care insurer sells stand-alone critical illness business. Discuss the relative merits of using a passive valuation approach. [6]

Answer 19

Compared to active valuation approaches, passive valuation approaches: + tend to be more straightforward to implement
[1⁄2] + tend to involve less subjectivity, … [1⁄2]
… eg a net premium valuation is relatively insensitive to the choice of valuation basis
+ tend to result in relatively stable emergence of accounting profit + may be less likely to be subject to procyclicality and systemic risk: [1⁄2] [1⁄2] [1⁄2]
a passive valuation of assets (such as historic book value) would be little affected by volatile asset prices
[1⁄2]
an active approach (such as market value) may result in the need to sell risky assets after a fall in prices, which could lead to further price falls
[1⁄2] – are at risk of becoming out of date, … [1⁄2]
… and hence management might fail to take appropriate actions in time; … [1⁄2] … in particular, they might fail to take account of important trends, …
… such as increasing claim incidence rates due to earlier diagnoses of certain illnesses …
… or increasing inflation of regular expenses and claims expenses [1⁄2] [1⁄2]
– may provide a false sense of security when the reality is that market conditions have changed significantly
– tend to be less informative in terms of understanding the impact of market conditions on the ability of the company to meet its obligations …
… particularly in relation to financial guarantees and options … [1⁄2] [1⁄2] [1⁄2]
… although it is unlikely that a CI insurance policy would include any financial options and guarantees, …
[1⁄2]
and it is unlikely to be exposed to the equity market … [1⁄2]
… although it may be exposed to price volatility if it holds corporate bonds. [1⁄2] [Maximum 6]

Question 20

Define the active valuation approach. [2]

Answer 20

An active approach would be based more closely on market conditions✓✓, with the assumptions being updated on a frequent basis✓✓.
An example would be the use of market-consistent valuation approaches for both assets and liabilities✓✓, and a risk-based capital approach to solvency capital requirements✓✓.

Question 21

Outline the advantages of an active valuation approach. [0.75]

Answer 21

Active valuation approaches are more informative in terms of understanding the impact of market conditions on the ability of the company to meet its obligations✓✓, particularly in relation to financial guarantees and options✓.

Question 22

Outline the advantages of an active valuation approach. [2.5]

Answer 22

Financial results are potentially more volatile using an active value approach✓✓.

Under adverse equity market conditions (eg a stock market crash)✓✓, an active valuation approach using risk-based capital would indicate that higher capital requirements are needed✓✓. In order to reduce this requirement, companies would need to sell equities – which itself could exacerbate the market conditions✓✓.

There is also systemic risk, as this would be the case for all health and care insurance companies at the same time✓✓. Therefore it may be the case that regulators include amendments to the valuation approaches under such conditions, to avoid this situation✓✓.

Question 23

Explain the impact if the overall valuation approach is somewhere between the passive and valuation approaches, including elements of each. [1.5]

Answer 23

This can result in a greater mismatch between assets and liabilities✓✓, and hence greater profits/losses or changes in free assets when market conditions change✓✓.

For example, an approach that uses a net premium valuation for liabilities and market value of assets could experience greater volatility of results than one that uses a market-consistent valuation for both.✓✓

Question 24

What is the SCR? [1]

Answer 24

It is usual for insurance supervisors to require that an insurer maintains at least a specified level of solvency capital in addition to the reserves or technical provisions held.✓✓
This solvency capital can be seen as providing an additional level of protection to policyholders.✓✓

Question 25

Describe the interplay between reserves and solvency capital requirements. [3.5]

Answer 25

In considering the adequacy of the reserves that have been set up, it is important to do this within the context of the solvency capital requirements and not in isolation✓✓. Similarly the adequacy of the solvency capital requirements cannot be looked at in isolation of the reserving requirements✓✓.

Practice on the relative balance between the two components varies between countries and regulatory jurisdictions.✓✓
In some, reserves are set up on a relatively realistic basis✓, ie with relatively small margins from the expected values✓, but there is a requirement for a substantial level of solvency capital✓ determined using risk-based capital techniques✓.

In other countries, reserves are set up on a relatively prudent basis✓, ie with relatively large margins✓, but with a relatively small solvency capital requirement✓ that is not specifically related to the risks borne by the company✓.
.