Chapter 0: Introduction to general insurance

Question 1

Why do general insurers exist?

Answer 1

To meet a need
- enables individuals and companies to take on risks that they would not otherwise undertake
- enabled the insured to make small, known outlay to insure against the risk of potentially large loss (prefer more certain outcome)

To make profit
- Constraints: customer ability to pay, statutory controls & competition
- If not meet need / expensive = PH lapse & reputational damage

Question 2

What is general insurance?

Answer 2

• Any type of insurance that is not life insurance
• In most cases a general insurance policy is a contract of indemnity
• Other policies may pay specified amounts on specified contingencies only (eg R10000 if you lose an eye) or if the loss is unclear, the amount might be determined by a court of the law

Question 3

Risk and uncertainty in general insurance

Answer 3

• Mainly frequency and severity of claims, but also:
• Recovery of fixed expenses
• Third party failure (brokers and reinsurers)
• Falls in asset values
• Insurance cycles

The size of the free reserves will influence the ability of the insurer to cope with these risks, as will reinsurance cover and the investment portfolio

Question 4

Role of the actuary in general insurance

Answer 4

• Reserving
• Premium rating
• Determining a suitable investment strategy
• Capital allocation
• Expense allocation
• Risk assessment (eg modelling catastrophic events)
• Assessing reinsurance requirements
• Strategic management of the business
• Assessing effectiveness of marketing strategies
• Assisting with early settlement of liabilities in the event of wind-up

Question 5

General Insurer’s Balance Sheet

Answer 5

• The balance sheet of a general insurer is a summary (strictly an estimate) of the financial status of the company at the time of the balance sheet
• Solvency Margin / Free Reserves = Assets - Technical Reserves - Capital Requirements
• Assets = Investments + Fixed Assets + Net Current Assets (eg money due from brokers)

Question 6

Different types of balance sheets

Answer 6

• Statutory accounts - May be in a prescribed format or there may be certain principles that must be applied
• Internal management accounts may be produced to assist internal decision-making. These are likely to be on an ongoing, realistic basis, although a variety of “what-if” scenarios are also likely to be produced

Question 7

Major claim Characteristics

Answer 7

• Refer to the ways and speed in which claims originate, are reported, are settled and are on occasion reopened.
• Two main types of delays: Reporting and Settlement delays

Question 8

Reporting delays

Answer 8

• The reporting delay is the time from the event occurrence through to the time that the insurance company is notified of the event
• The policyholder may be slow in getting round to advising the insurer, possibly because the amount involved is quite small
• Other times the policyholders do not submit claims because they do not realise there is cause for claiming eg for industrial diseases (asbestosis or industrial deafness) it may vbe many years before the condition emerges. Reporting delays are considerable in these cases

Event delay - The part of the delay between when the insured event happens and when the policyholder realises the event has happened

• In many cases the event delay is minimal (eg car accident)
• Therefor many people simply use the term “reporting delay” to mean “reporting delay + event delay”

Question 9

Settlement delays

Answer 9

• The settlement delay is the period between notification to the company and the payment of the claim

These delays are due to
- Initial administrative processing
- Establishing whether the insurer is liable
- Waiting for a condition to stabilise (eg will the insured part recover, or is the disability permanent)
- Establishing how much should be paid

In a few cases where the insurer and the claimant cannot agree, these cases may go to court

In general (not always):
- property damage claims are settled more quickly than claims in respect of bodily injury
- large claims take longer to settle than small claims

Question 10

Short Tail

Answer 10

Claims are generally reported quickly and settled quickly by the insurer

Question 11

Long Tail

Answer 11

There is a sizeable proportion of total claim payments that take a long time for the insurer to settle

Question 12

Outstanding claims reserve

Answer 12

First of 2 main components of the technical reserves

Can be given a total figure or be split into anything up to 4 separate components

• Reserve for outstanding reported claims
• Reserve for incurred but not reported (IBNR) claims
• Reserve for re-opened claims
• Reserve for claims’ handling expenses

Even if not showed explicitly reserve for all 4 should still be held. eg (3) can be included in (1), and (4) can be split between (1) and (2)

Question 13

Reserve for outstanding reported claims

Answer 13

Estimated reserve needed to settle the claims that the company knows about at the accounting date

Question 14

Reserve for incurred but not reported (IBNR) claims

Answer 14

The IBNR reserve is needed to cover the claim payments for incidents which have happened, but which have not been reported to the insurance company

Question 15

Reserve for re-opened claims

Answer 15

An additional reserve which may be explicitly shown to allow for claims that the insurance company treats as being fully settled, but which might one day require further payments. In practice, insurers differ significantly over when they “close” a claim

Question 16

Reserve for claims’ handling expenses

Answer 16

In settling claims the company will incur some additional expenses (eg legal fees). The reserve for these expenses may be held separately

Question 17

Two distinct approaches for estimating outstanding claims reserves

Answer 17

• Making estimated of the liability for each individual outstanding claim (“case estimates”) - individual estimates cannot be used for IBNR because the insurer does not know about the claim yet
• Using statistical techniques to estimate the total outstanding payments for the portfolio - more useful for classes of insurance where there are lots of claims (eg private motor) and where there is stability in the number and amount of claims

In practice, insurers use a combination of the two

Question 18

Reserves for unexpired policies

Answer 18

2nd main component of technical reserves

• reserves for liabilities in respect of existing policies with some unexpired exposure
• ie future claim events from policies with future periods of cover remaining at the accounting date

Question 19

Unearned premium reserves (UPR)

Answer 19

• Usual basis for determining the reserves in respect of the unexpired exposure is to hold a portion of premiums in respect of that exposure
• Thus UPR is a retrospective assessment of the reserve (eg using the straight averaging approach)

Question 20

Straight averaging basis

Answer 20

• eg for a policy with half of its term still to run, it might be reasonable to hold a reserve of half of the premium that was charged.
• eg for an annual policy with a month left to run a reserve of one twelfth of the premium might be held

Fundamental weaknesses in practice:
- it ignores the fact that the risk from the policy may not be spread evenly over the period of cover
- it ignores the fact that expenses of setting up and servicing the policy may not be incurred evenly over the period of cover

net UPR = proportion of risk unexpired x (premium - acquisition costs)

gross UPR does not allow for acquisition costs

Question 21

Acquisition costs

Answer 21

Expenses incurred by the insurer at the start of a policy

Commission forms the main component

Assuming risk and ongoing costs are spread evenly across the period and acquisition costs are 20%, then we can assume the remaining 80% is the proportion split according to the remaining period

Question 22

Unexpired Risk Reserve (URR)

Answer 22

A prospective assessment by thinking of possible future claim events

This reserve would need to cover all the claims and all the expenses that are expected to be incurred in the future by the unexpired portion of existing policies

Question 23

Unearned Premium Provision (UPP)

Answer 23

We normally expect the UPR to be bigger than the URR

This is effectively the same as expecting the premiums to be big enough to cover claims and non-acquisition expenses - which is what a profit seeking insurer would want

In cases where the UPR > URR there is no need to keep reserves > UPR for unexpired policies.

Because of the accounting accruals principle we would generally hold at least the full UPR.

Holding a reserve = UPR we would expect some profit to emerge over the coming months for these policies

Regulation is moving toward allowing insurers to hold the URR even when lower than the UPR, which essentially allows immediate release of profits.

This reserve will be referred to as the Unearned Premium Provision (UPP) and the UPR will be done away with

Question 24

Additional Unexpired Risk Reserves (AURR)

Answer 24

Where URR > UPR it is more complex. These cases imply that the company expects to make a loss on unexpired policies because it expects to pay out more in claims and expenses then the amount of premiums held back for the unexpired period

The UPR will be insufficient to meet the expected payments, and the insurer should set up additional reserves to meet this strain

AURR = URR - UPR (minimum of 0)

Question 25

Other types of technical reserves

Answer 25

Claims equalisation reserve (CER)

Catastrophe reserve

Question 26

Claims equalisation reserve (CER)

Answer 26

• Used to smooth the profits from one year to another
• In a good year when profits are large, money is transferred to the CER, reducing the initial assessment of profit. In a bad year, money is transferred from the CER, increasing the initial assessment of profit

Question 27

Catastrophe reserve

Answer 27

• An additional reserve to cover losses that might arise from a catastrophe
• If a large catastrophe reserve is held there would be less need for the insurer to hold extensive free reserves (ie excess of assets over liabilities)
• Conversely, the free reserves for a company that does not hold a catastrophe reserve need to be sufficient to cover the possibility of a catastrophe (or 2)

Question 28

Alternative terms for Free Reserves

Answer 28

• Free assets
• Solvency Margin
• Shareholders’ Fund
• Capital Employed

Question 29

Significance of free reserves

Answer 29

• Firstly, free reserves can be seen as the pool of funds being used to provide the backing for insurance risks. Enables the insurer to meet claims after adverse events.
• Secondly, there may be a legal requirement for an insurance company’s free reserves to exceed a statutory minimum level. In South Africa, this minimum capital amount is often called the Minimum Capital Requirement (MCR)

The extent of free reserves are closely linked to:

• The maximum amount of business the company is able to write (free reserves provide a cushion against unexpected adverse results). The more business written the larger the required cushion. Conversely, there is a maximum amount of business that a given level of free reserves can support
• The classes of business written: Some classes of business have more variable claims experience than others and some classes involve bigger risks. Bigger free reserves can support more variable and larger risks.

Question 30

Major factors influencing the company’s investment strategy

Answer 30

• Size of free Reserves (the bigger the free reserves, the greater the extent to which the investment strategy can be aimed at maximising returns
• Nature of liabilities (fixed in monetary terms / real)
• Legislative influences (need to maintain free reserves above a particular solvency margin - not hold too many assets with volatile market values)
• Term of liabilities
• Currency of liabilities
• Uncertainty of liabilities (influences the proportion of assets to be held in a liquid form and which have reasonably stable market values)
• Taxation (max post tax investment returns)

(SNIT CUT)

Question 31

Written vs Earned Premiums (for profit purposes)

Answer 31

Written Premiums - The total amount of premium income written in the year

Earned premiums - Amount of premium income relating to to insurance cover provided during the year

• Expenses incurred should be treated similarly

Question 32

Paid vs Incurred claims (for profit purposes)

Answer 32

Paid claims - The total amount of claim payments made by the insurer during the year

Incurred claims - The amount of claims paid plus the increase in the total reserve for outstanding claims (eg if claim if delayed to next year the outstanding claims increases for this year)

Question 33

Underwriting result

Answer 33

Underwriting result (or underwriting profit) is the term given to the excess of premiums over claims and expenses:

Earned Premiums
- Claims Incurred
- Expenses Incurred
= Underwriting result

The underwriting result in the revenue account for insurance companies are equivalent to the operating profit of non-insurance companies

The above is based on the accruals concept for determining profits

Question 34

Cashflow Diagram

Answer 34

Double arrows mean can be net inflow or net outflow.

Diagram can be used to generate ideas for the exam