Chapter 0: Introduction to general insurance Flashcards
Why do general insurers exist?
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
What is general insurance?
- 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
Risk and uncertainty in general insurance
- 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
Role of the actuary in general insurance
- 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
General Insurer’s Balance Sheet
- 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)
Different types of balance sheets
- 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
Major claim Characteristics
- 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
Reporting delays
- 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”
Settlement delays
- 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
Short Tail
Claims are generally reported quickly and settled quickly by the insurer
Long Tail
There is a sizeable proportion of total claim payments that take a long time for the insurer to settle
Outstanding claims reserve
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)
Reserve for outstanding reported claims
Estimated reserve needed to settle the claims that the company knows about at the accounting date
Reserve for incurred but not reported (IBNR) claims
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
Reserve for re-opened claims
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
Reserve for claims’ handling expenses
In settling claims the company will incur some additional expenses (eg legal fees). The reserve for these expenses may be held separately
Two distinct approaches for estimating outstanding claims reserves
- 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
Reserves for unexpired policies
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
Unearned premium reserves (UPR)
- 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)
Straight averaging basis
- 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
Acquisition costs
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
Unexpired Risk Reserve (URR)
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
Unearned Premium Provision (UPP)
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
Additional Unexpired Risk Reserves (AURR)
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)
Other types of technical reserves
Claims equalisation reserve (CER)
Catastrophe reserve
Claims equalisation reserve (CER)
- 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
Catastrophe reserve
- 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)
Alternative terms for Free Reserves
- Free assets
- Solvency Margin
- Shareholders’ Fund
- Capital Employed
Significance of free reserves
- 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.
Major factors influencing the company’s investment strategy
- 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)
Written vs Earned Premiums (for profit purposes)
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
Paid vs Incurred claims (for profit purposes)
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)
Underwriting result
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
Cashflow Diagram
Double arrows mean can be net inflow or net outflow.
Diagram can be used to generate ideas for the exam
