Chapter 10: Establishing the Price - Pricing Factors Flashcards
How can risk premium be defined?
The expected ultimate cost in claims of the risk being accepted, including an allowance for the degree of uncertainty
Essentially it is the amount required to pay claims
What is a claims run-off?
Changes in claims reserves or claims being re-opened due to more information becoming available or court rulings on liability
What are latent claims?
Claims that takes many years to be reported. An example is mesothelioma from asbestos - some claims are being made for incidents which occurred 40-50 years ago.
Also called long tail claims
Similar to INBR but much more time has elapsed
What is meant by INBR?
Incurred but not reported
Estimated reserves based on expected claims for events that have occurred but not yet been reported to the insurer
How should claims data be adjusted to reflect exposure?
They should be adjusted to reflect exposures today. Claims data is historical and must be viewed within that context
For example in many industries technological advancements have automated some processes which previously would have been risky therefore it would not be accurate to price the risk based upon historical claims
What is claims farming?
Where a company (eg claims management company) or person encourages another to make a claim
What are the 4 main factors to take into consideration when setting the price?
- Risk premium (claims payments)
- Expenses
- Profit
- Taxes and levies
What are the two categories of expenses?
Fixed and variable
What is the difference between fixed and variable expenses?
Fixed expenses are the same cost for every policy, whereas variable expenses may change with the size of the risk
What are some examples of variable expenses?
Underwriting Risk management/surveys Commission Claims handling Risk management funds Low claims rebates
What is meant by return on capital employed?
The profit as a percentage of the capital employed
What is investment income?
Insurers control a large amount of capital in the common pool. Whilst they must retain certain levels of reserves they can also invest some capital, usually in low risk areas, which gives them another source of income
What is meant by “underwriting result” and what measures this?
The actual profit or loss of the insurer without taking investment income into account, as measured by the combined operating ratio
What is the combined operating ratio (COR)?
A combination of the loss ratio, commission ratio, and expense ratio
What does the COR measure?
The underwriting result. Essentially the financial health of the insurer
(COR is combined operating ratio)
What is a hard market?
When rates and premiums are increasing as a result of less capital in the market
What is a soft market?
When rates and premiums are decreasing in order to attract business
How do insurers tend to balance their investment portfolio?
By investing in a mixture of:
- Interest-bearing investments
- More volatile investments (equities)
What is the main problem with taking the investment income into consideration during pricing?
If claims are larger than expected but the investments underperform then it may cause the insurer financial difficulty
What are the main 3 examples of levies in the UK?
- Financial Services Compensation Scheme
- Motor Insurers’ Bureau
- Mesothelioma Act 2014
What did the Mesothelioma Act 2014 do?
Established a levy on all employers’ liability premiums to fund the Diffuse Mesothelioma Payment Scheme to support those suffering from mesothelioma related illnesses who were unable to trace their employers. They can be awarded 100% of the average claim
What is the purpose of the FSCS levy?
To fund the Financial Services Compensation scheme, who pay claims when the insurer has become insolvent
What is the purpose of the MIB levy?
To fund the Motor Insurers’ Bureau, who seek to pay claims relating to an uninsured or untraced driver
Why would an insurer want a high ROCE?
To make them a more attractive investment and encourage more shareholders to invest, and also to provide a greater return for existing shareholders
(ROCE is Return on Capital Employed)
What is claims inflation?
The increase in costs to settle claims over time
How do equities compare to interest bearing investments?
Equities tend to deliver a high rate of return over the medium to long term but are more volatile in the short to medium term
What is a work transfer arrangement?
The insurer pays the intermediary a percentage of the premium as commission for them taking on more work such as issuing documentation or underwriting with delegated authority
What can work transfer arrangements make it more difficult for an insurer to achieve? Why?
Combined operating ratio
Their expenses are higher so they must write to a lower loss ratio
When are incurred but not reported (INBR) claims particularly important to take into underwriting consideration?
At the end of the underwriting year
Why must insurers with a high degree of volatility take care to ensure they generate higher profits?
To encourage investors and make them a more attractive investment despite the higher risk than less volatile insurers
What impact did the Legal Aid, Sentencing, and Punishment Act 2012 (LASPO) have on loss ratios and why?
A short term reduction in loss ratios, but this has not been continued over the long term
This was due to changes in the ways claims were notified and settled
Which line of business is particularly concerned with long-tail/latent claims?
Employers’ Liability
What is the FSCS levy based on?
The gross direct premium of the insurer
What is the MIB levy based on?
The insurer’s motor claims experience
What are catastrophe claims?
A large number of claims arising from a common event
How can investment income impact an insurer’s rates? What must they be careful of?
They may cut rates to increase competitiveness when returns are good, however they must take care they do not cut them too much in case their investment income decreases
What should insurers account for when pricing risks?
Risk premium (expected claims)
Expenses
Premium taxes + levies
An insurer has a ROCE of 50%. What does this mean?
Their return on capital employed is 50%
Their profit is equal to 50% of the capital employed
In commercial insurance how much brokerage is typical?
It varies, can be 7.5% for a motor fleet up to 25% or even more for some commercial credit policies
Can also vary depending on relationship with insurer and TOBAs
Why must an underwriter ensure their reinsurance costs are equitable?
To avoid higher premiums putting them at a competitive disadvantage
(If their reinsurance is expensive they must charge a higher premium to the insured, who may be discouraged by the higher price and more likely to shop around for a lower premium)
