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M92 Business and Finance > Chapter 10 - Financial Strength Of Insurance Companies > Flashcards

Chapter 10 - Financial Strength Of Insurance Companies Flashcards

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1
Q

Rating agencies are concerned with the insurance companies ability to pay claims rather than its general…

A

Debt

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2
Q

What are the four main rating agencies?

A

Standard and poor, Moody’s, AM best and Fitch.

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3
Q

All customers buying insurance are essentially buying…

A

A promise.

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4
Q

Who generally relies on rating agencies financial strength ratings when placing business?

A

Commercial customers and brokers

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5
Q

What are some of the reasons insurance companies bother paying a fee to the rating agencies for their services in assessing their financial rating?

A
  • demonstrates to policyholders and other third parties how likely the company is able to pay its claims
  • allows for comparisons between insurers
  • would allow an extremely strong insurer to charge a higher amount e.g AAA rated can charge more than BBB as they can say to customers they are buying into stronger and more secure company.
  • brokers will likely only deal with companies of a certain rating, e.g A- but none less than this.
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6
Q

Standard and poors rating methodology uses a combination of both …

A

Both quantities and qualitative information

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7
Q

The rating process looks at a wide range of information so is what In nature and forming an opinion?

A

Objective

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8
Q

Which areas are part of standard and poors common analytical framework?

A
  • economic and industry risk
  • competitive position
  • management and corporate strategy
  • enterprise risk management
  • operating performance
  • investments
  • capital adequacy
  • liquidity
  • financial flexibility
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9
Q

In regards to standard and poors analytical framework, what is economic and industry risk concerned with?

A

This looks at the environmental framework in which insurance companies operate. Typical points would be to look at the threat of new entrants, volatility of the sector and the potential tail to liabilities or risk of catastrophic losses.

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10
Q

In regards to standard and poors analytical framework, what is competitive position?

A

The profile of the business mix in terms of the competitive strengths and weaknesses. This is particularly relevant in terms of the insurance company’s strategy.

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11
Q

In regards to standard and poors analytical framework, what is management and corporate strategy section?

A

This looks at the quality and credibility of an insurers senior management team. Standard and poor believe that this is one of the most important elements in determining how successful a company will be going forward.

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12
Q

In regards to standard and poors common analytical framework, what is enterprise risk management?

A

ERM is the method by which a company manages risk (both risks that have an upside as well as a Downside.) ERM looks at assessing the frequency and severity of risk, risk mitigation, monitoring and reporting. Some insurers ERM looks at encomic capital model.

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13
Q

In regards to enterprise risk management, standard and poor have said that in the future…

A

Require companies to have an effective ERM to earn the stronger financial strength ratings.

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14
Q

Standard and poor incorporate the results of ERM modelling in their analysis of ….

A

Capital adequacy.

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15
Q

In regards to standard and poors analytical framework, what is looked at in the section, operating performance.

A

This involves looking at the performance ratios, loss ratio, expense ratio, combined ratio, return on equity etc.

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16
Q

In regards to standard and poors analytical framework, what is looked at under the section of investments?

A

They look at how the company’s investment strategy fits in with its liability profile,and to what extent investment results contribute to total company earnings.

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17
Q

In regards to standard and poors analytical framework, what is looked at under capital adequacy?

A

This looks at the quality of the capital required to run the business.

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18
Q

In regards to standard and poors common analytical framework what is looked at in regards to liquidity?

A

The company’s ability to manage cash flows efficiently and easily borrow money if required.

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19
Q

In regards to standard poors analytical framework, what is looked at in regards to financial flexibility?

A

Looks at the insurers potential need for additional capital or liquidity in the future.

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20
Q

All the aspects of standard and poors analytical framework are what in regards to each other and the rating of a company?

A

All analytically Interconnected. They are weighted each differently in regards to the contribution towards a company’s rating. A lot depends on a company’s specific circumstances.

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21
Q

The confidence standard and poor have that a company’s capital is adequate will influence their perception of…

A

A company’s earning stability, it’s ability to grow capital and whether it will be able to meet underlying risks.

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22
Q

What does an AAA rating show?

A

The highest rating. Extremely strong financial security. Perhaps also seen as too cautious.

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23
Q

What does the AA rating show?

A

Very strong financial security - differing only slightly from those rated higher.

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24
Q

What does an A rating show?

A

Strong financial security - somewhat more likely to be affected by adverse business conditions.

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25
Q

What does a BBB rating show?

A

Good financial security - but is more likely to be affected by adverse business conditions.

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26
Q

An insurer related as BB or lower is regarded as…

A

Having vulnerable characteristics that may outweigh its strengths. BB Is better than CC.

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27
Q

What is the “NR” additional term that standard and poor use?

A

Not rated, which implies no opinion.

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28
Q

What does a + or - mean with regards to standard and poors ratings?

A

Shows standing within major rating categories, e,g A-

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29
Q

What is the additional term, credit watch, that standard and poor use?

A

Highlights the potential direction of a rating following short term events causing standard and poor to place the rating under surveillance. Negative means the rating may be lowered, positive means the rating may be raised and developing means that the rating may be raised, lowered, or affirmed.

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30
Q

What is pi under standard and poors additional terms?

A

This means ratings are based off public information and means that there has not been an in depth private meeting with the insurer.

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31
Q

Critics of the credit rating process have commented that…

A

Credit rating agencies do not downgrade companies promptly enough.

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32
Q

Enrons rating remained investment grade four days before…

A

The company went bankrupt

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33
Q

What have academics claims may be a good indicator of deteriorating financial strength and why?

A

Yield spreads. The reason for this is that a yield spread is the difference between a yield on a bond and a benchmark yield. Corporate bonds start to expand as credit quality deteriorates but before a rating downgrade, implying that these may be a good early indicator of deteriorating financial strength.

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34
Q

Do insurance companies and reinsurance companies pay rating agencies to asses their financial strength and ability to pay claims?

A

Yes

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35
Q

What are the steps of the rating process?

A
  • insurance company meets the agency and signs the contract
  • at least two analysts spend a day with the senior executives to understand the insurance company’s business
  • an exhaustive analysis is u ever taken over the next few weeks and may require answers to further questions
  • lead analyst will recommend a rating to a committee of eight analysts who then debate the methods and reasoning.
  • committee will vote on the rating
  • insurance company is then told the rating and can either accept it or appeal and the committee re sits. Once agreed the rating issues a press release which is negotiated with standard and poor prior to issue.
  • the rating agency will then monitor the insurer and carry out an annual review.
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36
Q

An AAA rating may mean that a company is…

A

Over capitalised, which from an investors perspective could mean return on equity is depressed. Investors would earn a higher return on equity if company could deliver same returns using a lower capital base.

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37
Q

Some insurers make public their target financial strength and select a rating of…

A

A or AA

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38
Q

If an insurer is not happy with the rating and withdraws from the rating agency process, the agency can still…

A

Rate the company using publicly available information

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39
Q

There is an overriding regulatory requirement that: “a firm must at all times maintain…

A

Overall financial resources, including capital resources and liquidity resources, which are adequate, both as to the amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due. GENPRU 1.2.26

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40
Q

Who has responsibility for deciding a company’s risk appetite?

A

The board

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41
Q

The risk appetite statement would typically include:

A
  • a statement of the risk that it is acceptable for the company to bear
  • what risk are not acceptable
  • the probability of failure that is deemed to be acceptable and
  • the maximum loss that is acceptable from any one incident
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42
Q

The prudential regulation authority require that the probability of failure should not be…

A

Higher than one chance in a two hundred over a twelve month timescale.

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43
Q

Why would an insurance company target a better chance chance of failing than the PRA’s target minimum?

A

If it wanted for example a stronger financial strength rating

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44
Q

The risk appetite statement would be used by an insurance company to set:

A
  • the risk acceptance criteria
  • an investment policy
  • a reinsurance policy and
  • other financial and risk policy statements
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45
Q

Reinsurance can be used to minimise exposure to risks that a …

A

Company does not want to bear

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46
Q

Insurance companies increasingly use an economic capital model to assist them in a range of decisions such as:

A
  • pricing
  • portfolio target returns
  • reinsurance purchasing
  • investment selection
  • demonstrating capital adequacy
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47
Q

The economic capital model can be used to judge the…

A

Appropriate level of capital to hold

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48
Q

In determining the appropriate level of capital to hold an insurance company will also have regard to maintaining an appropriate buffer in excess of…

A

The regulatory minimum capital requirement

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49
Q

In regards to capital, a balance must be struck between…

A

Having enough capital to minimise breaching the the minimum solvency margin, and not too much capital which could unduly depress the returns on equity available to shareholders.

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50
Q

PRA will review how the board sets and communicates the appropriate level of risk to bear and from this how…

A

The company determines how much capital to hold.

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51
Q

The risk management framework, I.e how a company identities and manages risks within a company, and how the changing nature of risks influences the company’s view on the appropriate level of capital to hold will be looked at by…

A

The PRA

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52
Q

The regulatory requirements have been subject to change in recent years as the EU moves towards having…

A

Uniform updated regulatory requirements in all member countries.

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53
Q

Summary or regulatory requirements table: UK insurers along with those from other EU states were subject to ,any years to the solvency rules set out in the life and non life directives of the…

A

1970’s

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54
Q

Summary of regulatory requirements: the directives of the 1970’s became out of date so were replaced by the EU with a solvency 1 directive specifying a ….

A

Minimum Capital requirement

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55
Q

Summary of regulatory requirements: the MCR is the higher of two amounts: a ????????? (Which is a flat monetary amount designed for very small insurers) and an amount which applies to the Majority of insurers that has to be calculated from the volume and type of business.

A

Base capital resources requirement

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56
Q

Summary of regulatory requirements: an amount that applies to the majority of insurers that has to be calculated from the volume and type of business is the ????????? Or in the case of a life company a ?????????????

A

General insurance capital requirement, but in the case of a life company a long term insurance capital requirement

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57
Q

Summary of regulatory requirements: an extra bit that protects life company’s from market risk is called…

A

Resilience capital requirement

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58
Q

Summary of regulatory requirements: solvency I has been implemented into UK law in the form of an MCR requirement in the PRA handbook in the source book GENPRU. Thus all UK regulated insurers legally must have…

A

Capital at least as large as their MCR

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59
Q

Summary of regulatory requirements: the EU is introducing its solvency II directive with effect from 1 January which will be a risk based replacement for…

A

Solvency I

60
Q

Summary of regulatory requirements: the PRA believes that MCR represents about half as much as capital as is needed by an insurer in the UK marketplace and was not…

A

Prepared to wait until solvency II, so put in place its own more stringent rules.

61
Q

Summary of regulatory requirements: threshold conditions for authorisation that UK insurer must have capital resources that are…

A

Adequate having regard to the size and nature of the business.

62
Q

Summary of regulatory requirements: the PRA specifies that UK insurers must determine a…

A

Capital resources requirement

63
Q

Summary of regulatory requirements: the CRR is the greater of the MCR (I.e must not fall below the EU legal minimum) and a risk based calculation which results in a higher ???????? Which must be met if the insurer is to avoid intervention by the PRA.

A

Enchanted capital requirement

64
Q

Summary of regulatory requirements: the PRA also requires insurers to carry out regular assessments on what firms think their own capital should be. This is known as the…

A

Individual capital assessment

65
Q

Summary of regulatory requirements: once the PRA is in possession of of a firms ECR and ICA calculations, it will decide whether it agrees with the firm. If it does not agree, the PRA may provide its own view. This is called ?????????

A

Individual capital guidance

66
Q

Calculating the individual capital assessment encourages management to take responsibility for the…

A

Needs of its own business rather than rely on externally imposed standards

67
Q

Summary of regulatory requirements: UK authorised insurers are now working to capital requirements that are about twice that of EU counterparts, even those operating in UK market but authorised to do so by EU states. This anomaly is likely to…

A

Continue until 2016 when the EU solvency II directive is implemented.

68
Q

The amount of regulatory capital held by an insurance company is the sum of the equity and long term debt that falls within the PRAs rules to be classified as tier…

A

Tier or or tier 2 capital

69
Q

To ensure that an insurance company doesn’t have too many eggs in one basket…

A

PRA imposes rules on the valuation of assets, there will be specified maximum values for certain types of asset.

70
Q

The equity for regulatory purposes is likely to be lower than…

A

The equity in the published financial statements

71
Q

The PRA terminology for the capital required under the solvency I basis is the minimum capital requirement. The MCR is also known as the required minimum margin. The MCR is defined as being:

A

The higher of a flat figure euro amount (the base capital resource requirement) and an amount calculated using simple business metrics.

72
Q

A base capital resource requirement is specified as a flat monetary figure in the rulebook, which for most companies, will be…

A

€3,500,000

73
Q

As sterling has strengthened compared to the euro, the base capital resource requirement will…

A

Decrease in pound terms

74
Q

The PRA publishes the exchange rate to use when?

A

Once a year at the end of October

75
Q

For non life insurers, what must be calculated?

A

General insurance capital requirement

76
Q

The General insurance capital requirement, for most companies will be the higher of two bases of calculation, these are…

A

Premium based and claim based.

77
Q

There is a rule to the limit the amount of GICR can…

A

Fall in any one year to the percentage by which technical provisions ( the amount set aside for claims together with the unearned premium provision ) have fallen.

78
Q

A non life insurer is required to hold an MCR of the higher of the base capital requirement or its…

A

General insurance capital requirement

79
Q

For most reasonably sized non life insurers, the required solvency on the solvency I basis should come out in the range 15% - …

A

25% of gross premiums, depending on the levels of liability business written and reinsurance in place.

80
Q

The PRA has made it clear that it expects all UK regulated firms (non life and life) to hold capital…

A

Around twice the minimum amounts required under current EU rules under its requirements for adequate financial resources

81
Q

In addition to specifying a general capital adequacy requirement, the PRA also specifies requirements for how a firm should ensure…

A

Capital adequacy, via a risk identification and management process and stress and scenario resting of its risk assessments and, consistent with its approach in other areas, requires the process to be documented.

82
Q

The PRA is using the threshold conditions for UK authorisation to enable it to apply its own, higher risk based standards. In 2005 the former regulator, the FSA introduced the ??? Which is the greater of either ??????

A

Capital resources requirement, which is the greater of either the minimum capital requirement or enhanced capital requirement.

83
Q

The ECR is a risk based regulatory capital requirement based on specific rules and is designed to be about…

A

Twice the MCR.

84
Q

A breach of the MCR triggers a requirement for the firm to provide the PRA with…

A

A plan to restore its financial position above the regulatory minimum and is a cue for further regulatory attention.

85
Q

In addition to the ECR, the PRA has instructed every UK authorised insurer to carry out regular assessments of the amount and quality of capital which in the firms view is adequate for the size and nature of their business. This is called the…

A

Individual capital assessment

86
Q

In regards to individual capital assessment, the PRA does not…

A

Prescribe detail of now these ICAs should be arrived at, but specifies the risk factors firms should consider and the types of assessment they should carry out.

87
Q

The major sources of risks to be considered with regards to individual capital assessment include:

A
  • credit risk
  • market risk
  • liquidity risk
  • operational risk
  • insurance risk
  • concentration risk
  • residual risk
  • securitisation risk
  • business risk
  • interest rate risk
  • pension obligation risk
88
Q

Guidance for ICAs is set out in…

A

INSPRU

89
Q

If an insurance company has an encomic capital model, it is likely to use this to calculate…

A

The individual capital assessment

90
Q

The delay in implementing solvency II has led to the PRA saying that capital models developed for solvency II may be used for the ICA calculation. This is referred to as…

A

ICAS+

91
Q

The PRA will review firms ECRs and ICAs and other available information as part of their ongoing review of firms. Where deemed appropriate they will provide…

A

Individual capital guidance

92
Q

Individual capital guidance is about the PRA advising what level of capital needs to be for a firm. Whilst the ICG is technically only guidance, it will be expected that a firm would notify the PRA if…

A

If it failed to maintain capital equal to ICG under principle 11 - open dealings with the regulator.

93
Q

Where a regulated firm is a member of a larger group of companies, this creates additional risk and issues for the firm and requires adjustments to the capital requirement to the firm viewed on a…

A

Standalone basis

94
Q

As a member of a group, a regulated firm:

A
  • may have access to additional capital (not in its own balance sheet) from other members of the group
  • may increase its risk through intra group trading (e.g risk accumulation, the value of investments in and debts due from other group companies.)
95
Q

Firms that are parts of groups will have specific ????? By the ??????

A

Additional rules by the regulator

96
Q

Stress and scenario testing has for a long time been an important element in assessing whether…

A

Insurance companies have an adequate capital amount.

97
Q

A new requirement is to conduct reverse stress testing which is…

A

Process by which an insurance company identifies and assesses the scenarios most likely to render its business model unviable.

98
Q

A firms business model is described as being unviable at the point when crystallising risks cause…

A

The market to lose confidence in the firm.

99
Q

A consequence of a firms business model being unviable is that…

A

Counter parties and other stakeholders would not be willing to transact with or provide capital to the firm and where relevant, that exciting counter parties may seek to terminate their contracts. Such a point could be reached well before a firms regulatory capital is exhausted.

100
Q

As part of their detailed statistical and financial reporting obligations, all UK authorised insurers are required to report their MCR and ECR calculations how often to the PRA?

A

Annually

101
Q

Firms are not required to hold capital to their…

A

Enhanced capital requirement

102
Q

Although firms are required to maintain adequate financial resources at all times, they do not need to calculate their MCR and ECR on a…

A

Daily basis

103
Q

As calculating ECR and MCR often would be incumbent on management, most firms will generally maintain capital in ????? Because ??????

A

Excess of the regulatory requirement so that except in times of turmoil (e,g catastrophe incidents of major financial market falls), little needs to be done in between annual calculations of the regulatory requirements.

104
Q

Firms that barley have adequate regulatory capital, or only a slight surplus over the requirement, in times of turmoil will need to…

A

Monitor their capital adequacy more frequently

105
Q

Where firms are unable to provide the PRA that they have me or will soon have, access to sufficient capital, the PRA can…

A

Take appreciate enforcement action against the firm

106
Q

If an insurance company breaches its MCR, as a minimum it would be excepted to…

A

File a detailed plan on how it would be expected to rectify the position.

107
Q

If a company has long term debt, it is reasonably like to have covenant in the debt agreement which would require….

A

It to report regulatory breaches to the lender.

108
Q

An alternative to increasing the amount of capital is to..

A

Increase the amount of reinsurance as a substitute.

109
Q

In the case of inadequate regulatory capital there are two basic options:

A
  • raise more regulatory capital.

- reduce the regulatory capital requirement

110
Q

In regards to raising more regulatory capital, the company can…

A
  • issue more shares
  • issue long term debt that meets the requirements for tier 1 or tier 2 regulatory capital and
  • switching out of assets which are not fully allowable for regulatory capital purposes into those that are fully allowable.
111
Q

In regards to reducing the regulatory capital requirement, this could be by means of:

A
  • reducing the volume of business written, particularly in lines which generate a high capital requirement
  • purchasing reinsurance and/or
  • switching out of higher risk areas such as equities, into lower risk ones such as government bonds
112
Q

Solvency II is a fundamental review of…

A

Capital adequacy regime for European insurers and reinsurers

113
Q

Solvency II was originally planned to go ahead by the end of 2012, this was delayed until January 2014, and it is now schedules to go live in…

A

January 2016

114
Q

Solvency II aims to establish a revised set of…

A

EU wide capital requirements, valuation techniques and risk management standard that will replace the current solvency I requirements.

115
Q

It is worth noting that while the essential concepts and objectives driving the individual capital adequacy standards (ICAS) regime are similar to those underlying solvency II, many detailed requirements such as stringent statistical quality tests and rigours standards of model control will differ from those with which…

A

Insurance companies are familiar.

116
Q

The PRA has made it clear that having an effective ????? ????? ??????? Is an integral part of the solvency II requirement.

A

Effective risk management process

117
Q

What is the first pillar of the solvency II regime?

A

Demonstrating adequate financial resources. Applies to al firms and considers requirements including own funds, provisions and calculation of solvency II capital requirements ( the solvency capital requirement and MCR) through either an approved full or partial internal model or the European standard formulae approach.

118
Q

What is the second pillar of the solvency II regime?

A

Demonstrating an adequate system of governance. This includes an effective risk management system and prospective risk identification through the own risk and solvency assessment (ORSA)

119
Q

What is the solvency II supervisory review process?

A

The overall process conducted by the supervisory authority in reviewing the insurance and reinsurance undertakings, ensuring compliance with the directive requirements and identifying those with financial and or organisational weaknesses susceptible to producing higher risks to policyholders.

120
Q

What is the third solvency II pillar called?

A

Public disclose and regulatory reporting requirements

121
Q

Solvency II is being created in accordance with the what four level process?

A

Lamfalussy

122
Q

What is level one of the lamfalussy four level process?

A

Involves developing a European legislative instrument that sets out essential framework principles, including implementing powers for detailed measures at level 2.

123
Q

What is level two of the lamfalussy process?

A

Implementing measures. This involves developing more detailed implementing measures (prepared by the commission following advice from the European insurance and occupational pensions authority (EIOPA) that are needed to implement the level 1 framework legislation.

124
Q

What is level three of the lamfalussy process?

A

Guidance. EIOPA works on joint interpretation recommendations, consistent guidelines and common standards. Additionally, EIOPA undertakes peer reviews and compares regulatory practice to ensure consistent implementation and application.

125
Q

What is the level 4 of the lamfalussy process?

A

Enforcement. More vigorous enforcement action by the commission is underpinned by enhanced cooperation Between member states, regulators and the private sector.

126
Q

The level 1 directive text was adopted by the European Parliament on April 2009 and was endorsed by the council of ministers on May 2009. This was a key step in …

A

The creation of solvency II

127
Q

Insurance companies have been heavily involves in preparing for …

A

Solvency ii

128
Q

In preparing for solvency II, the first step companies have taken is…

A

Specification for the standard model. (Essentially a standard formulaic assessment)

129
Q

The standard model for solvency II has been developed with the results of…

A

Quantified impact study q5 excersise.

130
Q

In 2009 there was fears the the industry that massive….

A

capital increases required.

131
Q

In regards to preparing for solvency II, some companies have rather than a standard model…

A

Planning to use an internal model ( similar to economic capital model ). They will have been informed if they have been considered for approval.

132
Q

In regards to planning for solvency II, companies will now involved in their own risk and…

A

Solvency casement. (ORSA)

133
Q

When deciding the complexity of the modelling that an insurance company requires will be taken by the PRA in a what approach?

A

Proportionate

134
Q

An ORSA will become a requirement in other countries such as USA and medium and larger US firms will be required to…

A

Regularly conduct an ORSA

135
Q

Insurers planning to use an internal model have the pass the use test. The use rest requires…

A

The insurer to demonstrate that their is sufficient discipline in its internal model development and application such that it is widely used and plays and important role in the management of the firm.

136
Q

In addition, approval to use an internal model will require a firm to demonstrate compliance with several other mandated tests and requirements, including…

A

Statistical quality, data, documentation, calibration and profit and loss attribution. Sensitivity, stress and scenario resting also need to be evidenced.

137
Q

The PRAs work with insurance company’s suggest that even the best prepared firms are still…

A

Short of the solvency II standards in at least some of these areas.

138
Q

The EU solvency directive specifies the requirement for which function?

A

Actuarial

139
Q

Currently the PRA requires the use of actuaries in…

A

Life firms

140
Q

Non life companies by the PRA do not currently require actuaries, other than …

A

Lloyd’s where formal actuarial options are required of all syndicates.

141
Q

Actuarial knowledge by the European regulators is seen as …

A

Indispensable to an adequate system of governance.

142
Q

By the EU directive, although actuary compulsory, they do not…

A

Need a formal actuarial qualification, but must be carried out by persons of sufficient Knowledge of actuarial and financial mathematics. And be able to demonstrate relevant experience and expertise.

143
Q

With regards to the EUs requirements for an actuarial function. These Must contribute to the effective implementation of risk management system in particular with respect to design, calibration and build of …

A

Internal model, with feedback loop being used to improve the model.

144
Q

The actuarial function by the requirements of the EU should use the outputs of the …

A

Internal model.

145
Q

An example of an actuary using the outputs of an internal model is…

A

Providing an understanding of its reserve volatility and may well use the internal model to asses the firms technical provisions.

146
Q

An insurance company’s standard and poors credit rating contains a pi component, this indicates…

A

The impact of the relevant yield spread

M92 Business and Finance (10 decks)

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