Chapter 23: Reserves and solvency capital requirements

Question 1

List thetypes of reservesassociated withshort-term contracts

Answer 1

unearned premium reserve (UPR):
balance of premiums received in respect of periods of insurance not yet expired

unexpired risk reserve (URR):
reserve for where it is felt that premiums are inadequate to meet future claims and expenses

reserves for claims that have been incurred but not reported
reserves for claims incurred but not enough reported
reserves for claims reported but not assessed, or not recorded
reserves for claims reported but not yet fully settled

equalisation reserve
investment mismatching reserve

Question 2

List thetypes of reservesassociated withlong-term contracts

Answer 2

reserves for in-force business

reserves for claims that have been incurred but not reported
reserves for claims that have been reported but not yet fully settled

option reserves
investment mismatching reserve

Question 3

List the pros and cons usingcase estimatesto calculatereserves

Answer 3

cons:
extremely difficult to check
rely on individual skill and judgement
can be naturally conservative or optimistic

pros:
can be used when statistical methods not suitable
appropriately weighs up the qualitative factors influencing claim amount
only approach that can make use of all known data

Question 4

List examples of statistical methodsto calculatereserves

Answer 4

chain-ladder method (assumption needed for fully run-off period)
BF method
Bootstrapping (used to estimate the variance of a projected reserve)

Question 5

Briefly discuss solvency capital requirements

Answer 5

provides an additional layer of protection to policyholders

by enabling insurer to withstand, often unexpected conditions and continue to meet policyholder liabilities

SCR may be based on a formula, or it may be based on a risk measure

important to consider SCR together with reserving requirements (and vice versa)

Question 6

Describe the passive valuation approach

Answer 6

relatively insensitive to changes in market conditions

valuation basis updated relatively infrequently:
risk that assumptions become outdated leading to reserves becoming less prudent

example of passive approach used to determine value of liabilities :
net premium valuation method

example of passive approach used to determine value of assets:
historical cost or “book value” with amortisation over time

capital requirements likely determined using simplified approach (eg formula)

Question 7

Describe the active valuation approach

Answer 7

based more closely on market conditions:
allows us to assess the impact of market conditions on insurer’s ability to meet its obligations

valuation basis updated relatively frequently:
more relevant, shows more realistic financial position

example of active valuation approach used to determine value of assets/ liabilities:
market-consistent approach

capital requirements likely determined using risk-measure

Question 8

List the steps to determine ultimate loss for each development month using BF method

Answer 8

Step 0: method applies to cumulative claims

Step 1: use ultimate loss ratio (assumption - may be influenced by seasonality of claims) and total premiums earned (both given) to determine total expected claim amounts

Step 2: use development factors to work backwards to determine the outstanding claims for each month, which should be the difference between total expected claim amounts – total expected claim amounts divided by the product of the relevant development factors

Step 3: Ultimate loss for each development month = cumulative claims paid to date + outstanding claims