Chapter 4: Market Security Flashcards
Solvency
Having more assets than liabilities
Solvency Equation
Assets >= Paid claims + Unpaid claims + Operating Costs
Solvency Margin
Amount by which assets exceed liabilities
Types of unpaid claims
- Those that are known
- Those that are not
Incurred but not reported figure (IBNR)
additional amount of funds to be reserved to cover unpaid claims
Assets
Items of value/resources that a business owns or controls.
Can be both tangible (building) and intangible (value of goodwill)
Assets in insurance
Premiums and Investment income
Capital
Level of investment in the business
Working Capital
Difference between assets and liabilities in practical terms
Liabilities
Any situation where money is owed elsewhere
Primary insurer liabilities
Claims (paid and outstanding)
- Also includes the costs for reinsurance and the costs for running the business
Liquidity
Ease with which assets can be converted into cash
iliquid assets
Assets which cannot be easily converted into cash
Ratios
Relationship between financial factors which can predict profitability
Loss Ratio
Relationship between premium and claims (paid and outstanding)
Loss ratio <100% indicates profit on a pure loss ratio basis
Combined Ratio
Ratio which compares operating costs as well as claims against premiums and investment income
Solvency II
pan-European solvency regime that operates in the EU
Who does Solvency II apply to
- Insurers
- Reinsurers
- Captives
- Mutuals
With their head office in the EU
Compliance does not just fall to compliance officer
Main aims of Solvency II
- Better regulation
- Deeper integration of the EU market
- Enhanced policyholder protection
- Improved competitiveness of EU insurers
3 Pillars of Solvency II
Quantitative Requirements
Supervisory Review
Disclosure
Quantitative requirements of Solvency II
requires insurers to demonstrate they have adequate financial resources to cover exposure level
Solvency II adds more focus on business risk over insurance related risks
Solvency Capital Requirement (SCR) and Minimum Capital Requirement (MCR)
Solvency Capital Requirement (SCR)
Insurer must keep a certain amount of assets available in excess of liabilities
failure to meet this is a warning sign for regulators
Minimum Capital Requirement
Amount of capital where, if breached, regulators are likely to intervene
Supervisory Review in Solvency II
Every insurer must have a effective risk management system
Internal review process required is OSRA (Own risk and solvency assessment)
Should be carried out on an ongoing basis
Own risk and Solvency Assessment (OSRA)
Internal review of risk management undertaken by insurers
Covers the entirety of the processes and procedures used to assess risks.
Should be done on an ongoing basis
Disclosure in Solvency II
Insurers have to disclose publicly more information now
Examples of business risks faced by an insurer
- Credit/Counterparty risk
- Operational Risk
- Market Risk
- Liquidity Risk
- Enterprise risk
- Group and Capital Risk
Credit/Counterparty risk to insurer
- Premiums not being paid
- Reinsurance claims not being recoverable because the reinsurer is insolvent
Operational risk to insurer
- Risks written or claims settled outside of authority
- Business inoperable due to building damage
- Market systems not available for use
Market risks to insurer
- Investments failing
- Exchange rate losses
Liquidity risk
- Not being able to release investments quick enough
- Cash flow issues
Group and capital risks to Insurers
Large organisations (ones that are syndicates and companies) need to monitor the activity of each division
Enterprise risks to insurers
Enterprise risk management (ERM) covers wider ranging management than impact the entire business
The Solvency II and Insurance (Amendments) (EU EXIT) Regulations 2019
To ensure provisions of solvency II continue to work in UK since leaving the EU
Financial Services and Markets Act 2023
Revokes regulations from 2019 and brings control of industry back to the UK
Government continue to set policy framework
No longer mutual recognition of regulatory systems. UK has to obtain equivalence status from the EU
Goals of the European Insurance and Occupational Pensions Authority (EIOPA)
- Provide better consumer protection
- Ensure high level of regulation and supervision
- Ensure greater harmony across the EU
- Strengthen oversight of cross-border groups
- Promote coordinated EU supervision response
Focus on Stability
FCA and PRA under the Financial Services and Markets Act
- Now have additional objectives to meet to enhance competitiveness and growth of UK financial services sector
Central Fund
Pot of money held centrally by Lloyd’s
Operates as the final link in chain of security
Links in the Lloyd’s chain of security
- Syndicate level assets
- Member’s funds at Lloyd’s (FAL)
- Central Assets
Syndicate level assets (First link)
- Premiums received for business written
- Funds must be held in ways that can be released quickly to pay claims
Member’s Funds at Lloyd’s (FAL) (second link)
- If syndicate funds are inadequate
- Deposited at Lloyd’s by members
- Members can ask for funds up to their limit of liability
- SCR is used to calculate how much is required in support
- Economic Capital Assessment (ECA) uplifts the amount required to ensure sufficient capital
Central assets (Last link)
- by this point insurer would be in liquidation
- last resort
- Ultimate control is with the Council
- Basic rate for existing members is 0.35%
Big 4 rating agencies
- Fitch
- Standard and Poor
- A. M. Best
- Moody’s
Rating agencies
Companies which rate insurers (and reinsurers) publishing their results to the public
Provide risk evaluations
Function of rating agencies in insurance
- Provide wider financial market intelligence
- Provide risk evaluations
- Provide credit ratings
How are ratings made
Consider:
- Ability to pay claims
- Operating performance (quality of management and past profitability)
- Business profile
Different agencies use different scores
Lloyds is rated as a single market place whilst insurers rated singularly
Use of ratings
Use ratings to consider best market to use
Used when considering purchasing reinsurance
Impact of a decrease in insurer rating
- Could happen if an agency concludes the business is not being run with acceptable standards
- may find that they are considered unacceptable as a market and will lose business
- If other market / peers have their ratings reduced at the same time the impact is neutralised
