Chapter 41: Pricing and insuring risks Flashcards
Risk classification
Risk classification is a tool for analysing a portfolio of risks by their risk characteristics, such that each subgroup of risks represents a homogeneous body of risk.
Risk classification helps the provider to (2)
- charge a more accurate premium for the risks to be covered
- eliminate unnecessary aspects of contract design and to focus cover
Risk appetite may relate to (2)
- existing exposure to the risk
- the culture of the individual / company
- if a company, the structure of the company (eg mutual, proprietary, subsidiary, parent)
3 properties of insurable risk
- the policyholder has an interest in the risk
- the risk is of a financial and reasonably quantifiable nature
- the claim amount payable is commensurate with the size of the financial loss.
6 Desirable criteria for a risk to be insurable
- individual risk should be independent
- the probability of the event occurring should be relatively small
- large numbers of similar risks should be pooled to reduce variance
- there should be a limit on ultimate liability undertaken
- moral hazard should be eliminated as far as possible
- there should be sufficient existing data / information in order to quantify risk
Once risks have been adequately classified, a provider needs to decide which risks it is prepared to (3)
- take on and keep
- take on but lay off through the use of reinsurance or alternative risk transfers
- refuse
Key principle of pooling risks
Insurers and reinsurers take on risks in return for a premium because in doing so they can combine or pool many risks together, which means that there is greater certainty in the future payments they are likely to have to make on the occurrence of an insured event.
The factors used in setting premiums
rating factors
8 Features of a company that may influence its risk appetite
- size
- age
- the level of capital available
- existence of a parent company / other guarantees
- the level of regulatory control it is exposed to
- institutional structure (eg mutual / proprietary)
- the previous experience of the board members
- attitude to risk of providers of capital
Risk efficient system
Where there is a good market for risk transfer.
Explain the importance of the policyholder having an interest in the risk
The policyholder must have an interest in the claim event NOT HAPPENING and will not (in theory) encourage it to happen.
Explain the importance of the risk being of a “financial and reasonably quantifiable” nature
This is so that an insurer is able to assess the risk and set an appropriate premium.
Explain the importance of the risk being “commensurate with the size of the financial loss”
If the claim amount is too small, the policyholder is unlikely to deem the insurance worthwhile.
If it is too large, this will encourage fraud and moral hazard.
For the purposes of life insurance, in which other parties might an individual be deemed to have an insurable interest? (3)
- business partners
- someone with whom the individual shares joint ownership of a property
- someone on whom the individual is financially dependent
The principle of pooling risks
Insurers and reinsurers take on risks in return for a premium because in doing so, they combine or pool risks together, meaning there is GREATER CERTAINTY in the future payments they are likely to have to make on the occurrence of an insured event.
(due to the LAW OF LARGE NUMBERS)