Chapter 41: Pricing and insuring risks Flashcards

1
Q

Risk classification

A

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.

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2
Q

Risk classification helps the provider to (2)

A
  • charge a more accurate premium for the risks to be covered

- eliminate unnecessary aspects of contract design and to focus cover

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3
Q

Risk appetite may relate to (2)

A
  • existing exposure to the risk
  • the culture of the individual / company
  • if a company, the structure of the company (eg mutual, proprietary, subsidiary, parent)
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4
Q

3 properties of insurable risk

A
  • 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.
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5
Q

6 Desirable criteria for a risk to be insurable

A
  • 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
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6
Q

Once risks have been adequately classified, a provider needs to decide which risks it is prepared to (3)

A
  • take on and keep
  • take on but lay off through the use of reinsurance or alternative risk transfers
  • refuse
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7
Q

Key principle of pooling risks

A

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.

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8
Q

The factors used in setting premiums

A

rating factors

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9
Q

8 Features of a company that may influence its risk appetite

A
  • 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
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10
Q

Risk efficient system

A

Where there is a good market for risk transfer.

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11
Q

Explain the importance of the policyholder having an interest in the risk

A

The policyholder must have an interest in the claim event NOT HAPPENING and will not (in theory) encourage it to happen.

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12
Q

Explain the importance of the risk being of a “financial and reasonably quantifiable” nature

A

This is so that an insurer is able to assess the risk and set an appropriate premium.

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13
Q

Explain the importance of the risk being “commensurate with the size of the financial loss”

A

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.

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14
Q

For the purposes of life insurance, in which other parties might an individual be deemed to have an insurable interest? (3)

A
  • business partners
  • someone with whom the individual shares joint ownership of a property
  • someone on whom the individual is financially dependent
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15
Q

The principle of pooling risks

A

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)

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16
Q

Explain the importance of risks being independent of each other

A

This is so that there is a spread of risk (ie catastrophes arising from concentrations of risk are avoided) and so that the law of large numbers can apply.

17
Q

Explain the importance of the risk event having a low probability of occurring.

A

If the likelihood of the insured event is too high, the cost of cover, and hence the premium, could be unaffordable.

18
Q

Explain the importance of there being a large number of similar risks which can be pooled

A

This is so that the law of large numbers can apply so that actual experience is likely to be in line with expected experience, and hence uncertainty surrounding claims is reduced.

19
Q

Explain the importance of there being an ultimate limit on the liability undertaken by the insurer

A

This is because an insurer will only have a finite amount of capital with which to absorb risk.
An unlimited liability could cause the insurer to go insolvent.

20
Q

Explain the importance of eliminating moral hazards as far as possible

A

This is because they are difficult to estimate and can be costly to an insurer.