Chapter 9 Flashcards
For regulatory purposes, what kind of debt is not included in an insurer’s capital?
Long-term
When do insurers need additional capital?
As they write more policies (to cover unexpected losses)
Replenish policyholders surplus for reductions due to policy acquisition costs
To support expanded sales and marketing
What happens if an insurer doesn’t meet RBC standards?
They will be subject to additional monitoring and review by the state
Under RBC, when would an insurer be a candidate for seizure.
When measurements are less than 50% of the standard
What is the most common way for an insurer to generate capital?
Business operations (underwriting operations and investment income)
Besides business operations, which other methods of generating capital do insurers use?
Reevaluating balance sheet values
Reducing dividends
Reducing risk
How does an insurer add to capital without taking on more debt?
Net income
What are the internal factors underwriting profits are based on?
Rate making
Expense control
Marketing
What are the external factors underwriting profits are based on?
Regulation
Competition
Inflation
What are the two most significant liabilities from the sale of insurance?
Unearned premium reserve
Loss reserve
What effect on income and expenses does decreasing the reserve have?
Lower expenses
Increase income and policyholders surplusaa
How does a leaseback transaction work?
Sell at market bureau
Rent from new owner
Cash into equity
When would be a good time to use a leaseback transaction.
Building held at historical cost (ex. Built in 1930 for $50,000 and now worth $5 million
What happens if a stock insurer reduces dividends?
Stock price and investor confidence may be reduced
How do insurers usually reduce risk?
Limit growth
Withdraw from risky lines
Reinsurance (most common)
What are an insurers external methods of generating capital?
Issuing stock Reorganization Issuing debt Catastrophe bonds Reinsurance
What is more expensive? Issuing stock, or debt?
Stock
What is a big advantage of issuing stock over debt?
Financial stress isn’t increased because lack of dividends isn’t a default
Why would a mutual jnsurer want to demutualize?
To seek external capital.
Why is demutualization so difficult?
Stock companies are subject to federal securities laws which are complex.
Can be expensive and time consuming.
How is a full demutualization done?
Surplus is distributed to policyholders as stock, cash, or policy enhancements
Contract rights remain but no longer have ownership rights
How is a mutual holding company conversion done?
A mutual holding company owns the stock insurer. Then the holding company can sell stock insider shares to raise capital.
Contractual rights are with the stock insurer and other rights are with the holding company.
What is the main way mutual insurers raise capital?
Issuing bonds
What are surplus notes classified as according to SAP?
Surplus
What type of reinsurance can increase capital?
Loss portfolio transfer
What are LPTs used for?
Withdraw from a segment of business
Why does ceding commission provide the insurer with?
Surplus relief
What does the ceding commission cover?
Policy acquisition expenses
Transfer of insurance risk is the primary goal of reinsurance? What is the secondary?
Surplus relief
What are the factors that an insurer looks at when developing a dividend policy?
External sources of capital
Expected returns on company investments. (If shareholders could make more in another investment then dividend should be paid)
Investor attitude toward uncertainty (often prefer current dividends over higher future returns)
Which factors affect insurance company dividends?
Cash flow (unrealized gains generate income but not cash for dividends)
Capital structure (can raise cash by issuing debt/equity or by expanding )
Ownership (mutuals pay dividends to policyholders)
Instead of paying dividends, what might an insurer do?
Repurchase its own stock (this provides cash to existing shareholders and reduced future dividend payments)
Invest funds in alternative opportunities (with greater returns)
