Chapter 9

Question 0

For regulatory purposes, what kind of debt is not included in an insurer’s capital?

Answer 0

Long-term

Question 1

When do insurers need additional capital?

Answer 1

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

Question 2

What happens if an insurer doesn’t meet RBC standards?

Answer 2

They will be subject to additional monitoring and review by the state

Question 3

Under RBC, when would an insurer be a candidate for seizure.

Answer 3

When measurements are less than 50% of the standard

Question 4

What is the most common way for an insurer to generate capital?

Answer 4

Business operations (underwriting operations and investment income)

Question 5

Besides business operations, which other methods of generating capital do insurers use?

Answer 5

Reevaluating balance sheet values

Reducing dividends

Reducing risk

Question 6

How does an insurer add to capital without taking on more debt?

Answer 6

Net income

Question 7

What are the internal factors underwriting profits are based on?

Answer 7

Rate making
Expense control
Marketing

Question 8

What are the external factors underwriting profits are based on?

Answer 8

Regulation
Competition
Inflation

Question 9

What are the two most significant liabilities from the sale of insurance?

Answer 9

Unearned premium reserve

Loss reserve

Question 10

What effect on income and expenses does decreasing the reserve have?

Answer 10

Lower expenses

Increase income and policyholders surplusaa

Question 11

How does a leaseback transaction work?

Answer 11

Sell at market bureau
Rent from new owner
Cash into equity

Question 12

When would be a good time to use a leaseback transaction.

Answer 12

Building held at historical cost (ex. Built in 1930 for $50,000 and now worth $5 million

Question 13

What happens if a stock insurer reduces dividends?

Answer 13

Stock price and investor confidence may be reduced

Question 14

How do insurers usually reduce risk?

Answer 14

Limit growth
Withdraw from risky lines
Reinsurance (most common)

Question 15

What are an insurers external methods of generating capital?

Answer 15

Issuing stock
Reorganization 
Issuing debt
Catastrophe bonds
Reinsurance

Question 16

What is more expensive? Issuing stock, or debt?

Answer 16

Stock

Question 17

What is a big advantage of issuing stock over debt?

Answer 17

Financial stress isn’t increased because lack of dividends isn’t a default

Question 18

Why would a mutual jnsurer want to demutualize?

Answer 18

To seek external capital.

Question 19

Why is demutualization so difficult?

Answer 19

Stock companies are subject to federal securities laws which are complex.

Can be expensive and time consuming.

Question 20

How is a full demutualization done?

Answer 20

Surplus is distributed to policyholders as stock, cash, or policy enhancements

Contract rights remain but no longer have ownership rights

Question 21

How is a mutual holding company conversion done?

Answer 21

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.

Question 22

What is the main way mutual insurers raise capital?

Answer 22

Issuing bonds

Question 23

What are surplus notes classified as according to SAP?

Answer 23

Surplus

Question 24

What type of reinsurance can increase capital?

Answer 24

Loss portfolio transfer

Question 25

What are LPTs used for?

Answer 25

Withdraw from a segment of business

Question 26

Why does ceding commission provide the insurer with?

Answer 26

Surplus relief

Question 27

What does the ceding commission cover?

Answer 27

Policy acquisition expenses

Question 28

Transfer of insurance risk is the primary goal of reinsurance? What is the secondary?

Answer 28

Surplus relief

Question 29

What are the factors that an insurer looks at when developing a dividend policy?

Answer 29

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)

Question 30

Which factors affect insurance company dividends?

Answer 30

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)

Question 31

Instead of paying dividends, what might an insurer do?

Answer 31

Repurchase its own stock (this provides cash to existing shareholders and reduced future dividend payments)

Invest funds in alternative opportunities (with greater returns)