Claims Reserving and Capital Flashcards
Importance of accurate reserving
A key requirement of an insurance company is to ensure that it makes appropriate provisions for the eventual cost of claims arising on policies it has written
What factors influence uncertainty over setting appropriate levels of claims reserves?
•Future legislation change retrospectively impacting existing claims
•Future claim payment patterns differing from historical ones
•Claims emerging from long tail business written a long time ago
•Cases of latent exposure being reported (asbestosis)
•Outcome of litigation on existing claims
•Failure to recover reinsurance
•Unanticipated changes in claims inflation
•Unexpected changes to interest rates
Incurred but not reported (IBNR)
To accurately estimate claims value it is also necessary to estimate whether claims are adequately stated. Case estimates for liability claims are likely to understate the total cost for many reasons e.g. some injury claims will develop into high cost claims and it is very difficult to identify which claims will go this way but estimates can be made on a portfolio basis
Projection of paid claims
The simplest reserving method is to extrapolate paid claims forward
Projection of incurred claims
It is expected that this method will be more accurate than just paid claims as it includes more information. It is important to understand what changes have been made to claims handling procedures as changes will impact the result
Loss ratio method
Establishes aggregate reserves for all claims for a type of business based on a loss ratio. Useful for new business areas
Bornhuetter-Ferguson Method
Combination of the loss ratio method and either paid or incurred claims method e.g. 5% claims paid and 95% loss ratio in year 1, 15% claims paid ratio and 85% loss ratio in year2…
AM Best Ratings
A++ to A+ — superior
A to A- — excellent
B++ to B+ — very good
Standard & Poors and Fitch Ratings
AAA — Extremely strong
AA — Very strong
A — Strong
BBB — Good
Moody’s Ratings
AAA — Exceptional
AA — Excellent
A — Good
BAA — Adequate
Insurance company rating process
•Meet the agency & sign a contract
•At least 2 analysts spend a day or two with senior executives
•Exhaustive analysis undertaken over several weeks and additional questions may be required
•Lead analyst recommends a rating to committee of 8 analysts who debate the methods and reasoning
•Committee vote on rating
•Rating provided to insurer who can accept or appeal
•Once agreed a press release is published by the agency
•Agency will then monitor the insurer and carry out an annual review
Why do insurers like to have a financial strength rating?
•Demonstrates to policyholders that a third party has measured the likelihood of them meeting financial commitments
•Allows for comparison between insurers
•Allows extremely strong insurers to charge higher premium as the customer is buying into a stronger company
•Brokers and customers can decide on their risk appetite by choosing the financial rating they prefer for their carriers
Typical analytical framework
Economic and industry risk
Competitive position
Management & corporate strategy
Enterprise risk Management
Operating performance
Investments
Capital adequacy
Liquidity
Financial flexability
What does a risk appetite statement include?
•A statement of the risks that are acceptable for a company to bear
•What risks are not acceptable
•The probability of failure that is deemed acceptable
•The maximum loss that is acceptable for a single incident
•The target level of financial security
•The quality and diversity of investments
PRA - Probability of failure
The probability of failure should not be higher than one in two hundred over a 12 month time scale
What is the risk apetite statement used to set?
Risk acceptance criteria
Investment policy
Reinsurance policy
Other Financial and risk policy statements
Solvency lI — 3 Pillars
- Aims to ensure firms are adequately capitalised with risk based capital
- Imposes higher standards of risk management and governance within a company
- Aims for greater levels of transparency for supervisors and the public
Tier 1 Capital
Company equity and retained earnings. The highest quality capital and must be available to absorb losses on a day to day “going concern” basis
Tier 2 capital
Such as subordinated debt, is a lower form of capital and only required to absorb losses on insolvency
Tier 3 capital
Lowest quality capital and only has limited loss absorbing capacity. It’s unlikely firms will have any significant quantities of tier 3 capital
Solvency Capital Requirement (SCR)
The SCR is the quantity of Capital that is intended to provide protection against unexpected losses over the following year up to the statistical 1 in 200 mark. Most firms calculate based on the standard formula
Minimum Capital Requirements (MCR)
The MCR denotes a level below which policyholders would be exposed to unacceptable risk and is intended to correspond to 85% probability of adequacy over the following year
Supervisory ladder of intervention
•Firm breaches SCR: must consider and action a plan to restore its capital position and/or reduce its risk profile
•Firm breaches MCR: regulatory action is taken and the firm must submit a plan for approval, explaining how it will restore capital above MCR in 3 months. If this isn’t achieved authorisation is removed
Options in case of inadequate capital
• Raise more capital
• Reduce regulatory capital requirement
Stress testing
Firms consider the potential impact of certain adverse circumstances on their business
Reverse stress testing
Stress tests that require a firm to assess scenarios and circumstances that would render the business model unviable
Balanced scorecard
Strategy implementation tool that harnesses multiple internal and external performance metrics in order to balance Financial and strategic goals
Perspectives:
•Internal
•Financial
•Customer
•Learning and growth
