Dibra - How Insurers Fail

Question 1

Define insolvency.

Answer 1

Involuntary market exit due to a winding up order issued by a supervisory authority.

Question 2

When is a ‘wind-up’ order issued?

Answer 2

When an insurer is no longer viable:

• CapAv < minCapReq due to unacceptable level of risk in 1 or more categories (IMCO)
• excessive liquidity and insolvency risk

Question 3

Define insolvency risk.

Answer 3

The risk that an insurer does not have sufficient assets to meet policyholder & other obligations.

Question 4

Define liquidity risk.

Answer 4

The risk that a company cannot meet short-term financial demands, usually from an inability to convert assets to cash without loss of capital.

Question 5

Identify EXTERNAL causes of insurer failure. (4)

Answer 5

• U/W cycle, profitability
• catastrophes
• economic & financial market factors
• international exposures

Question 6

Describe economic and financial market factors. The principles and provide examples.

Answer 6

• volatility (not levels), of economic indicators correlates with increased insolvency risk
  Eg: high interest rates alone don’t contribute to insolvency

Question 7

Describe economic and financial market factors (illustrations).

Answer 7

• insurer often operate with U/W loss BUT compensate by investing premiums
• that strategy is riskier when interest rates/investment return rates are volatile

Question 8

Describe economic and financial market factors (equity prices).

Answer 8

Not highly correlated w/ insolvencies in Canada because Canadian companies invest mainly in fixed income securities.

Question 9

Leading proximate causes of insolvency. (4)

Answer 9

• inadequate pricing, deficient loss reserves
• foreign parent
• rapid growth
• alleged fraud

Question 10

Identify INTERNAL causes of insurer failure. (4)

Answer 10

GOVERNANCE & internal controls (breakdown)
NEW entrants (competition & inexperience)
GROWTH - too rapid (higher LRs for new business)
SIZE - too small to absorb losses

Question 11

Describe the Governance internal cause of failure.

Answer 11

Poor strategic decisions, U/Wing due to inadequate internal controls on data integrity

Question 12

Describe the New entrant internal cause of failure.

Answer 12

Competition from established companies, inexperienced management.

Question 13

Describe the Growth internal cause of failure.

Answer 13

• rapid growth correlated WITH deteriorating loss reserves

- growth into areas (with lack of expertise)

Question 14

Describe the Size internal cause of failure.

Answer 14

Small firms are less able to absorb unexpected financial stress.

Question 15

Which insurer has higher insolvency risk?

Answer 15

A smaller, newer, less geographically diversified company that is experiencing rapid growth.

Question 16

Why is it that full wind-up costs are hard to measure?

Answer 16

Aside from UEP and claim costs, there are ancillary costs incurred by regulators, agents, accountants and reinsurers.

Question 17

What is the purpose of the PACICC?

Answer 17

To protect policyholders from undue financial loss in an insolvency.

Question 18

What is the source of funding for the PACICC?

Answer 18

The PACICC is funded through assessments of solvent members companies.

Question 19

Important aspect of insolvency costs.

Answer 19

The treatment of dividends paid to a guarantee fund as a creditor of the estate.

Question 20

Compare the treatment of Liquidated Dividends of the PACICC vs the guarantee funds of the US/UK.

Answer 20

PACICC: Liquidated dividends are returned tot he solvent members
US/UK: Liquidated assets reduce any current or future assessments