Economics of the insurance industry part 2

Question 1

Three ways an insurer can increase economic value?

Answer 1

1. Increase the UW margin
2. Reducing the capital intensity ratio
3. Reducing the cost of capitol

Question 2

RoC is approximately the same as its CoC and UW margin, therefore what?

Answer 2

Value neutral

Question 3

How does a high solvency ratio potentially impact an insurer’s economic value?

Answer 3

It reduces economic value due to higher capital holdings, resulting in lower investment returns.

Question 4

Reinsurers have a considerably less balanced portfolio than primary insurers and hence the capital efficiency of their portfolio is likely to be XX than that of a primary insurer and their cost of capital XX.

Answer 4

lower
higher

Question 5

Name three reasons why a reinsurer may be reluctant to use retrocession as a regular risk transfer?

Answer 5

1. The reinsurer may not want to share information about its portfolio with its competitors.
2. If the retrocessionaires default on the risk, the reinsurer is itself exposed to a risk of insolvency.
3. The retrocessionaire may accept a risk once year and not the next. The reinsurer may then need to refuse its own client due to lack of capacity.

Question 6

Give examples as to why risks that are not capital efficient for an insurer may be for a reinsurer. (3)

Answer 6

1. Because reinsurers have different books of business from the reinsured.
2. The reinsurer has a larger portfolio of a particular type of risk and therefore can take advantage of the law of large numbers.
3. The reinsurer has a wider range of risks in its portfolio and can therefore take advantage of the benefits of diversification.

Question 7

Name 5 key functions of reinsurance

Answer 7

1. Risk absorption
2. Catastrophe relief
3. Stability in loss experience
4. Enhancing solvency
5. Risk diversification

Question 8

Benefits of reinsurance for the reinsurer (3)

Answer 8

1. Economies of scale - reinsurers operate on a larger scale and can pool risks from many insurers. Law of large numbers.
2. Specialisation and comparative advantage - allows them to manage risks more effectively as they operate in multiple geographical areas and specialise in managing specific types of risks.
3. Risk pooling and diversification - Reinsurers pool risks from various companies and geographies. Allows them to spread out risk exposure reducing impact of any single cat event.

Question 9

Reinsurance - name three mutual benefits

Answer 9

1. Stabilised market - ensures that insurers can cover large claims, maintains consumer trust and market stability.
2. Profit sharing - insurers can write more policies without assuming excessive risk, while reinsurers earn premiums and potentially profit from well managed risk portfolios.
3. Information and knowledge sharing - Reinsurers possess extensive risk modeling and assessment expertise, which they share with insurers.

Question 10

What is the primary purpose of construction a loss distribution tree in insurance?

1. To categorise types of insurance claim based on sum insured.
2. To assess the probability of various loss scenarios.
3. To analyse historical claims data for trends.
4. To forecast claims.

Answer 10

To forecast claims.

Question 11

What is the main reason an insurance company needs capital?

1. To fund growth and expansion.
2. To invest in financial markets.
3. To cover unexpected large claims.
4. To create value for shareholders.

Answer 11

To cover unexpected large claims.

Question 12

Which of the following is a key financial objective of an insurer? (2)

1. Maximising market share
2. Maintaining a strong solvency ratio.
3. Maximising profit.
4. Maximising economic value.

Answer 12

Maintaining a strong solvency ratio.

Maximising economic value.

Question 13

What does the solvency ratio measure for an insurance company?

1. Capital adequacy in relation to its risks.
2. Profitability compared to competitors.
3. Efficiency of claim settlement processes.
4. Pricing accuracy within the market.

Answer 13

Capital adequacy in relation to its risks.

Question 14

In insurance, what is the economic value primarily driven by?

1. Underwriting profits and investment income
2. Customer retention rates
3. Geographic expansion and diversification of business
4. Effective risk assessment and pricing.

Answer 14

Underwriting profits and investment income.

Question 15

How does maintaining a strong solvency ratio influence an insurer’s economic value? (2)

1. Can be potentially leading to lower overall economic value due to underutilised capital.
2. It enhances the insurer’s reputation and trust, potentially leading to increased demand for business.
3. It decreases the insurer’s market share due to conservative financial practices.
4. It directly increases the insurer’s market share in the industry due to business reputability.

Answer 15

1. Can be potentially leading to lower overall economic value due to underutilised capital.
2. It enhances the insurer’s reputation and trust, potentially leading to increased demand for business.

Question 16

Which factor is essential to be recorded in insurer’s profit and loss account?

1. Sum of all premiums collected.
2. Market share in the industry.
3. Actual claims.
4. Forecasted claims

Answer 16

Forecasted claims

Question 17

What is the ‘cost of capital’ in the context of the insurance industry?

1. The interest paid on borrowed funds.
2. The expense of regulatory compliance.
3. The return required by investors.
4. The operational cost of running the business.

Answer 17

The return required by investors.

Question 18

What is typically considered the minimum regulatory requirement for an insurer?

1. Capital adequacy
2. Return on capital
3. Solvency ratio
4. Minimum value of shares

Answer 18

Capital adequacy

Question 19

What key ratio is most directly improved by an insurer effectively managing its claims and underwriting process?

1. Loss ratio
2. Return on equity
3. Expense ratio
4. Combined ratio

Answer 19

Combined ratio

Question 20

Insurer can increase economic value by:

Increasing the XX - improving the profitability of the business written.

Answer 20

Underwriting margin

Question 21

Insurer can increase economic value by:

Reducing the XX - making the business more capital efficient.

Answer 21

Capital intensity ratio

Question 22

Insurer can increase economic value by:

Reducing the XX - but this increases the risk of not being able to pay its obligations.

Answer 22

Solvency ratio

Question 23

Insurer can increase economic value by:

Reducing the XX - reducing claims volatility and taking more conservative risks

Answer 23

Cost of capital

Question 24

The XX ratio is a critical measure in insurance, representing the proportion of premiums used to cover claims and expenses.

Answer 24

Combined ratio

Question 25

the two basic sources of capital are?

Answer 25

Equity - funds provided by shareholders Debt - money lent by the banks and other lenders.

Question 26

The XX is a fundamental metric in insurance, measuring the ratio of losses to earned premiums.

Answer 26

Loss ratio