Insurance Flashcards
What is the purpose of insurance companies
The purpose of general insurers is twofold: to meet a need and to make money.
what is General insurance?
General insurance is any type of insurance that is not life insurance. It encompasses a wide range of types of insurance
Insurance companies themselves are subject to?
Policyholders reduce their uncertainty by passing risks to insurance companies. Insurance companies themselves are subject to risk and uncertainty.
Actuaries have traditionally played which roles in general insurance?
Actuaries have traditionally played roles in reserving and setting premiums but have also moved into much wider areas within general insurance. PB page 46
How is Insurers’ profitability is constrained
Insurers’ profitability is constrained by how much the customer is willing to pay, statutory controls on insurers, and competition from other insurance companies.
what are the Major uncertainties in insurance
Major uncertainties in insurance center around how many claims will occur and how much the insurer will have to pay to settle them. Other risks to the insurer include failure to recover fixed expenses, failure of other parties, falls in asset values, and the insurance cycle.
what will influence the insurer’s ability to cope with risks
The size of free reserves will influence the insurer’s ability to cope with risks. Reinsurance cover and investment policy also play a role in the insurer’s ability to cope with risks.
Technical reserves are held to cover the liabilities related to policies that have already been written and may also be called
insurance reserves or insurance provisions.
Which two main categories of liabilities do technical reserves cover:
(a) past liabilities in respect of accidents or losses that have occurred prior to the accounting date and (b) future liabilities in respect of future insurance cover from policies for which premiums have already been received.
Claim characteristics refer to
Claim characteristics refer to the ways in which and the speed with which claims originate, are reported, are settled, and are sometimes reopened.
Reporting delays are the time from
when the event occurs through to the time that the insurance company is notified of the event.
Settlement delays are the period between
Settlement delays are the period between notification to the company and the payment of the claim.
Difference between Short tail claims and long-tail claims
Short tail claims are generally reported and settled quickly by the insurer, while long tail claims take a long time for the insurer to settle.
The outstanding claims reserve is the first of the two main components of technical reserves, and it covers
the estimated reserves needed to settle the claims that the company knows about at the accounting date, incurred but not reported (IBNR) claims, expected increases (or decreases) in estimates for reported claims, additional reserves for claims that might require further payments, and claims handling expenses.
Why might the latest balance sheet of an insurance company (as given in the company
accounts) not give a true indication of the financial strength of the company?
Some judgement is required in setting values for assets and liabilities. So, for example,
when assessing the financial strength of the company a prudent (not realistic) basis may
be used.
Also, the balance sheet is a snapshot at a given moment. Circumstances may have
changed since the date of the balance sheet.
The outstanding claims reserve is one of the two main components of
technical reserves in insurance companies.
The outstanding claims reserve can be split into up to five separate components, which is?
including reserve for outstanding reported claims, reserve for incurred but not reported (IBNR) claims, reserve for incurred but not enough reported (IBNER), reserve for re-opened claims, and reserve for claims handling expenses.
Insurance companies should hold reserves to cover all of these items, even if the reserves are not shown split into these categories.
The reserve for outstanding reported claims is the estimated reserve needed to settle the claims that
that the company knows about at the accounting date.
The reserve for IBNR claims is needed to cover
The reserve for IBNR claims is needed to cover the claim payments for incidents which have happened but have not been reported to the insurance company.
The reserve for IBNER claims is needed to cover
The reserve for IBNER claims is needed to cover expected increases or decreases in estimates for reported claims.
The reserve for re-opened claims is an additional reserve that may be explicitly shown to allow for
The reserve for re-opened claims is an additional reserve that may be explicitly shown to allow for claims that the insurance company treats as being fully settled but might one day require further payments.
The reserve for claims handling expenses is held separately to cover additional expenses incurred
in settling claims in each of the above classes.
The need for outstanding claims reserves arises from
arises from reporting and settlement delays.
which two approaches are used by insurers to estimate the liability for outstanding claims.
Case estimates and statistical techniques
Individual estimates cannot be used for IBNR claims because
because the insurer does not yet know about the claim.
Statistical techniques are more useful for classes of insurance where there are
lots of claims and stability in the numbers and amounts of claims.
There is great uncertainty about the payments an insurer will need to make in respect of outstanding claims, which leads to
uncertainty in profitability and other aspects of the insurer that rely upon estimates for outstanding claims.
Long-tail classes have larger reserves for outstanding claims in relation to premium income, leading to
greater uncertainty.
The technical reserves can be split into two main components. What are they?
Outstanding claims and unexpired risks.
The outstanding claims reserves might be split into two, or perhaps even five
components. What are they?
Outstanding reported and IBNR
or
outstanding reported, IBNR, IBNER re-opened claims and claims handling
expenses.
ST7 Q1.5
Class 1 must be a short-tail class of business (because total claims reserves are
relatively low), with little in the way of reporting delays, eg household contents.
Class 2 is a long-tail class (because the total claims reserves are a much bigger
proportion of premiums), with extensive reporting delays. A class such as employers’
liability is possible, where some illnesses may not emerge for many years which will
make IBNR significant
Technical reserves in insurance include both reserves for claim events that
have already occurred and reserves for policies with unexpired exposure.
The reserves for unexpired exposure are determined by holding a portion of premiums in respect of that exposure, which is known
the Unearned Premium Reserve (UPR).
The UPR is the premiums that have been received which have not yet been
earned
The straight averaging approach to determine the UPR has some weaknesses as it does
not consider that risk and expenses may not be incurred evenly over the period of cover.
Acquisition costs incurred by the insurer at the start of a policy, such as commission paid to the sales outlet, should be allowed for
when setting the reserves in respect of unexpired exposure.
The UPR can be calculated using a formula that takes into account
UPR= proportion of risk unexpired X ( premium - acquisition costs),
The UPR calculated in this way is the net UPR, which does not allow for the acquisition expenses.
The URR would need to cover all the claims and expenses that are expected to be incurred
in the future by the unexpired portion of existing policies.
The URR would need to cover all the claims and expenses that are expected to be incurred
in the future by the unexpired portion of existing policies.
The UPR is generally expected to be bigger than the URR, as premiums are expected
to be big enough to cover the claims and expenses, which is what a profit-seeking insurer would generally want.
In cases where the UPR is greater than the URR, there is no need for the insurer to
keep reserves greater than the UPR for unexpired policies. However, the full UPR is generally held due to the accounting accruals principle.
Holding a reserve equal to the UPR for unexpired policies may result in
in some profit emerging over the coming months from these policies.
However, for policies where the URR is greater than the UPR, the insurer needs to
hold a reserve greater than the UPR to cover the possible future claim events.
These additional reserves are known (again, quite logically) as the additional unexpired
risk reserves (AURR), or the additional reserves (or provision) for unexpired risks.
It should not surprise you that
AURR =URR - UPR (minimum of zero)
State in layman’s terms the key difference between the UPR and the URR. Which of
the two calculations, UPR or URR, is open to most uncertainty?
Whereas UPR is the portion of premium set aside for unexpired risks, the URR is our
estimate of how much we need to cover the claims and expenses from unexpired risks.
The URR is probably open to more uncertainty. (We know what premiums we charged,
but we don’t know what the claims experience will be next year.)
In addition to reserves for outstanding claims and unexpired policies, which other two types of technical reserves can insurance companies may hold
claims equalisation reserves and catastrophe reserves.
Claims equalisation reserves (CER) are used to smooth the profits of an insurance company from year to year. In a good year, profits are transferred to _______, and in a bad year, funds are transferred from the ____ to ________the assessment of profit.
Claims equalisation reserves (CER) are used to smooth the profits of an insurance company from year to year. In a good year, profits are transferred to the CER, and in a bad year, funds are transferred from the CER to increase the assessment of profit.
Insurance companies hold ____ to reduce the volatility of profits over time, as insurance business can be highly volatile due to large fluctuations in _________.
Insurance companies hold CERs to reduce the volatility of profits over time, as insurance business can be highly volatile due to large fluctuations in claims.
______________ are used to cover the losses that might arise from a catastrophic event. These events can be natural or man-made, such as floods, earthquakes, explosions, or oil spillages.
Catastrophe reserves
Catastrophe reserves are contingency reserves held in case of an exceptional event, and insurers do not expect to use them for paying ?
claims.
Holding a large explicit catastrophe reserve can reduce the need for an insurer to hold __________________, which are the excess of assets over liabilities
extensive free reserves
Conversely, insurers that do not hold a catastrophe reserve need to have sufficiently large_________ to cover the possibility of a catastrophic event.
free reserves
What are the two main approaches to estimating outstanding claims? Which of the two
should be used for estimating IBNR? Which of the two is more likely to benefit from
actuarial input?
Solution 1.9
(a) Estimates of individual outstanding reported claims.
(b) Statistical estimation of totals.
Use statistical methods for IBNR.
Actuarial input is more likely to be used in the statistical estimation of totals.
An insurance company that recognises that it has been writing business unprofitably for
the last six months shows just three different types of technical reserve in its accounts.
What do you think they might be? How would your answer change if the question had
said very profitably instead?
Solution 1.10
● Outstanding claims reserves (includes IBNR etc)
● UPR
● AURR (needed because URR expected to exceed UPR as unprofitable)
If the question had said that the company was writing business very profitably, then we
would not have needed an AURR. So the answer would have been:
● Outstanding reported claims reserves
● IBNR
● UPR.
Free reserves are the excess of assets over
technical reserves and are essential for the functioning of an insurance company.
Different expressions are used to refer to the excess of assets over liabilities, such as
free assets, solvency margin, shareholders’ funds, and capital employed.
Solvency margin is a common interpretation of the excess of assets over liabilities and may also be referred to as
the minimum capital requirement or required minimum margin.
The free reserves are important for managing an insurance company, as they determine
the maximum amount of business the company can write and the classes of business it can support.
Free reserves provide a cushion against unexpected adverse results, and policyholders rely on them to ensure that
the insurer can meet claims in the event of a disaster.
Legal requirements may also mandate a minimum level of
free reserves.
Other aspects of the management of a general insurer are also influenced by the size of
the free reserves. What do you think the effect of higher free reserves will be on an
insurer’s:
● reinsurance programme?
● investment strategy?
● pricing policy?
Higher free reserves result in:
● less need for reinsurance
● greater investment freedom, ie scope to mismatch
● greater scope for competitive pricing
Setting appropriate premium rates is crucial for the success of an
an insurance company
which is the major area of actuarial involvement in insurance
Premium rating
Actuaries are interested in the frequency and severity distributions of claims for reserving, ______, and __________
Actuaries are interested in the frequency and severity distributions of claims for reserving, pricing, and capital modeling.
Estimation of claim distributions helps pricing actuaries calculate?
the pure risk premium.
Actuaries model ______claim distributions or find reasonable approximations.
Actuaries model aggregate claim distributions or find reasonable approximations.
Actuaries identify characteristics of policyholders with the greatest impact on risk taken using _________and _________
GLMs and multivariate analyses.
____________ approach calculates the risk premium as the actual cost of claims during a past period, expressed as an annual rate, per unit of exposure.
The burning cost
____________________________approach calculates the risk premium as the expected average claim cost multiplied by the expected average number of claims in the period.
The frequency-severity
Original loss curves are used to derive premium rates when
past claims data is too sparse to derive a credible price using traditional techniques.
A pricing actuary estimates the expected cost of claims based on ?
past data.
Adjustments may be needed to allow for unusually heavy/light experience in the past data, large or exceptional claims and ?
trends in claim experience, inflation, changes in risk and/or cover, environmental factors, and incomplete past data.
Further adjustments are made to arrive at the office premium, including expected reinsurance costs and _____, expense loadings, loadings for profit, and ________
Further adjustments are made to arrive at the office premium, including expected reinsurance costs and recoveries, expense loadings, loadings for profit, and allowance for investment income.
Further adjustments are made for practical considerations such as business objectives, competitive pressures,_______, the insurance cycle, _________, and the use of no-claims discounts.
Further adjustments are made for practical considerations such as business objectives, competitive pressures, brand or customer loyalty, the insurance cycle, market acceptability, and the use of no-claims discounts.
Capital represents
any resources held by the company in excess of its liabilities,
capital modelling helps ensure that
he company has enough capital to meet its obligations with confidence.
Capital modelling also helps allocate capital between
different classes, products, and individual policies.
A capital model typically takes the form of a cashflow model that projects all aspects of a general insurer’s business into the future to assess the company’s ability to meet its financial obligations.
that projects all aspects of a general insurer’s business into the future to assess the company’s ability to meet its financial obligations.
Assumptions that will be required for the model capital modeling include
future premium income, future claims, reserving basis, expenses, investment return, reinsurance arrangements, economic variables, likelihood/cost of catastrophes, insurance cycle, operational losses, tax, and dividends.
A capital model will usually analyze the insurer’s business in detail,
with projections for different classes of business, sources of business, locations, claim types, asset types, asset categories, etc.
Different methods, such as _________and _______, will be used to account for the volatility in the general insurance business, and ___________ will be used to determine confidence levels.
Different methods, such as stress testing and scenario testing, will be used to account for the volatility in the general insurance business, and stochastic models will be used to determine confidence levels.
The modern approach to assessing the level of capital that general insurers are required to hold is to allow for the
inherent riskiness of the insurer’s activities.
The types of risks that may be taken into account in the capital modelling process include
insurance risks, reserving risk, market risk, credit risk, operational risk, liquidity risk, and group risk.
Companies can be rewarded for maintaining a sound risk management policy,
and less risky insurers may require lower capital levels in the model.
Insurance companies need to consider the __________of their liabilities when choosing investments.
nature
Fixed monetary returns are appropriate for liabilities that are in fixed monetary amounts. However, for liabilities that need to be settled in prices applicable at the time of settlement, investments that tend to____________ are desirable.
Fixed monetary returns are appropriate for liabilities that are in fixed monetary amounts. However, for liabilities that need to be settled in prices applicable at the time of settlement, investments that tend to maintain their real value are desirable. (Nature of Liabilities:)
Investments for Insurance Companies: Factors to Consider
Nature of Liabilities:Term of Liabilities:Currency of Liabilities:Uncertainty of Liabilities:Size of Free Reserves:Legislative Influences:Taxation:
Term of Liabilities:
Investments should have similar terms to those of the ________. The appropriate term of investments depends on the classes of business written.
Term of Liabilities:
Investments should have similar terms to those of the liabilities. The appropriate term of investments depends on the classes of business written.
Short-term investments tend to be ________for many liabilities, while long-tail classes of business may _________medium-term and long-term investments.
Short-term investments tend to be appropriate for many liabilities, while long-tail classes of business may require medium-term and long-term investments.
Currency of Liabilities:
In some classes of insurance, insurers may have liabilities in several currencies, hence___?
Assets should be held to match.
Uncertainty of Liabilities:
There is often uncertainty about the amounts that will be necessary to settle claims and the timing of claim payments. Insurance companies must hold a proportion of assets in a liquid form sufficient to__________.
cover this uncertainty.
Size of Free Reserves:
The greater the free reserves (relative to the size of the company), the greater the_____________.
extent to which the investment strategy can be aimed at maximizing returns.
Legislative Influences:
Insurers may be wary of holding too many investments that have___________ values due to the need to maintain ___________ above a particular minimum solvency margin.
Legislative Influences:
Insurers may be wary of holding too many investments that have volatile market values due to the need to maintain free reserves above a particular minimum solvency margin.
Taxation:
why the taxation basis for insurers is relevant to the choice of investment strategy.
Taxation:
Insurers want to maximize their post-tax investment returns, so the taxation basis for insurers is relevant to the choice of investment strategy.
Insurance companies are described as “capital intensive”. Explain why they need so
much capital in relation to payroll, size of premises etc
This is the same as asking why they need large free reserves:
● it may be a legal requirement
● to meet normal fluctuations in claims experience
● to protect against unexpected adverse experience (catastrophes, large claims etc)
● to support and attract new business
● to protect against failure of a third party, eg a reinsurer.
We discuss these ideas in more detail later in the course.
Question 1.14
Which two aspects of an insurance company’s operations will have the most impact on
the company’s investment strategy?
Solution 1.14
● classes of business written, hence nature / term / currency and uncertainty of
liabilities
● size of free reserves.
Profits can be calculated using the following formula: ?
post-tax profits = premiums - claims - expenses + investment return - tax. (Profitability and cashflow
8.1 Basic measure of profits)
When calculating profits, it is important to ensure that figures used for premiums, claims, and expenses are ?
sensible and consistent.
The accruals principle states that?
income and expenditure should accrue over the period to which they relate.
Written premiums refer to _____________, while earned premiums refer to________________________________.
Written premiums refer to the total amount of premium income written in the year, while earned premiums refer to the amount of premium income relating to insurance cover provided during the year.
Written premiums refer to _____________, while earned premiums refer to________________________________.
Written premiums refer to the total amount of premium income written in the year, while earned premiums refer to the amount of premium income relating to insurance cover provided during the year.
Earned premiums are consistent with the accruals concept as they tell us _______________________
how much premium has accrued during the year.
Paid claims refer ____________ while incurred claims refer to _________.
Paid claims refer to the total amount of claim payments made by the insurer during the year, while incurred claims refer to the amount of claims paid plus the increase in the total reserve for outstanding claims.
Claims incurred is consistent with the_______
accruals principle.
When policies are written, the insurer pays commission and other initial expenses, which are referred to as___________
Acquisition Costs.
Acquisition costs for unexpired policies at the accounting date are known as ______________________________
Deferred Acquisition Costs (DAC).
The expenses item needs to be based on an incurred basis, just like ___________
just like premiums and claims
The ________item should be shown as Expenses Incurred, rather than just showing expenses paid.
The expenses item should be shown as Expenses Incurred, rather than just showing expenses paid.
The Underwriting Result, also known as Underwriting Profit, is the ____________
The Underwriting Result, also known as Underwriting Profit, is the excess of earned premiums over claims and expenses.
The formula for calculating the Underwriting Result is: ?
The formula for calculating the Underwriting Result is: Earned premiums - Claims incurred - Expenses incurred = Underwriting result.
The Underwriting Result is based on________
The Underwriting Result is based on the accruals concept.
The Underwriting Result shown in the revenue account of a general insurance company is analogous to
the operating profit of non-insurance companies.
Question 1.16
The following data is available for a general insurance company for an accounting year
(in £ million):
premiums receivable: 165
unearned premium brought forward at 1 January: 75
unearned premium carried forward at 31 December: 83
claims paid: 103
outstanding claims reserve at 1 January: 124
outstanding claims reserve at 31 December: 133
expenses incurred: 31
Produce the revenue account showing the underwriting profit (or loss) for the year
Solution 1.16
Earned premiums 157 ( = + − 165 75 83 or 165 75 − − (83 ) )
Claims incurred 112 ( = + − 103 133 124 or 103 133 124 + − ( ) )
Expenses incurred 31
Underwriting profit 14
Cashflow diagram page 72 A cashflow diagram is a useful tool for understanding the mechanics of________
an insurance operation.
The diagram summarizes the various cashflows that may take place, including _____
premiums, taxes, expenses, commissions, reinsurances, shareholders, technical reserves, free reserves, investments, and claims.
________is the insurance company’s own insurance, where the reinsurer covers part of the risk the insurer has taken on. The insurance company sometimes makes __________ from the _________.
Reinsurance is the insurance company’s own insurance, where the reinsurer covers part of the risk the insurer has taken on. The insurance company sometimes makes reinsurance recoveries from the reinsurer.
The double arrow for investments highlights that
money may be lost on investments as well as being gained.
Shareholders hope to receive dividends, and they may be asked to put more money into the company through
rights issues.
List seven different types of reserve which, when added together, make up the total
technical reserves. Which of these is most likely to be zero, and why?
Solution 1.17
● Outstanding reported claims
● IBNR
● IBNER
● Re-opened claims
● Claim handling expenses
● Unearned premium reserve
● Additional reserve for unexpired risks.
The AURR is most likely to be zero. If it is not zero, it indicates that we think that we
have recently been writing business on unprofitable terms
Question 1.18
What would happen to the post-tax profits of a general insurer if the company decided
to reduce the reserve it had been holding for IBNR by £20 million? Assume tax is
charged at a rate of 30%. Suggest (ie use some imagination and make something up) a
single event which might cause this to happen
Solution 1.18
This year’s pre-tax profits would be increased by £20 million, so assuming that this
goes straight into the assessment of tax, we would pay an extra £6 million tax. Post-tax
profits would be increased by £14 million.
IBNR might be revised downwards if it included a big allowance for claims that might
come through from a particular cause, eg employees claiming against their employers
for back-ache from sitting at desks. If a court case has just gone through in favour of
the employer, then the insurer will give a big sigh of relief and reduce its IBNR
Question 1.19
Complete the following statements by filling in the blanks.
AURR is the _______ of _______ over _____, subject to a _______ of ________.
UPR is the portion of __________ that relates to __________ cover.
Claims incurred is defined as the __________ __________ plus the __________ in
outstanding claims reserves.
The main determinants of the investment strategy will be:
● the __________, __________, __________ and __________ of the __________
● the relative size of the __________ __________.
A reserve used to smooth profits from year to year is called a claims _______ _______.
The excess of __________ premiums over __________ claims and __________ is
called the ________ __________
AURR is the excess of URR over UPR, subject to a minimum of zero.
UPR is the portion of premiums which relates to unexpired cover.
Claims incurred is defined as the claims paid plus the increase in outstanding claims
reserves.
The main determinants of the investment strategy will be:
● the nature, term, currency and uncertainty of the liabilities
● the relative size of the free reserves.
A reserve used to smooth profits from year to year is called a claims equalisation
reserve.
The excess of earned premiums over incurred claims and expenses is called the
underwriting result (or underwriting profit)
Reinsurance is the insurance of
insurance companies.
Insurance companies use __________to reduce risk to themselves.
Insurance companies use reinsurance to reduce risk to themselves.
Reinsurance is useful in situations where ________, such as ____________ or commercial properties.
Reinsurance is useful in situations where the risk is too large for one insurer to take on, such as large industrial or commercial properties.
_______________ or ______________can help insurers to reinsure a portion of the risk that they cannot cope with.
Proportional reinsurance or coinsurance can help insurers to reinsure a portion of the risk that they cannot cope with.
___________occur when insurers have an unbalanced portfolio of risks, such as too much exposure to liability claims or a concentration of policies in a certain geographical area or type of policyholder.
Accumulations of risk
Accumulations of risk can exacerbate the ________
problems of non-independent risks.
Insurers can mitigate the risk of accumulations by
arranging reinsurance to help them cope with the possibility of a catastrophic event occurring.
Question 1.20
Imagine you work for an insurance company specialising in selling travel insurance,
through travel agents, to parties of over 50’s going on skiing holidays in the US.
Give some examples to explain why your company is likely to want to take out some
reinsurance.
Solution 1.20
It depends critically on how wide the cover provided is, but examples of some
potentially scary things, for which reinsurance may help the insurer sleep at night, are:
● One or more whole parties could be affected by the same claim event, eg:
– delayed departure from airport
– no snow on arrival, or other sub-standard holiday features
– plane / coach crash
– avalanche.
● Similarly, if one or more travel agents became bankrupt the insurer might,
conceivably, suffer a large loss from many claims.
● One or more of the skiers may suffer injury, with potentially enormous medical
expense claims, especially with older skiers (complications?) and especially in
the US.
