Mildenhall Ch 2: The Insurance Market

Question 1

Define Policyholder Liabilities and provide 2 examples

Answer 1

Any amounts owed to policyholders.

Ex:
1. Loss reserves
2. Unearned Premiums Reserves

Question 2

Define Assets

Answer 2

Total financial resources owned by insurer that can be used to meet policyholder liabilities in exchange for premiums.

Question 3

Define Required Assets

Answer 3

Minimum amount of assets that insurer must hold.

Question 4

Define Intermediaries

Answer 4

Refers to insurance company who acts as intermediary between policyholder and investors.

Never means agent or broker in this textbook.

Question 5

Define Units

Answer 5

Portfolio components

Ex:
1. policy
2. groups of policies
3. LOB

Question 6

Define Aggregate Loss

Answer 6

Sum of losses from insurer’s portfolio over single period.

Premium excludes UW expenses but includes margin for risk.

Question 7

Define contingency provision

Answer 7

The contingency provision is separate from margin and is intended to cover biases in ratemaking.

Question 8

Define Shared Liability

Answer 8

Assets - Expected Loss = Capital + Margin

Liability of financing assets other than expected losses is shared between policyholders and investors.

Question 9

Define Loss Ratio

Answer 9

Loss/Premium

Ratio of Loss to Premium

Question 10

Define Premium Markup

Answer 10

1 / ELR

Inverse of expected loss ratios.

Cat bonds often quote premium markup instead of LR.

Question 11

Define Premium Leverage

Answer 11

Premium / Capital

Ratio of premium to capital

Question 12

Provide 4 characteristics of Thick-tailed LOBs

Answer 12

Losses in thick-tailed portfolio unit have:
1. High coefficient of variation
2. Right-skewed
3. High kurtosis
4. Significant probability of assuming substantial value

Question 13

Define catastrophe model

Answer 13

Computer simulation tool used to estimate potential cat losses from insurance portfolio.

Question 14

Calculate coefficient of variation (CV)

Answer 14

CV = SD / Mean

Question 15

Define Capital

Answer 15

Funds over & above reserves needed to ensure insurers pay for policyholder obligations.

Aka net assets or surplus.

Question 16

Complete the sentence:
Capital is regulated by …

Answer 16

Statute

Question 17

Define Equity

Answer 17

Value of owner’s residual interest.

Question 18

Briefly explain why accounting equity is often lower than capital.

Answer 18

Because debt can be included in capital but not in equity.

Question 19

Briefly explain why accounting equity can be negative but market value is always positive.

Answer 19

Because of limited liabilities in market value.

Question 20

Complete the sentence:
Equity is regulated by …

Answer 20

Equity is NOT regulated

Question 21

Define skewness

Answer 21

Measures asymmetry of loss distribution.

Positive means right tail is longer.

Question 22

Define kurtosis

Answer 22

Describes the tailness of loss distribution.

Higher value means thicker tail.

Question 23

List the 5 monetary variables that control Ins. Co. operations.

Answer 23

1. Expected Loss
2. Premium
3. Assets
4. Margin
5. Capital

Question 24

List the 3 unitless ratios that control Ins. Co. operations

Answer 24

1. Loss Ratio
2. Cost of Capital
3. Leverage

Question 25

Calculate Premium

Answer 25

P = Loss + Margin

Question 26

Calculate Assets

Answer 26

A = P + Q = Premium + Capital = E(X) + M + Q

Question 27

Calculate Cost of Capital

Answer 27

CoC = M/Q = Margin / Capital

Question 28

Calculate Asset Leverage

Answer 28

Assets / Premium = A / P

Question 29

Fully describe the Cfs in a one-period Ins. Co.

Answer 29

Insurers are one-period, limited liability entities with no existing liabilities that come into existence at time t=0.

At t=0, it writes single-period(s) insurance contract(s) & collect premium from insureds. Premiums is fully earned by time t=1 (no UPR).

It raises capital from investors at time t=0 by selling them all or part of its uncertain t=1 residual value.

It pays all claims at time t=1 & gives residual value to investors. If assets are insufficient, it defaults and investors lose original investment.

Question 30

Calculate grown assets at time t=1

Answer 30

a’ = (1+r)a = min(X, a’) - max(0, a’-X)

r is return on assets