Odomirok Ch 21: Measurement Tools

Question 1

List 2 reasons measurement tools are very useful:

Answer 1

1. The results of a tool may indicate the need for further investigation (either via evaluation of other tools, or inquiry of management)
2. When multiple tools are used together over a period of several years, they can provide an early warning of “high risk” insurers

Question 2

Limitations of measurement tools

Answer 2

• Each tool only provides one piece of evidence. Therefore do not rely on only one tool
• The tools should not replace an audit. In addition, they do not guarantee that the input data is accurate/ complete. They also do not indicate if the management has implemented good internal management, systems and controls.
• The tools will not uncover fraud

Question 3

The statutory financial statements provides what 2 views of financial health of the insurer:

Answer 3

• Balance sheet strength: ensure that the insurer can pay its claims
• Earnings potential

Question 4

List some financial statements that can be used to assess Loss and LAE reserve adequacy:

Answer 4

• Five year historical data exhibit: shows how losses have developed over time
• Notes to the financial statements: includes management’s discussion about changes in the incurred losses.
• Schedule P, Parts 2-4: provides data to perform tests of reserve adequacy
• Schedule F, Part 3 (& Notes): loss reserves are net of reinsurance, so the reinsurance collectability does have an impact on reserve adequacy.

Question 5

How can the accident year loss & LAE ratios help regulators assess the adequacy of unearned premium reserves:

Answer 5

If ratios exceed 100%, it is possible that the unearned premium is insufficient to cover future losses that will emerge.

Question 6

What factors should the regulators consider regarding the investable assets when considering the balance sheet strength:

Answer 6

• Changes in investable asset values and yields on invested assets should be monitored
• If the insurer generally invests in riskier assets than the industry average, the regulators should assess the effectiveness of their hedging practices

Question 7

What are some early warning signs for future problems in earnings?

Answer 7

-Large growth in WP during a soft market

-Increases in underwriting or other expense
ratios

• Deteriorating loss ratios:
• Increased exposure to catastrophic/ large events:

-Losses on investments/ change in mix of
invested assets/ declining yield on investment
assets:

-Increase in the provision for reinsurance

Question 8

What may large growth in written premium during a soft market (underwriting cycle), as indicated by the Five-Year Historical Data exhibit suggest:

Answer 8

The insurer may be making concessions on rate or commission.

Question 9

Where can a user of the financial statements see deteriorating loss ratios:

Answer 9

Five-Year Historical Data exhibit (calendar year) or Schedule P (accident year).

Question 10

Where can a user of the financial statements see increased exposure to catastrophic/ large events:

Answer 10

Writings by state in Schedule T; or by line of business in the Underwriting & Investment Exhibit. General interrogatories, Part 2 provides details about the probable maximum loss, and the provisions that had been implemented to protect the company against such a loss

Question 11

What do credit rating agencies provide?

Answer 11

• financial strength ratings (FSRs): rating of the insurer’s ability to meet its obligations to the policyholders
• debt/ issuer ratings: measure the insurer’s ability to meet its debt obligations.

**Ratings are based on both qualitative and quantitative measures

Question 12

Name some uses of Financial Strength Ratings for different stakeholders

Answer 12

• Policyholders can refer to them as a guide of the chance that the insurer will be able to pay its claims.
• Directors of corporate policyholders may require the use of highly rated insurers
• The insurers will look at the reinsurer’s FSRs when deciding which companies to cede business to
• Investors may use the information to assist in their decision about whether to invest in the insurer

Question 13

Provide some examples of poor decision making that have lead to insolvencies:

Answer 13

• little or no reinsurance
• insufficient reinsurance for the amount of risk
• very rapid premium growth
• significant adverse development
• inadequate pricing
• serious data problems