Prudential Standard FSI 4.3 (Non-life Underwriting Risk Capital Requirement)

Question 1

3 Components of non-life underwriting risk

Answer 1

• Premium and reserve risk
• Lapse risk
• Catastrophe risk

Question 2

Non-life underwriting risk

Answer 2

Risk arising from non-life insurance obligations, such as

• poor claims experience
• expense over-runs
• policy lapses

Question 3

Optional adjustment to non-life underwriting risk

Answer 3

The non-life underwriting risk capital requirement also allows for an optional adjustment to account for the loss-absorbing or amplification capacity of insurance policies that involve an element of risk sharing between one or more parties of the contract.

Question 4

Risk may allow for the risk mitigating effect of eligible risk mitigation instruments, on the condition that…

Answer 4

care is taken not to double-count the impact thereof.

The risk of impairments from counterparty default on such instruments must be taken into account.

Question 5

Premium Risk

Answer 5

Refers to the risk of fluctuations in the 
- timing
- frequency, and
- severity
of insured events.

Includes the risk that premium provisions turn out to be insufficient to compensate claims.

Also includes the risk arising from expense volatility (expense risk).

Relates to insurance policies to be written or renewed during the period, and to unexpired risks on existing policies.

Question 6

Reserve risk

Answer 6

Refers to the risk of fluctuations in the timing and amount of claim settlements.

Question 7

Calculation of earned premium

Answer 7

Earned premium =
unearned premium provisions (brought forward)
+ written premiums
- unearned premium provisions (carried forward)

Earned premiums should be NET of applicable reinsurance.

Earned premiums may allow for expected policy lapse and cancellation rates, subject to such assumptions being consistent with those used in the valuation of technical provisions.

Question 8

Lapse Risk

Answer 8

Non-life insurance policies may include contractual options which influence the obligations arising from them.

Where such contractual options are included in a non-life insurance policy, the calculation of premium provisions must take into account the lapse risk associated with the exercise rates of these options.

Lapse risk is the risk that assumptions regarding the exercise of contractual options are different to those assumed in the valuation of premium provisions.

Question 9

Lapseshock 1

Answer 9

Lapsing of 40% of the in-force insurance policies for which lapsing would result in an INCREASE OF THE TECHNICAL PROVISIONS excluding the risk margin.

Question 10

Lapseshock 2

Answer 10

Decrease of 40% in the number of future insurance policies or reinsurance contracts that are allowed for in the valuation of technical provisions, but not in-force at the valuation date, where this decrease would result in an INCREASE IN TECHNICAL PROVISIONS excluding the risk margin.

Question 11

How should the lapse shocks be applied?

Answer 11

lapseshock 1 and lapseshock 2 must apply uniformly to all insurance policies and reinsurance contracts subject to lapse risk.

In relation to reinsurance contracts, lapseshock 1 must apply to the underlying insurance policies.

For the purpose of determining the change in the value of the Basic Own Funds under lapseshock 1, an insurer must base the shock on the type of lapse which most negatively affects its Basic Own Funds on a per policy basis.

Question 12

Catastrophe risk

Answer 12

The risk of loss, or of adverse change in the value of the insurance obligations, resulting from significant uncertainty of pricing and provisioning assumptions related to extreme or exceptional events.

Catastrophe risk stems from extreme or irregular events that are not sufficiently captured by the capital requirements for premium and reserve risk.

Question 13

2 Methods for calculating non-life catastrophe risk capital requirements under the Standard Formula

Answer 13

1) Standardised scenarios; and/or
2) Factor-based methods

(or a combination of these)

Question 14

When should insurers use Method 2 to calculate its non-life catastrophe risk requirement? (3)

Answer 14

a) Circumstances where the standardised scenarios under Method 1 do not adequately assess the risk profile of their insurance obligations.
b) Exposures outside of South Africa
c) Insurance business classified in the Miscellaneous, Agriculture - Equipment and Agriculture - Other (sub-)lines of business.

Question 15

The catastrophe standardised scenarios under Method 1 are broadly classified into 3 categories

Answer 15

• Natural catastrophes
• Man-made catastrophes
• Catastrophe scenarios specific to inwards non-proportional reinsurance

Question 16

Method 1: Standardised scenarios

4 Natural Catastrophes

Answer 16

Extreme / exceptional events arising from perils such as:

• Windstorm
• Flood and subsidence
• Earthquake
• Hail

Question 17

Method 1: Standardised scenarios

8 Man-made catastrophes

Answer 17

Extreme / exceptional events relating to:

• Motor
• Fire to Property
• Marine
• Aviation
• Liability
• Consumer credit, Trade credit, Guarantees
• Terrorism
• Accident and Health

Question 18

Method 1: Standardised scenarios

How should the capital requirement for natural catastrophes be calculated?

Answer 18

As the maximum loss, net of risk mitigation, resulting from the following scenarios:

• 1-in-200 year single Earthquake event
• 1-in-200 year single Hail event;
• or three distinct 1-in-10 year natural catastrophe events, plus a 1-in-20 year natural catastrophe event in the same year.

Question 19

Method 1: Standardised scenarios

How should the capital requirement for man made catastrophes be calculated?

Answer 19

As the SQUARE ROOT of: 
(
the SUM of  
SQUARED [ 
capital requirements, net of risk mitigation, after allowing for the impairment of the credit taken for risk-mitigation instruments 
]  
)
for events arising from:
- Motor
- Fire to Property
- Marine
- Aviation
- Liability
- Consumer Credit, Trade Credit and Guarantees
- Terrorism
- Accident and Health

Question 20

First-party insurance structures include (3)

Answer 20

• Captive insurers
• First-party cells within a cell captive insurer
• First party contingency policies

Question 21

Simplifications for first-party insurance structures are allowed for, as such structures: (4)

Answer 21

• Only underwrite the risks of their parent companies and operate as an extension of their parents
• Typically have a simple risk structure compared to commercial insurers
• Are limited in size and day-to-day management is normally outsourced
• Generally have the majority of the risks reinsured

Question 22

Optional adjustment for insurance policies with risk sharing features

Answer 22

Adjusts the capital requirement for premium and reserve risk to account for the loss absorbing / amplification effect of insurance policies that involve an element of risk sharing between one or more parties to the contract (e.g. underwriting manager, policyholder, insurer and/or reinsurer).

The adjustment factor will be positive if there is a loss amplification effect and negative if there is a loss-absorbing effect.

Question 23

Calculation of the capital requirement for:

Motor catastrophe risk

Answer 23

The greater loss, net of risk mitigation, after allowing for the impairment of the credit taken for risk mitigation structures, resulting from the following scenarios:

a) A major motor collision in SA
b) A large accumulation of losses of multiple insured vehicles in a single location in SA

Cat = MAX( loss arising from a, loss arising from b),

Question 24

Calculation of the capital requirement for:

Fire catastrophe risk

Answer 24

Either one of the following methods:

1) Calculate the loss (net of risk mitigation) resulting from an insurer’s largest fire concentration; or
2) Calculate the maximum loss (net of risk mitigation) resulting from scenarios that take accumulation of risk into account

Question 25

Calculation of the capital requirement for:

Marine catastrophe risk

Answer 25

The greater loss, net of risk mitigation and excluding salvages, resulting from the following scenarios:

a) A collision between 2 container carriers, where the two container carriers are those where the insurer has the largest gross exposure (including marine cargo & liability)
b) A collision between 2 pleasure crafts or commercial fishing vessels, where the two vessels are those where the insurer has the largest gross exposure for hull and liability cover.
c) A claim from the insurer’s largest gross exposure to marine liability insurance.

Question 26

Calculation of the capital requirement for:

Aviation catastrophe risk

Answer 26

The greatest loss, net of mitigation (after allowing fro counterparty default impairment), resulting from the following scenarios:

a) A mid-air collision between 2 aircraft, where the aricraft vessels are those where the insurer has the largest gross exposure, and where the gross exposure includes 10% of liability exposures
b) The accumulated loss of all aircrafts insured in a single location due to a single event such as an explosion or a collision.

Question 27

To whom does the calculation of a capital requirement for terrorism catastrophe apply? (3)

Answer 27

Only to:

• SASRIA
• Insurers that provide top-up terrorism cover above that insured by SASRIA
• Reinsurers that provide reinsurance for terrorism.

Question 28

Calculation of the capital requirement for:

Terrorism risk

Answer 28

The greatest loss, net of risk mitigation, resulting from the following scenarios:

a) A 1-in-200 year individual loss from a single terrorism event
b) A 1-in-200 year aggregate loss from 2 terrorism events
c) A 1-in-200 year aggregate loss from 3 terrorism events

Question 29

3 Scenarios to be taken into account for
Calculation of the capital requirement for:
Accident and Health catastrophe risk

Answer 29

MASS ACCIDENT SCENARIO:
Mass accident scenario to all individual and group policies providing benefits under the accident and health line of business.

CONCENTRATION SCENARIO
The accident concentration scenario to group policies providing benefits under the accident and health line of business.

PANDEMIC SCENARIO
The pandemic scenario to policies providing benefits due to hospitalisation.