R 26 Insurance

Question 1

Life Insurance

Answer 1

Term life - provides a specified amount of insurance coverage for a fixed period. No payments are made to the policyholder’s beneficiaries if the policyholder survives the term of the policy.

Endowment life insurance is a subset of term insurance that has a payout at the stated contract maturity. If the policyholder dies before maturity, then there will be a payout at death.

A with-profits endowment policy involves a higher payout assuming the insurance company’s underlying investments perform well.
A unit-linked endowment policy involves the policyholder choosing an investment and having the payout amount linked to the performance of the investment.

Question 2

Employers on behalf of their employees usually arrange group life insurance.

Answer 2

Whole (permanent) life insurance provides a specified amount of insurance coverage for the life of the policyholder so payment will occur upon death, but there is uncertainty as to the timing.
For both term and whole life insurance, it is most common for premiums and the amount of coverage to be fixed for the entire period in question.

Question 3

Annuity contracts are the opposite of life insurance contracts.

Answer 3

In general, an initial lump sum payment is made by the annuitant to the insurance company in return for a stream of future payments from the insurance company to the annuitant for the remainder of life. Some annuities begin immediately while others start an agreed-upon number of years later (e.g., deferred annuities). Some deferred annuities have a guaranteed minimum amount of payments. The funds invested in the annuity will earn investment income; the total amount of the principal and income less the total payments made to the annuitant is equal to the accumulation value. Depending on the terms of the contract, the accumulation value may be withdrawn prematurely but likely with penalties.

Question 4

Risks faced by Insurance companies

Answer 4

Insufficient funds to satisfy policyholders’ claims : mortality risk and catastrophe risk or payouts that continue for longer than expected (e.g., longevity risk).
Poor return (market risk) on investments.
Credit risk in case of counterparty receivables and reinsurance
Operational risk
Moral hazard describes the risk to the insurance company that having insurance will lead the policyholder to act more recklessly than if the policyholder did not have insurance. Mitigations: include deductibles, coinsurance provisions, policy limits.

Adverse selection describes the situation where an insurer is unable to differentiate between a good risk and a bad risk. By charging the same premiums to all policyholders, the insurer may end up insuring more bad risks. Mitigations: initial due diligence and ongoing due diligence

Question 5

ratios

Answer 5

Loss ratio for a given year is the percentage of payouts versus premiums generated.
Expense ratio for a given year is the percentage of expenses versus premiums generated.he largest expenses are usually loss adjustments (e.g., claims investigation and assessing payout amounts) and selling (e.g., broker commissions).
combined ratio is sum of the loss ratio and the expense ratio.

Combined ratio after dividends for a given year is equal to the combined ratio plus the payment of dividends to policyholders as a percentage of premiums
Operating ratio for a given year is the combined ratio (after dividends) less investment income as a percentage of premiums.

Question 6

Mortality & Longevity

Answer 6

Mortality - dying early increases losses for insurance company
Longevity - living longer increases annuity payout 
Hedging: Longevity derivatives are used to hedge longevity risk inherent in annuity contracts and defined benefit pensions.
Longevity bond (or a survivor bond) whereby the bond coupon is set to an amount that is linked to the number of people in a defined population group that are still alive.

Question 7

Capital Requirements for Insurance Companies

Answer 7

No global capital requirements.Solvency II is a set of regulations that is applicable in the EU. there is a minimum capital requirement (MCR) and a solvency capital requirement (SCR):

If capital < SCR, capital must increase above the SCR.
If capital < MCR, business operations may become significantly restricted.
MCR is usually 25% to 45% of SCR.

SCR and MCR are calculated based on the sum of charges for

investment risk (assets), which includes credit and market risk,
underwriting risk (liabilities),
and operational risk. P&C insurance company requires more capital than Life insurance companies

Question 8

In United States, a guaranty system exists for both insurance companies and banks. Insurance companies are regulated at the state level while banks are regulated at the federal level.

Answer 8

For insurance companies, every insurer must be a member of the guaranty association in the state(s) in which it operates. If an insurance company becomes insolvent in a state, each of the other insurance companies must contribute an amount to the state guaranty fund (based on the amount of premium income it earns in that state). The guaranty fund proceeds are distributed to the policyholders of the insolvent company. In some cases, limits may apply on claims and there may be delays in settlement.

In contrast, the guaranty system for banks is a permanent fund to protect depositors and consists of amounts remitted by banks to the Federal Deposit Insurance Corporation (FDIC). No such permanent fund generally exists for insurance companies; therefore, insurance companies must make contributions whenever a default occurs.