Solvency Flashcards
When is an insurer considered solvent?
An insurer is considered solvent if it can meet all its liabilities as and when they fall due with an acceptably high level of probability.
Against what risks does capital provide a cushion?
Capital provides a cushion against the risks of unexpected losses arising from business expansion and fluctuations in the value of assets and liabilities, income, and expenditure, especially in claims and expenses.
Describe the risk management framework in six steps
The risk management framework encompasses six steps: objective setting, risk identification, risk assessment, strategy planning, risk monitoring, and control
Name at least three dimensions of aggregation in which diversification benefits can arise.
Diversification benefits can arise from aggregation in at least three dimensions: among similar risks (for example, within credit risk), across types of risk (for example, across market, credit, and underwriting risk), and across financial en- tities in a group (for example, across an insurer and a bank within a commonly owned group).
How do insurance company transactions with related parties create additional risks?
Insurance company transactions with related parties create additional risks be- cause there is an absence of market discipline, possibly signaling that funds are being employed in areas that will be of benefit to the related parties but not to policyholders.
While capital can mitigate operational risk, what other approaches are available to address operational risk?
While capital can mitigate operational risk, this type of risk also must be ad- dressed through good corporate governance, internal controls, and risk man- agement practices.
When insurers make use of internal models, what should the insurance supervisor do?
When insurers make use of internal models, the insurance supervisor should confirm that models have been developed, are reviewed at all stages of the model by those with appropriate expertise, and produce comparable results with the al- ternative approaches to determining capital in the industry.
What are the possible sources of a company’s founding capital?
A company’s founding capital can come from shareholders (private or govern- ment) or founding policyholders in the case of a mutual
What are the major categories of risk?
The major categories of risk normally used are insurance risk, market risk, credit risk, and operational risk.
What does scenario testing enable insurers to examine?
Scenario testing enables insurers to examine the results of a given course of ac- tion if a limited range of possible future assumptions or events occurs.
How to manage solvency risk to ensure insurers remain solvent under a variety of adverse but reasonably possible future circumstances?
- Scenario test. Does not consider the probability of event
- Develop a stochastic or statistical model of important variables, which incorporate information on how they have varied in the past
What causes the mismatch between models and real life?
- Wrongly specified models. wrong variables or wrong assumptions about stat distribution of the variables their relationships
- Parameter risk. Parameters in the model have not been estimated properly
- Stochastic variability is the uncertainty arises by chance
What is an economic capital
Capital requirement set by board of an insurer, which is needed to protect company against economic losses rather than an amount needed to meet a regulatory requirement
Need of capital: prudential regulator
Prudential regulators and supervisory authorities operate under various mandates that often require them to maintain public confidence in the financial soundness of the institutions they regulate. Such confidence is enhanced if insurers clearly have more than enough capital to ensure their solvency.
Need of capital: owner of capital
owners are likely to want a higher rate of return on the insurer’s capital than is available in the market from investments. This is obviously necessary if there are additional tax costs
Need of capital: policyholders
Policyholders want the certainty that higher levels of capital offer but prefer not to pay the additional premiums to cover the higher profits demanded by the owners of capital. This is one reason for the existence of mutual insurers, in which policyholders provide the capital, thereby reducing this particular problem.
What assumptions are covered in life insurance liabilities
Statistical models of mortality, disability, and perhaps other claim rates broken down by age and sex, often duration since the policies were taken out, and pos- sibly other categories; for disability income claims, assumptions as to the rate of recovery are needed
• Economic assumptions covering interest rates, investment returns, and infla- tion
• Business assumptions as to rates of lapse, surrender, or discontinuation of premiums.
What assumptions are used in non-life insurance liabilities
the economic and business assumptions are of the same sort, but the claim assumptions also cover the following:
• Statistical models of claim rates and the size of claims
• The delay between when claims are incurred and when they are reported and
finally paid.
Examples that regulators require companies to perform their own stress testing
For instance, the Australian Prudential Regulation Authority’s minimum capital requirements for general insurers include risk-based re- quirements for insurance and investment risk and an additional amount for “concen- tration risk.” This is the amount that the insurer estimates to be its “maximum event retention”—the most that the company expects to lose from a single event—after rein- surance recoveries.
What is insurance risk?
Risk that amount of claims will exceed the premiums collected
What is the amount required to cover the particular risk
the greater of the normal amount of risk-based capital and that required to pass the stress test
What is stress tests used for
Stress tests are required to supplement standard regulatory capital requirements and provide an understanding of the ability of an insurer to withstand threats to its solvency.
Should supervisory authorities be concerned about the size of the losses if com- panies become insolvent? For instance, should they make a distinction between a 0.1 percent chance of a loss of 20 percent of the policyholders’ money and a 0.05 percent chance of a loss of 80 percent of the policyholders’ money?
Government policymakers and supervisory authorities may place higher pri- ority on avoiding insolvencies that would require a significant reduction in amounts paid to policyholders, even if such situations are much less likely to occur than insolvencies that would involve less loss to policyholders.
Value-at-Risk methods provide an objective scientific approach to determining capital. True or false?
False. Although VaR models are quantitative, they use historical data and some subjective assumptions to model to the future.
The international standard for determining insurance capital is a probability of ruin of 0.5 percent. True or false?
False. There is so far no quantitative international standard for determining in- surance capital.
It is necessary to measure probabilities of ruin over a year because that is the fre- quency of the insurer’s accounts. True or false?
False. It is often convenient to measure probabilities of ruin over a year because that is the frequency of the insurer’s accounts
Bounded rationality is the term used for the theory that people cannot understand what is really happening in the world. True or false?
False. Bounded rationality is a theory that explains that rules of thumb are devel- oped and used (to save on the costs of developing more detailed understanding) and why they often work.
It is important to measure model risks because they can be much larger than sto- chastic risks. True or false?
False. Model risks are normally larger than stochastic risks, but they cannot be measured.
