Study 1: The Insurance Industry in Canada

Question 1

List the two fundamental principles of insurance.

Answer 1

1. The premiums of the many are used to pay the losses of the few.
2. The premium shall be commensurate with the risk.

Question 2

Why would an insurer spread risk over diverse geographic areas?

Answer 2

Risks spread over a larger geographic area soften the burden of localized disasters on insurers.

Question 3

What is a risk pool?

Answer 3

A risk pool is a syndicate of insurance or reinsurance companies that have organized to underwrite a particular risk or group of similar risks.

Question 4

Explain the Law of Large Numbers.

Answer 4

The Law of Large Numbers is a mathematical premise which states that the degree of certainty in probabilities increases as the number of events increases.

Question 5

Define adverse selection.

Answer 5

Adverse selection is a term that describes the process by which potential policyholders use private knowledge of their own high level of risk when deciding whether or not to buy insurance. You can anticipate that high-risk individuals, if allowed, will but lots of insurance and pay a comparatively high rate of premium. On the other hand, low risk clients might not buy any insurance because the price is too high. In another context, adverse selection also occurs when a broker places its poorer risks with one insurer and its better risks with another.

Question 6

For claims that take a long time to settle, what do we call the period of time between when the claim occurs and its final resolution?

Answer 6

Tail.

Question 7

Name two concerns of Ontario automobile excess reinsurers that relate to the effects of long-tail liabilities.

Answer 7

• the changing judicial interpretations of injuries

- coverage and expected response of the insurance policy

Question 8

List three ways that insurance benefits society.

Answer 8

1. Insurance provides security, confidence, savings, encouragement of investment, and for consumers, reductions in the price of goods.
2. Insurance allows activities to flourish (e.g. banks issue mortgages on insured buildings, retailers accept commercial risk of operating with liability insurance, professionals provide services when able to insure against malpractice liability, etc)
3. Insurance underpins the economy, facilitating economic growth and societal development (also has interdependent relationship with the growth of economy - more projects/business = more insurance required)

Question 9

Why is there a need for residual market mechanisms?

Answer 9

To provide insurance for consumers who are considered high-risk and therefore not attractive to mainstream insurers.

Question 10

In property and casualty insurance, what are the two traditional methods of distribution, and how do they differ?

Answer 10

Independent brokers or agents. Independent brokers solicit insurers and then choose an insurance company to fit the client’s needs, whereas agents also solicit consumers but sell the direct writer’s policies to the client.

Question 11

List three perceived advantages of the direct response method as a distribution channel.

Answer 11

• Professional advice with no commission costs or fees paid to independent brokers
• Technology-enabled sales and services (1-800 telephone service, Internet)
• Extended hours of access for consumers

Question 12

What are four basic functions of reinsurance?

Answer 12

• Financing
• Stabilization
• Capacity
• Resource protection against catastrophes

Question 13

What are seven potential effects of foreign ownership on a property and casualty insurance company operating in Canada?

Answer 13

• Deploying capital
• Divesting certain lines, mergers, acquisitions, and disposals
• Cost of retrocession covers and reinsurance
• Emerging risks
• Setting underwriting philosophies and procedures
• Technology
• Investment markets

Question 14

Describe one obstacle to deploying capital in Canada.

Answer 14

• Complex mark-to-market tax scheme for investments
• Heavy regulatory regime enforced at federal and provincial levels (multiple licenses, labour-intensive filings annually)
• Tax treatment of capital gains, provincial taxes, employer levies for healthcare, employment insurance, Canada pension contributions, etc

Question 15

Identify three effects of mergers within the insurance industry.

Answer 15

• Reduce capacity
• Smaller reinsurance capacity
• Give other reinsurers the opportunity to grow

Question 16

Why did catastrophe reinsurance rates not increase as much as expected after the 1998 ice storm in Ontario and Quebec?

Answer 16

The ice storm was just one of several billion-dollar natural loss events that occur around the world every year.

Question 17

Identify three risks that are likely for an insurer to face over time whether in a mature or emerging market.

Answer 17

• asbestos
• mold
• large natural catastrophes
• products liability
• political risk
• corporate scandals
• environmental liability
• terrorism
• litigiousness
• etc

Question 18

How is a foreign-owned insurer operating in Canada affected when it comes to setting underwriting philosophies and procedures?

Answer 18

Depends on the oversight from the parent company. When supervision is strict, the head office may set the tone for philosophies of its operations worldwide, laying out all major policies such as underwriting procedures. In extreme cases, the foreign-owned insurer may find that they have little or nor control over underwriting decisions - they may find themselves forced to defer to head office before they can rate and bind business. This can make an insurer slow to react to market changes.

Question 19

What are five technologies that may actually provide for more influence by foreign head offices over their Canadian subsidiaries?

Answer 19

• email
• teleconferencing
• video conferencing
• global networking
• electronic databases
• real-time Internet-based information exchange platforms

Question 20

Identify the federal statue that places restrictions on the overall makeup of insurers’ investment portfolios.

Answer 20

Insurance Companies Act of Canada