Background to Insurance (1-6)

Question 1

State the criteria that a risk must meet to be insurable

Answer 1

• the policyholder must have an interest in the risk being insured, to distinguish between insurance and gambling
• a risk must be of a financial and quantifiable nature
• the amount payable must bear some relationship to the financial loss incurred

Question 2

State additional criteria that a risk should ideally meet to be insurable

Answer 2

• individual risk events should be independent of each other
• the probability of the event should be relatively small
• large number of similar risks should be pooled
• there should be an overall limit on the liability undertaken by the insurer
• moral hazards should be eliminated as far as possible
• there should be sufficient statistical data/info to accurately estimate the size and likelihood of a loss occuring

Question 3

Explain why the policy document is important

Answer 3

The policy document sets out the T&Cs under which an insurer is liable to pay insurance claims in specific circumstances and must therefore be carefully worded to cover all possible circumstances under which payment will (and will not) be made.

Question 4

Explain the difference between the policy form and the schedule

Answer 4

Policy forms are normally standard for all personal lines business and small commercial policies, in the sense that an insurer will issue the same wording to all policyholders. Items that vary between policyholders will be included in a schedule.

Question 5

List items that might be included in a policy schedule

Answer 5

• details of vehicle/property/people covered
• excess applied
• any limits to the cover
• exclusions
• time limits
• whether or not any optional covers have been taken
• details of insurance premium paid

Question 6

Outline how policies for large commercial risks differ from those for small commercial risks and personal lines business

Answer 6

Large commercial and London Market risks tend to have policies that are individually made for the particular policyholder, possibly assembled from a library of standard clauses.

Question 7

Explain what exclusions are and why they are applied to insurance policies

Answer 7

Exclusions are clauses in a policy that limit the circumstances in which a claim may be made. Exclusions are used to avoid payment by the insurer in situations where the:
- policyholder is at an advantage through possessing greater personal information about the likelihood of the claim
- claim event is largely under the control of the policyholder
- claim event would be very difficult to verify
- loss occurs as part of the normal course of events (could be considered depreciation)
- probability of a claim is very high
- risk cannot be reasonably estimated
Exclusions are also used where the risk is covered by a third party such as the government (e.g. Terrorism in the UK). Exclusions can be used to reduce the premium for competitive reasons or to make it more appropriate to an individual.

Question 8

List the four general classifications of insurance cover

Answer 8

Liability, property damage, financial loss, fixed benefits.

Question 9

Explain how comprehensive motor insurance policies and household contents insurance policies combine insurance cover types

Answer 9

A typical comprehensive motor insurance policy will provide cover for:
- compensation for personal injury to third parties and damage to their property
- compensation for loss of or damage to the insured’s vehicle
- fixed benefits in the event of defined categories of personal accident to the insured
A typical policy covering household contents will provide cover for the financial loss, property damage and liability of the insured to third parties.

Question 10

Explain what package policies are

Answer 10

Policies for businesses often include all types of cover that the business needs appropriately called package policies.

Question 11

State the typical aim of an insurance policy

Answer 11

Typically, the intention is to provide the insured with money to cover his or her financial loss as a result of an insured event, although policies that provide benefits in kind are also possible.

Question 12

Explain why there is often a degree of choice in determining the exposure measure

Answer 12

In some types of insurance there is a degree of choice as to the measure of exposure, as it will not be immediately obvious which reliable and measurable factor bears the closest relationship to the expected claim amounts.

Question 13

Give four key characteristics of claims

Answer 13

As well as the amount that becomes payable, the claim characteristics refer to the ways in which and speed with which the claims:

• originate
• are notifed
• are settled and paid
• are, on occasion, reopened

Question 14

Explain what rating factors are

Answer 14

Rating factors will be either objectively measurable risk factors or other factors that can be used as reliable proxies for the risk factors.
Where credible exposure and claims data exist, experience rating can be used to take account of residual risk factors.

Question 15

Explain, using examples, how non-independence of exposures leads to risk and how this varies between classes

Answer 15

Some classes of business cause insurers more risk and uncertainty than others because of the nature of the risks involved and the claims that can arise from those risks.
Even within a given rating factor category, exposures can be very variable and dissimilar. The variability is increased where exposures are not independent, as this can lead to an accumulation of risk. For example, if the majority of policyholders in a household insurance portfolio live in a certain area of the country, there will be a disproportionate claim cost if there is a local catastrophe. Motor insurance lends itself to having a reasonable spread of exposures whereas creditor insurance will be heavily linked to the state of the economy and unemployment.

Question 16

Give three examples of how the nature of a risk may change over a policy year

Answer 16

1) Change of fire precautions within a building
2) Change of drivers or location under a motor policy
3) A change in economic conditions under a mortgage indemnity policy

Question 17

Give an example of a situation in which changes in the underlying risk would need to be reported to the insurer and an example in which they would not

Answer 17

In some cases a change in the underlying risk would need to be reported to the insurer by the policyholder. For example, a motor policyholder should inform the insurer if he or she moves house; this is a rating factor. In extreme cases, failure to notify the insurer could make the cover void. Changes in background conditions, such as economic conditions, would not normally need to be notified.

Question 18

Discuss how the cost of claim varies for different classes of business

Answer 18

The cost of claim from any given policy cannot be predetermined (except fixed benefit) and is often very variable. While there will often be a maximum sum insured stated, relatively few claims will be settled for that maximum. For most classes, a large proportion of claims will be for small amounts and there will only be a small number of large claims. The precise distribution will vary greatly between class, in particular between property and bodily injury claims, and also year by year.

Question 19

State the types of probability distribution conventionally used to model the sizes of individual claims in a class of business

Answer 19

Highly skewed distributions with no theoretical upper limit (e.g. lognormal or Pareto distributions)

Question 20

State how the parameters may be derived for the probability distributions applied to claim size and what broad factors affect their shape

Answer 20

Exposures are often too small to yield useful information individually so their experience is aggregated to derive parameters of the claim cost distributions when the risks are homogeneous enough and attritional. The shape of these claim cost distributions depend on risk characteristics demonstrated by different classes of business and the insured’s risk profile, among other factors.

Question 21

Give examples illustrating how different classes of business are affected by inflation in different ways

Answer 21

1) Property insurance responds mostly to the cost of property, and claims will tend to increase in line with general inflation, although repair costs can be linked to earnings.
2) A large proportion of motor claims cost is for the repair of the vehicle and will be affected by the level of earnings since these determine labour costs.
3) Liability classes are often subject to higher levels of inflation, especially on personal injury claims, as there is a trend of more generous compensation in many markets. However, this may arise in steps rather than as a continuous process of inflation, as landmark legal judgments are handed down or legal reform comes into effect.

Question 22

Discuss why there may be delays between the date a claim occurs and the date it is settled and how the extent of such delays varies between bodily injury and property damage claims

Answer 22

Claim delays can arise for various reasons. for example:

• a delay between the incident occurring and the policyholder becoming aware of it
• a delay between the insured becoming aware of the loss and reporting it
• a delay before sufficient details of the incident can be gathered to assess the value of the claim
• a delay until an injured party’s condition stabilises to the extent that assessment of damages is appropriate
• a delay in agreeing the actual value at which the claim is to be settled, and the payment of this amount to the insured

Bodily injury cases tend to have the longest delay tails, owing to the continuous issues of many of the claims involved, often with the need for legal proceedings. This may be worsened by the greater likelihood of latent claims or claims from industrial disease where the delay from event to reporting can be considerable.
By contrast, property damage classes have a much shorter delay tail, and hence in this respect a lower degree of risk, since the losses are more immediately apparent and can usually be valued reasonably accurately by a competent assessor.

Question 23

Explain how accumulations of risk might arise in property and liability [2]

Answer 23

Some classes of business are prone to accumulations of risk. Property classes are prone to catastrophes giving rise to a large aggregate total loss for the insurer. However, such accumulations need not be single incidents (e.g. dry summer may lead to a large number of subsistence claims).
Liability insurance is less susceptible to large single-incident accumulation losses, but a single cause may give rise to a large number of claims. The most obvious example is exposure to asbestos, which has given rise to claims under liability policies that are expected to exceed any single event catastrophes.

Question 24

Explain how fraud affects insurers [2]

Answer 24

Certain classes are more exposed than others to the risk that the insured will make false or invalid claims, or exaggerate the amount claimed following a loss. Often, it will be difficult or uneconomical to check whether the claims are genuine or not. At the extreme, such false claims could include arson and embezzlement. The rate of fraudulent claims has been observed to increase in times of economic stringency.

Question 25

Outline how minimum solvency requirements affect insurers and the purpose of such requirements [2]

Answer 25

General insurers require resources beyond those needed to cover their technical liabilities in respect of the business they have written. The excess of the value of the assets over the value of the liabilities is subject to minimum requirements if a company is to be allowed to continue to trade. The methodology for calculating this minimum is laid down in legislation that varies from one country to another. General insurers regulated in the UK and the EU have the option to calculate the required minimum of excess of assets over liabilities (SCR) using a standard formula or their own internal model. This requirement provides a safety margin against the uncertainty surrounding the ultimate future cost of liabilities and the value of the assets supporting them.

Question 26

Outline the key factors that determine the capital needed by the insurer [2]

Answer 26

``` The longer the tail of the business written the greater the uncertainty and hence, the more capital that will be required. In setting its capital requirements, beyond those specified by law, the general insurer will need to take into account the uncertainty and variability of the business it writes. For an individual CoB, the greater the uncertainty and variability in the future claims experience and run-off of reserves of a class, the larger the capital requirement for that class per unit of premium or reserves. An insurer that writes a variety of classes of business with a good spread of risks is likely to be exposed to less overall volatility than one that writes limited classes of business in limited markets. ```

Question 27

Describe the essential characteristics of liability insurance [1]

Answer 27

The essential characteristics of liability insurance is providing indemnity where the insured, owing to some form of tort (private or civil wrong, such as negligence), is legally liable to pay compensation to a third party.

Question 28

List the main types of liability insurance [3]

Answer 28

- employers liability - third party motor liability - marine and aviation liability - public liability - product liability - professional indemnity / errors and omissions (E&O) liability - directors' and officers' (D&O) liability - environmental liability

Question 29

State how the benefit under liability insurance may be restricted [2]

Answer 29

The extent of any legal liability may depend on prevailing legislation. For marine and aviation liability, international law prevails, depending on which jurisdiction applies and how the contract is worded. For classes such as motor and employers' liability, national laws are likely to apply. The benefit may be restricted by: - a maximum indemnity per claim or per event (this may involve more than one claim), or aggregate maximum per year - an excess

Question 30

Describe the benefits provided by employers' liability insurance [3]

Answer 30

EL insurance indemnifies the insured against the legal liability to compensate an employee or his or her estate for bodily injury, disease or death suffered, owing to the negligence of the employer, in the course of employment. Loss of or damage to employees' property is usually also covered. The benefit can be in the form of regular payments to compensate for disabilities that reduce the employee's ability to work, lump sum payments to compensate for permanent injuries to the employee and benefits under the legal framework. Legal costs will also be covered. Other costs such as care costs can also be included.

Question 31

State how insurance products to compensate employees for incidents occurring in the course of their employment may differ between countries [1]

Answer 31

The most important distinction is between countries that have a system of employers' liability (in which losses must arise from the employers' negligence if they are to form the basis of compensation, e.g. in the UK) and workers' compensation (in which losses merely have to be suffered in the course of employment. e.g. in the US).

Question 32

Describe the benefits provided by motor third party liability insurance [2]

Answer 32

This insurance indemnifies the owner of a motor vehicle against compensation payable to third parties for personal injury or damage to their property. The benefits will include compensation for loss of earnings, hospital costs and damage to property costs, and can be paid in a lump sum or periodically to the injured party. In most countries such cover is compulsory, although precise rules vary, for example in the amount of cover required. The cover provided may or may not be limited to that required by legislation.

Question 33

State the requirements in the UK relating to motor third party liability insurance [2]

Answer 33

Third-party liability cover is required for all motor vehicles in the UK, under the Road Traffic Act 1972. The cover must be unlimited in relation to third party injury claims. For third party property damage claims a minimum level of cover is set out in law.

Question 34

Describe the benefits provided by marine and aviation liability insurance policies [1]

Answer 34

The insured is indemnified against the legal liability to compensate a third party for bodily injury, death or damage to property arising out of operation of the vessel or aircraft. Third parties include, but are not limited to, passengers.

Question 35

Describe the benefits provided under public liability insurance [2]

Answer 35

The insured is indemnified against legal liability for the death or a bodily injury to a third party or for damage to property belonging to a third party, other than those liabilities covered by other liability insurance. There are two main types of cover, namely: - the risk at an insured's own premises (e.g. warehouses) - the risk when work is carried out by the insured away from their own premises (e.g. on a building site)

Question 36

Describe the benefits provided under product liability insurance [1]

Answer 36

This insurance indemnifies the insured against the legal liability for the death or bodily injury to a third party, or for damage to property belonging to a third party, that results from a product fault. This policy will usually also cover legal costs. Some policies will include the cost of recalling faulty products that have not actually caused damage.

Question 37

Describe the benefits provided under professional indemnity insurance [2]

Answer 37

This insurance indemnifies the insured against legal liability for losses resulting from negligence in the provision of a service, for example unsatisfactory medical treatment or incorrect advice from an actuary or solicitor. The insured will be a professional person or firm. Holding professional indemnity insurance is often a legal or regulatory condition of being allowed to practice a profession or may be imposed as a condition by a governing body.

Question 38

Describe the cover provided under D&O liability insurance [1]

Answer 38

D&O insurance indemnifies the insured against the legal liability to compensate third parties owing to any wrongful act of the insured in his or her capacity as a director or officer of a company. The insurance is personal to the director or officer, but is usually bought for him or her by the company.

Question 39

Describe the cover provided under environmental environmental liability insurance [2]

Answer 39

The insured is indemnified against the legal liability to compensate third parties as a result of bodily injury, death and damage to property as a result of unintentional pollution for which the insured is deemed responsible. The cost of cleaning up the pollution and regulatory fines may also be covered. Gradual and sudden environmental pollution will generally both be covered.

Question 40

List the insured perils under employers' liability insurance [2]

Answer 40

- accidents caused by negligence of the employer or by other employees - exposure to harmful substances (e.g. chemicals, coal dust, asbestos) - exposure to harmful working conditions (e.g. loud noises or repetitive strain)

Question 41

Describe the insured perils under marine and aviation liability insurance [2]

Answer 41

- loss of, or damage to, passengers' property, including luggage - bodily injury or death of passengers either while on board the vessel or aircraft or when boarding or leaving the aircraft - bodily injury caused by the vessel or aircraft - damage to property caused by the vessel or aircraft (There will likely be several exclusions including terrorism/war although extensions may be in place to cover these)

Question 42

Describe the insured perils under public liability insurance [1]

Answer 42

Depends on the type of policy. For example, a dog bite may be covered by a household policy, while compensation for injury from a falling object may be covered by a commercial policy held by a builder. In general, the policy will not be restricted to named perils, although some perils may be excluded.

Question 43

Describe the insured perils under product liability insurance [1]

Answer 43

Here the perils depend greatly on the nature of the product being produced, but include: - faulty design - faulty manufacture - faulty packaging - incorrect or misleading instructions

Question 44

Describe the insured perils under professional indemnity insurance [1]

Answer 44

The perils here depend on the profession being insured, for example: - wrong medical diagnosis - error in medical operation - error in actuarial report

Question 45

Describe the insured perils under D&O liability insurance [1]

Answer 45

- allowing a company to continue operating in circumstances when it should have been declared insolvent - any act resulting in the insured being declared unfit for his or her role - allowing false financial statements to be published

Question 46

Describe the insured perils under environmental liability insurance [1]

Answer 46

Any incident causing gradual or sudden environmental pollution

Question 47

State the basis of cover for each of motor third party liability, marine and aviation liability, product liability, professional indemnity, D&O liability and environmental liability [3]

Answer 47

- Motor third party liability - cover is usually provided on a loss-occurring basis. - Marine and aviation liability - policies are likely to be written on a loss-occurring basis. - Product liability - policies are likely to be written on a claims-made basis. - Professional indemnity - usually written on a claims-made basis. - D&O - usually written on a claims-made basis. - Environmental liability - likely to be written on a claims-made basis.

Question 48

State the main measure of exposure used for each of employers' liability and motor third party liability [2]

Answer 48

The main measure of exposure for employers' liability is payroll, or total wage and salary costs. The premium rate for an employer will be agreed when a policy is taken out and a premium will be paid on the basis of the estimated payroll for the year. At the end, an adjustment premium will be paid or refunded. For motor third party liability the measure of exposure is the vehicle-year. In other words, an agreed monetary premium is charged for the insurance of a single car for a year.

Question 49

Discuss possible measure of exposure for marine and aviation liability [2]

Answer 49

- passenger kilometres - passenger voyages - in-service seats - in-service vessels/aircraft - under marine insurance, sum insured, feet drilled and turnover are used when suitable

Question 50

State the most commonly used measure of exposure for each of public liability, product liability, professional indemnity and environmental liability [2]

Answer 50

- Public liability - turnover - Product liability - turnover - Professional indemnity - turnover (or sometimes funds under management) - Environmental liability - number of power stations/amount of energy generated/value of the land

Question 51

Explain why there can be long settlement delays in liability classes [2]

Answer 51

Several issues need to be resolved before a liability can be settled: 1) whether or not there has been a loss 2) whether or not the insured is liable 3) the quantum (amount) of the loss The loss may also be reduced if there is contributory negligence on the part of the victim. If the loss is personal injury, it may take several years before the victim's condition has stabilised and can be assessed for damages. Claim settlement will involve litigation for any claim of significant size, even though most cases are resolved out of court before they go to trial.

Question 52

Describe, using examples, how long reporting delays can arise in liability classes and why it might be unclear which insurer is liable for a given claim [3]

Answer 52

Some liable claims remain undetected for many years and are often referred to as 'latent claims'. This means that a loss may not become evident until many years after it was caused (e.g. mesothelioma from exposure to asbestos where symptoms are usually not evident for at least 20 years). A further complication is that claims may arise over a long period. For example, a storage tank may leak contents into the ground causing pollution for some years before the damage is discovered (or those with mesothelioma were exposed to asbestos for many years before their condition manifested). This means that it may not always be clear which insurer is liable for the loss and often some form of allocation is necessary.

Question 53

Explain why claim development patterns for similar classes can differ significantly between countries [1]

Answer 53

The legal environment has a significant effect on the settlement of claims, and this varies from country to country. Therefore, claims development patterns for similar classes of business may vary significantly between countries.

Question 54

Outline how claim cost distributions for liability classes differ from those for property classes [1]

Answer 54

Claim cost distributions tend to be more widely spread for property classes, and there can be some extremely large individual claims that take many years to settle.

Question 55

Outline how the characteristics of motor liability claims differ from those of other types of liability claims and other types of motor claims [2]

Answer 55

Motor liability claims tend to be more frequent and usually smaller than claims on other liability policies, both for property damage and for bodily injury to third parties. Settlement is often faster than for other types of liability claims, although claims arising from serious bodily injury do typically take several years to settle. Even so, motor liability claims, and particularly bodily injury claims, are significantly longer-tailed than other motor claims. In some jurisdictions, bodily injury claims can be settled as regular payments for life to the victim, rather than lump sum payments.

Question 56

State the underwriting factors considered in assessing an appropriate premium for employers' liability and public liability insurance [3]

Answer 56

``` For EL and PL, the main factor influencing the risk is the type of industry or the occupation of the insured. The underwriting factors are as follows: - type of industry or occupation - exposure and claims experience - location of the workforce - frequency of visitors to the site - the materials handled - the processes involved - safety precautions in place, for example sprinklers in a factory or office - turnover - size of deductible In addition, underwriters should vary the premium according to a general assessment of the risk management standards of the insured. ```

Question 57

State rating factors used for marine and aviation liability insurance [3]

Answer 57

- loss history - type of craft or vessel (as accident rates and types/sizes of claims will vary) for example, jets/turboprop/rotor wing for aircraft - commercial category (commercial/private/military) - satellites and missiles - use of craft or vessel (passenger/cargo/leisure/business) - geographic region (jurisdiction of litigation)

Question 58

State factors affecting the assessment of an appropriate premium for product liability insurance [2]

Answer 58

- the nature of the products produced by the insured - the distribution channel of the product - how much US exposure the product has (in general, product sold in the US show a different (higher) claims distribution and more claims are likely to be made) - its usage Each policy will be underwritten individually, and the underwriter will need to assess the risks arising from a policy subjectively.

Question 59

State factors affecting the assessment of an appropriate premium for professional indemnity insurance [1]

Answer 59

The nature of the profession is an important factor in assessing the level of premium. However, each policy will be underwritten individually, and the underwriter will need to assess the risks arising from a policy subjectively. The risks may also vary between size of professional firm, with sole practitioners presenting a very different risk profile from large professional services firms.

Question 60

State factors affecting the assessment of an appropriate premium for D&O liability insurance [1]

Answer 60

The nature of the company will be an important factor in assessing the level of premium. However, to a certain extent each policy will be underwritten individually, and the underwriter will need to assess the risks arising from a policy subjectively.

Question 61

State factors affecting the assessment of an appropriate premium for environmental liability insurance [2]

Answer 61

Each policy will be underwritten individually, and the underwriter will need to assess the risks arising from a policy subjectively. This will take into account: - the processes carried out by the insured - the likely effect on any accident - the likely cost of clean up - a general assessment of the risk management practices of the insured

Question 62

Describe the main characteristic of property damage insurance [1]

Answer 62

The main characteristic of property damage insurance is indemnifying the policyholder. However, here the indemnity is against loss of or damage to the policyholders' own material property.

Question 63

List the main types of property that can be insured [4]

Answer 63

The main types of property that are subject to such damage are: - residential buildings - commercial and industrial buildings - movable property - land vehicles - marine craft - aircraft - goods in transit - construction - engineering plant and machinery - extended warranty

Question 64

Describe the benefit often paid under property damage insurance [1]

Answer 64

The benefit is usually the amount needed to indemnify the insured against the value of the loss or damage, subject to any limits or excesses.

Question 65

Describe the benefits provided under a household buildings policy [2]

Answer 65

The amount paid under the policy is usually the amount needed to restore it to its previous condition, subject to any excess or deductible. Ancillary costs, such as the provision of temporary accommodation while the insured property is uninhabitable, may also be covered, but are not standard. They also normally include insurance for liabilities arising from the insured property.

Question 66

Explain why household policies are often sold as a package covering both buildings and contents [1]

Answer 66

The separation between the two is sometimes not entirely clear: which fixed items are part of the fabric of the property and which are contents? Tenants are not normally responsible for arranging buildings insurance and will need only contents insurance.

Question 67

Give examples of extensions to cover commonly seen in household policies [1]

Answer 67

- food in freezer spoiled during a power cut - pet insurance (also sold separately) - bicycles and the contents of sheds

Question 68

Describe the benefits provided under property contents cover [2]

Answer 68

The amount paid on a claim can be: - the replacement value (depreciation allowed for) - on a 'new for old' basis, under which the cost of an equivalent brand new item is provided (common in household but not commercial cover) The insurer may retain the right to provide a replacement item rather than provide monetary compensation.

Question 69

Describe the benefit provided under motor property cover [1]

Answer 69

The maximum benefit is the depreciated value of the vehicle. In most cases of damage, the insurer will pay to have the vehicle repaired.

Question 70

Describe the typical term for a construction insurance contract [1]

Answer 70

Large construction projects can take up to five years, and the associated policies will last until the end of the project. Since projects often overrun the policies are usually extendable. A policy for a large construction project may run for a couple of years after completion to cover the late discovery of construction faults.

Question 71

Describe the cover provided under extended warranty insurance [1]

Answer 71

Extended warranty insurance covers losses arising from the need to replace or repair faulty parts in a product beyond the manufacturer's normal warranty period. Policies may have a term of several years.

Question 72

State the insured perils for household buildings insurance [2]

Answer 72

Fire is the principal peril insured against but policies can cover explosions, lightning, theft, storm and flood. Subsidence and damage to building following measures to put out a fire are often also covered.

Question 73

State the insured perils for commercial buildings insurance [1]

Answer 73

Also referred to as 'fire insurance', but covers other perils as well such as weather related losses and malicious damage.

Question 74

State the insured perils for household contents insurance [1]

Answer 74

Fire and theft. Malicious damage and damage arising from weather related events are also usually covered. Accidental damage is often provided as an optional extra.

Question 75

State the insured perils for insurance of each of motor property, marine and aviation property, goods in transit, construction and engineering [3]

Answer 75

- Motor property - accidental or malicious damage, fire and theft - Marine and aviation property - perils of the seas, fire, explosion, jettison, piracy, sinking, damage, etc. - Goods in transit - damage, loss and theft - Construction - damage, destruction, design defect, faulty parts and failure to finish a construction project - Engineering - machinery breakdown, explosion and electronic failure

Question 76

List types of marine property insurance, other than marine hull and marine cargo [2]

Answer 76

- energy (offshore. onshore and construction) - liability (third party property) - specie (more valuable items in transit) - war

Question 77

Describe the measure of exposure to which premiums are related for household property [2]

Answer 77

Usually exposure is measured in sum insured years (sum for which a property is insured multiplied by the period at risk). The sum insured should be the cost of rebuilding the property should it be destroyed, including clearing away debris.

Question 78

Discuss the measure of exposure to which premiums are related for commercial property [4]

Answer 78

The measure of exposure is usually the sum insured year. However, the sum insured year is complicated for two reasons: 1) the amounts of stock held may vary significantly over the period of the insurance. Hence, the stock may be covered on a declaration basis, determined retrospectively with an adjustment premium. 2) There is no standard way for allowing for inflation in the policy. Hence, policies with different types of inflation treatment need to be considered separately to determine the exposure.

Question 79

Discuss the measure of exposure to which premiums are related for motor property insurance [1]

Answer 79

For motor property, vehicle miles would probably be the best measure of exposure for damage claims, as the chance of an accident depends on the extent that the vehicle is used. However, it will be difficult to validate miles traveled as stated by the proposer. Therefore the measure used is usually vehicle-year.

Question 80

Discuss the measure of exposure to which premiums are related for insurance of each of marine and aviation property, goods in transit, construction, engineering and extended warranty [3]

Answer 80

- Marine and aviation property - insured value of the hull/cargo - Goods in transit - the consignment value - Construction - the value of the contract - Engineering - the sum insured value or value of the contract - Extended warranty - the number of appliances, or appliance-years

Question 81

Describe the incidence of risk throughout the contract for engineering and construction insurance and how this affects the ratings process [2]

Answer 81

For both engineering and construction, the risk is not uniform throughout the timeline of the project. For example, if a site is destroyed by a storm at the start of the project, little may be lost. During the rating process, the risk profile will be taken into account and a percentage rate will be loaded for this, before it is applied to the exposure measure.

Question 82

In general terms explain how the characteristics of property claims differ from those of liability claims [1]

Answer 82

Property claims are generally reported and paid quicker than liability claims. Losses arise from incidents that are observed at the time and the value of the loss is usually straightforward to establish.

Question 83

Describe the claims characteristics of household and commercial property insurance [4]

Answer 83

The event giving rise to a claim for damage to buildings or contents usually occurs suddenly (fire/burglary) and the cause is easily determinable. Notification is then made promptly and a reasonably good estimate for the claim amount can be made promptly. Settlement is in many cases made by a single payment but can take longer and may be settled with intermediate payments. Delays may be greater in commercial properties as time may be taken to verify the value of the stock held. Domestic properties will tend to be fairly consistent in claim size with a small number of larger total loss claims and occasional liability losses. Commercial property claims tend to have a more scattered cost distribution. These classes are the ones most exposed to moral hazard. They also house potential catastrophe risk.

Question 84

Describe reporting and settlement delays for motor property insurance [1]

Answer 84

Claims for damage to the insured's vehicle are usually reported and settled quickly

Question 85

Describe the claims characteristics of marine and aviation property insurance [3]

Answer 85

- claims are usually reported as soon as the vessel reaches a major port and reporting delays may be very long after initial occurrence of the incident - settlement delays might be long if there is a dispute over legal liability or the amount that should be paid - minor damage is often repaired when the vessel goes into dock for routine maintenance - claims amounts can vary from relatively small amounts for minor hull damage to small vessels to large amounts in respect of the complete loss of large vessels or its cargo

Question 86

Describe the claims characteristics for goods in transit, construction and engineering, and extended warranty insurance [4]

Answer 86

- Goods in transit - potential reporting delays if claims are not reported until the vessel reaches its destination - Construction and engineering - property claims generally reported and settled quickly (liability claims longer). However, the claims from a single underwriting year can take many years to emerge because of the long term nature of the policies and the fact that policies are often multi-year. It may be hard to determine the date of loss for a construction policy. - Extended warranty - claim costs are fairly uniform by product. Where repairs are covered, there is a risk of multiple repairs being needed in the warranty period of a single product. Claims can arise as a proportion of good sold are faulty, which may be stable, or because of a defective product design which would add some volatility to the reporting pattern.

Question 87

Describe the risk factors for household property insurance, and list common ratings factors [4]

Answer 87

A measure of the scale of risk (for example the amount of the sum insured) is the key risk factor. The remaining principal risk factor is location. Common ratings factor include: sum insured, number of rooms, location, use of excesses, whether the property is used for business, whether the property is owned of rented by the policyholder, if the property is normally unoccupied during the day, house/flat etc. , standard of construction, age of building, type of locks/alarms.

Question 88

Describe the risk and rating factors for commercial property insurance [2]

Answer 88

Apart from the monetary value of the property and the surveyor's report of the property, the trade or business is the the key risk factor. Common ratings factors include: estimated maximum loss, age of building, fire protection equipment, construction type, excesses, location of the building, hazardous materials.

Question 89

Describe the risk and rating factors for motor property insurance [6]

Answer 89

``` Motor insurance is a good example of a class of insurance where possible risk factors can be identified, but it is generally difficult to regard them as meeting the criteria needed to use them as ratings factors. Possible risk factors: number of miles driven, ability of driver, average speed, theft risk, ease of damage and cost of repair. However, these are generally not measurable/quantifiable risks and the policyholder has the potential to stretch the truth in their favour. ``` Type of cover and policy excesses are the most important rating factors. Other rating factors are proxies for those risk factors for which direct information is unreliable. These include: use of vehicle, age of vehicle, occupation of policyholder, any additional drivers, gender of main driver, age of drivers, make and model of vehicle, extent of any custom modification to the vehicle, location, where the vehicle is kept overnight. However, now the use of telematics is allowing insurers to assess the drivers behaviour and key risk factors through the use of a black box.

Question 90

Describe the risk and rating factors for marine and aviation property insurance [2]

Answer 90

Risk factors - size, type and age of the craft or vessel along with the nature of the cargo. There are no definitive rating factors. Factors used may well depend on the rating factors deemed appropriate for any associated marine liability cover.

Question 91

List the main rating factors for goods in transit insurance [2]

Answer 91

- mode of transport - nature of goods - type of storage used (for example refrigerated) - time period of transit/number of transit stages - length of time spent at warehouse

Question 92

List the main rating factors for construction and engineering insurance [1]

Answer 92

- type of project - term of project - contracting firm - materials and technologies used - location of project

Question 93

List the main rating factors for extended warranty insurance [1]

Answer 93

- make and model of item being covered - length of the manufacturers guarantee - term of the warranty

Question 94

List the five categories of financial loss insurance [2]

Answer 94

Financial loss insurance can be categorised as follows: - fidelity guarantee - credit insurance - creditor insurance - business interruption cover, a.k.a. consequential loss - legal expense cover

Question 95

Describe the benefits provided under fidelity guarantee [2]

Answer 95

Fidelity guarantee covers the insured against the financial losses caused by dishonest actions of its employees (fraud or embezzlement). These will include loss of money or goods owned by the insured and reasonable fees incurred in establishing the size of the loss.

Question 96

Describe the benefits provided under credit insurance [2]

Answer 96

Credit insurance covers a creditor against the risk that debtors will not pay their obligations. The principal types are trade credit and mortgage indemnity. Trade credit may cover uncollectible debts and be sold on an annual basis. Mortgage indemnity covers the lender in a mortgage loan against the risk of the borrower defaulting and the value of the property on which the loan is secured not being sufficient to repay the loan.

Question 97

Describe the benefits provided under creditor insurance [2]

Answer 97

Creditor insurance provides cover to insureds who are subject to obligations to repay credit advances or debt. Most policies are made to individuals to cover personal loans, mortgage loans or credit card debts. The cover is usually against disability or unemployment - in this case, the policy will pay the loan payments until the borrower has recovered/found work or until the loan is repaid or the maximum number of repayments made.

Question 98

Describe the benefits provided under business interruption cover [2]

Answer 98

Business interruption cover indemnifies the insured against losses made as a result of not being able to conduct business. A fixed sum insured per day will normally be specified in the policy. There is usually a minimum period before a claim can be made.

Question 99

Describe the benefits provided under legal expense cover [2]

Answer 99

Legal expense cover indemnifies the insured against legal expenses incurred (the payments to legal representatives) as a result of: - legal proceedings being initiated against the insured - the need for the insured to initiate proceedings

Question 100

State the insured perils under financial loss insurance [3]

Answer 100

This will depend on the precise cover but may include: - dishonest actions by employees (fidelity guarantee) - failure of third parties specified in the policy (credit) - accident or sickness resulting in loss of income (creditor) - fire at the insured's own property (business interruption) - fire at neighbouring premises causing a loss of access to own property - legal proceedings being brought against the insured (legal expense cover)

Question 101

State the measure of exposure to which premium is related for each type of financial loss insurance [3]

Answer 101

- Fidelity guarantee and credit insurance - depends on the precise cover provided (mortgage indemnity could be excess divided by value of property) - Creditor insurance - total loan amount (or total loan amount repayable) - Business interruption cover - annual profit or turnover of the firm - Legal expense cover - the number of policyholders/policyholder-years

Question 102

Describe the claim characteristics of financial loss insurance [4]

Answer 102

Financial loss insurance covers a wide variety of risks that can give rise to a financial loss. In general, these risks tend to be short tailed, even if the policies concerned have relatively long terms for general insurance. - Credit insurance - depends heavily on economic factors - Creditor insurance - normally a series of payments made until the insured recovers of the limit on the payments is breached. The frequency depends on factors such an unemployment rates / sickness rates. - Business interruption cover - the reporting delays are directly associated to any associated property claim. Settlement is likely to be slower than property claims owing to the greater need for verification.

Question 103

Describe the risk and ratings factors for financial loss insurance [6]

Answer 103

TBC

Question 104

Describe general insurance products where the benefits are fixed [4]

Answer 104

Fixed benefit claims arise under personal accident insurance. Benefits are usually specified fixed amounts in the event that the insured party suffers the loss of one or more limbs or other specified injury, or accidental death. An individual is usually to assumed to have unlimited financial interest in his or her own life, and this may be extended to personal injury, although the insurer should take care to avoid moral hazard by granting large sums insured for relatively minor injuries. Policies such as these are often sold as units of sum insured; for example, a unit might be £25,000 and the policyholder might select a number of units to be covered, up to a maximum. Other fixed benefits cover includes fixed amounts per day in periods of disability usually after a waiting period.

Question 105

State the insured perils and measure of exposure to which premiums are related for personal accident insurance [2]

Answer 105

The perils are any form of accident that results in the loss of limbs or other specified injury. For personal accident insurance the true measure of exposure is the person-year multiplied by the sum insured. For group policies, the number of people covered may need to be adjusted at year-end and the premium adjusted in line with their risk characteristics.

Question 106

Describe the claim characteristics of personal accident insurance [3]

Answer 106

Claims are usually reported quickly. The incidence of an event is usually very clear (reducing reporting delays) although with accidental death claims the insured's dependents may not always know the policy exists and may discover their entitlement after the extended period. The claims may be settled quickly, although sometimes you may have to wait for a claimants permanent disability to stabalise. As the claim cost is known, settlement delays are reduced. The claim frequency tends to be reasonably stable.

Question 107

Describe the risk and rating factors for personal accident insurance [2]

Answer 107

Apart from sum insured, the prime factor affecting the risk is usually occupation. Those following hazardous hobbies may also have a higher risk than average. Gender may be a factor (note current European regulations ban gender being used as a rating factor). The rating factors are the same as the risk factors because they can all be measured.

Question 108

Describe how covers may be combined under a motor policy [1]

Answer 108

It is common for motor liability cover and cover for damage to the vehicle to be provided in a single policy. In the UK, a motor policy that provides cover for liability and damage to the vehicle from all perils including accident is known as 'comprehensive'.

Question 109

Suggest what combination of covers might be found in a commercial property policy [1]

Answer 109

Small business are conventionally covered by 'package' policies, which include buildings, contents and liability insurance. They may also include business interruption.

Question 110

Explain how construction risks are typically insured [1]

Answer 110

Construction risks are typically insured under a contractors' all risks (CAR) policy. This will include the contractor's liability for losses caused to third parties.

Question 111

Describe the cover provided by cyber insurance [3]

Answer 111

The insurer will indemnify the insured against losses incurred as a result of a specified cyber or data loss event. This may include legal expenses. Cover includes both liability and intellectual property losses for businesses that hold sensitive customer data, use computer systems to conduct their business, or have a website. Policies are likely to be individually underwritten to reflect the individual needs of the policyholders.

Question 112

State the main exposure measures of cyber insurance [1]

Answer 112

Company revenue for business interruption related cover or the value of IT equipment at risk

Question 113

State the underwriting factors for cyber insurance [2]

Answer 113

The premium rate will depend on a number of factors, including the: - IT maturity of the insured - dependence of the revenue on IT - industry sector Given the fast paced nature at which the cyber risk landscape is evolving, coupled with the lack of ability to assess the IT maturity of each insured, underwriters are increasingly using cyber security firms' data and software to access the potential for a cyber attack on the insured.

Question 114

Describe the common insured perils for cyber insurance [3]

Answer 114

- virus damage - hacker attack - infringement of intellectual property - slander or libel - online identity fraud - personal data or privacy issues (e.g. loss of or disclosure of private data) - losses relating to breaches or actions by suppliers or business partners

Question 115

List and describe briefly the traditional sources / providers of general insurance and reinsurance [7]

Answer 115

The general insurance market is very diverse. World-wide, general insurance is provided by insurance companies and Lloyd's Syndicates. A corporate entity may also manage its self-insurance through a captive. Cover is also sometimes provided by government as insurer of last resort. In turn, insurance providers will wish to obtain reinsurance (e.g. from the London Market, from Lloyd's, from specialist reinsurance companies, from other direct insurers, from capital markets, or from a combination). Direct insurance companies (as opposed to reinsurers) provide insurance for individuals and companies and can be divided into the following three groups: 1. Composite insurance companies (write general and life) 2. (Pure) general insurance companies that write many classes of GI 3. Insurance companies that specialise in writing business in a selection of classes of general insurance Most insurance companies are proprietary companies limited by shares. However, some mutual insurance companies do exist, they are more common in some markets than others.

Question 116

Define the London Market and it's participants [6]

Answer 116

The London Market is that part of the insurance market in which insurance and reinsurance business is carried out on a face-to-face basis in the City of London. The London Market concentrates mainly on providing insurance and reinsurance cover to companies. It specialises in: - the larger direct insurance risks - both property and liability - that are beyond the capability of other direct insurance companies (for example, energy and aerospace risks) - international risks - reinsurance The participants in the London Market would include: - Lloyd's syndicates - UK subsidiaries or branches of overseas insurance or reinsurance companies - the reinsurance departments of UK composite companies, or reinsurance subsidiaries of such - small professional reinsurance companies set up by (or acquired by) large broking firms for the specific purpose of transacting London Market business - captives - P&I clubs - companies owned by a group of insurance or reinsurance companies Lloyd's does also provide motor insurance and some other personal lines cover.

Question 117

Define a captive and state the reasons for setting up a captive [6]

Answer 117

A captive insurance company is an insurer that is wholly owned by an industrial or commercial enterprise and set up with the primary purpose of insuring the parent or associated group companies and retaining premiums and risk within the enterprise. (The term "captive insurance company" is sometimes used to describe an insurance company set up to sell insurance to the parent's customers - although this is not technically correct). The usual reasons for setting up captives include the following: - to fill gaps in insurance cover that may not be available from the traditional insurance market - to manage the total insurance spend of large companies or groups of companies - to enable the enterprise to buy cover directly from the reinsurance market rather than from direct insurers - to focus effort on risk management - to gain tax and other legislative or regulatory advantages (captives are usually set up in a location that facilitates this advantage) In addition to accepting the risks of their parent companies, captives may also accept external risks on a commercial basis. In some territories, this is necessary in order for insurance premium paid by the parent to be tax-deductible.

Question 118

Describe P&I Clubs [3]

Answer 118

P&I Clubs are mutual associations of ship owners tha twere originally formed to cover certain types of marine risks (mainly liability), that could not be covered (at an acceptable price) under a commercial marine policy. Today, they can be found in the commercial market, but due to technical expertise, P&I Clubs still provide a significant proportion of the world's coverage against marine liability claims. In addition to insurance, they also provide technical assistance and advice on issues relating to the shipping industry.

Question 119

Describe the function of a pool [2]

Answer 119

A pool is an arrangement under which the parties agree to share premiums and losses for specific insurance classes or types of cover in agreed proportions. Specific pooling arrangements are particularly used where the risks are very large (e.g. atomic risks) or through mutual associations that cater for an industry. The critical difference between insuring with a conventional insurer and insuring with a pool is that the insured's liability to an insurer is limited to the premium charged, whereas the liability to a pool will be related to the insured's share of the total claims and other costs that arise.

Question 120

Explain, with examples, how insurance markets around the world vary [7]

Answer 120

All insurance markets tend to comprise of the same participants: mutual and joint-stock insurance companies. Pools are also found in a number of markets, though not all. The most developed insurance markets tend to be in large developed economies (UK, US, Japan, Canada, France,..). Many markets have reinsurance companies, but reinsurance is more likely to be placed internationally than direct business - notable reinsurance markets are the UK, US, Switzerland and Germany. Bermuda has also become a major international centre for insurance and reinsurance. A number of large insurance companies and groups are domiciled there, and some UK insurance groups have moved their principal domicile there in recent years. Bermuda has been the world's most important domicile for captive insurance companies for some decades (other includes the Cayman Islands, Vermont, Guernsey, Luxembourg and Dublin). Insurance and reinsurance groups are not limited to a single market and many operate out of multiple markets.

Question 121

Describe the slip system [9]

Answer 121

The London Market insurance providers, including Lloyd's, have traditionally acquired business through specialist brokers and in particular, international brokers using the slip system. Under the slip system in the subscription market: - the broker prepares a slip that shows, in a standard format, the main features of the risk to be insured - the broker shows the slip to one or more quoting underwriters, who, on the basis of the slip and further information as appropriate, quote a premium - the cedant will then select a lead underwriter and a 'firm order' price for the broker with which to approach the market. This firm order price may be below any of quoted prices. - the lead underwriter accepts a share of the risk by stamping and signing the slip - the broker then approaches other underwriters (the following market) to accept the risk on the same terms. The follow underwriters indicate the share they are willing to take by signing and stamping the slip - the broker continues until they have finished placing the risk - if the written lines exceed 100% then, in agreement with the insured they are reduced (or 'signed down') to 100% - if it is not possible to find capacity to place 100% of the risk, an additional shortfall cover may need to be placed at different terms In general, all (re)insurers on the slip will receive the same terms. However, in some markets the lead underwriter may receive a higher rate to reflect the additional work that they carry out on behalf of the following market.

Question 122

List the regulatory restrictions that may be placed on a general insurer [6]

Answer 122

1. A requirement to have an external audit of the insurer's accounts and to release publicly certain information pertaining the the insurer 2. Restrictions on the type of business that a general insurer can write or classes for which the insurer is authorised 3. Limits or controls on the premium rates that can be charged 4. Restrictions on the information that may be used in underwriting and premium rating 5. A requirement to deposit assets to back claim reserves 6. A requirement that a general insurer maintains a minimum level of solvency, measured in some prescibed manner 7. Restrictions on the types of assets or the amount of a particular asset that a general insurer can take into account for the purposes of demonstrating solvency 8. A requirement to use prescribed bases for calculating premiums or for valuing the general insurer's asset and/or liabilities when demonstrating solvency 9. Restrictions on individuals holding key roles in companies 10. Licensing of agents to sell isnurance and requirements on the methods of sale and disclosure of commissions / broking terms 11. A requirement to pay levies to consumer protection bodies 12. Legislation to protect policyholders if a general insurer fails

Question 123

Describe the EU Gender Directive and its effect on insurers [3]

Answer 123

The EU Gender Directive (2004) aimed at 'implementing the principle of equal treatment between men and women in the access to and supply of goods and services'. From 2012, due to the removal of the opt-out clause, insurance companies have no longer been able to use gender as a rating factor. Insurance companies are careful to avoid using proxy rating factors that are highly correlated to gender. Clearly, the inability the differentiate between rating factors is having significant implications for insurance pricing, particular to motor insurance. It is not yet clear how premium rates or underwriting practices have changed as a result of this ruling. However, it is likely that premiums have not simply met in the middle, but that there have been additional contingency loadings for the risk of business mix by gender not being as expected within the unisex pricing.

Question 124

Describe the effect of fiscal regime on general insurers [2]

Answer 124

In most countries the taxation of general insurers broadly follows that for other businesses although there may be special features, such as allowing equalisation of reserves to be held to allow for the uncertain nature of general insurance business. Some countries impose a tax on general insurance premiums for some or all classes of business.

Question 125

Explain the importance of professional guidance when carrying out general insurance work as an actuary [2]

Answer 125

When carrying out work for a general insurer or reinsurer an actuary should always bear in mind any professional guidance relating to the work being carried out and the professional body to which he or she belongs. An actuary should also bear in mind guidance on professional standards in addition to guidance on technical issues. In addition to formal guidance, the professional body may issue advice from time to time on specific issues.

Question 126

Explain using examples, the implications of inflation on general insurance business [12]

Answer 126

The general levels of inflation in the economy affect the cost of providing insurance and are therefore likely to be reflected in the premiums. However, different types if insurance are affected by different types of inflation. Failure to anticipate inflation can lead to insurers charging less than adequate premiums and under-reserving. The most common inflation is on consumer goods called the retail price inflation. These may be reasonably expected to affect the cost of claims of household contents policies although note that the RPI may include include items such as food and housing costs. For property claims, the costs will be linked to the cost of building materials and crucially labour costs. Labour costs tend to be more linked to wages than prices and wages tend to increase more than prices so the cost of insurance is likely to increase more than the general prices. As will motor property claims. Another aspect of inflation is'loss amplification' or 'demand surge'. This arises where there is a temporary increase in costs of labour or raw materials due to a large number of claims arriving as the same time (e.g. a catastrophe). One areas in which inflation has been persistently higher than the most quoted indices is medical expenses which would normally require its own index. Some types of insurance are immune from inflation because they provide fixed benefits. Personal accident policies expect the sum insured to increase with inflation without a link to an index. Liability insurance have a more complex relationship with inflation. Claims for personal injury have several components including: - compensation for loss of income, which will have the same inflation indices as other income related costs - cost of medical and nursing care, which will develop according to medical expenses inflation - awards for pain and suffering tend to be set judgmentally

Question 127

Give an example of how economic factors other than inflation can affect claims frequency [1]

Answer 127

The frequency of losses can also depend on economic factors. For example, in times of recession there might be an increase in the number of claims on creditor business, in respect of arson on property business and in theft generally.

Question 128

Describe the effect of inflation on the cost loading for an insurance policy [1]

Answer 128

The cost loading for an insurance policy is also subject to inflation. Insurance is a relatively labour intensive industry suggesting that this component of policy costs may be likely to increase in line with wage inflation.

Question 129

Describe the stages of the insurance / underwriting cycle [5]

Answer 129

In the past it has been observed that insurance premium rates have varied in ways that do not reflect the underlying cost of providing the insurance. This is most common in large commercial and industrial insurance but affects all classes of business. In general, the cycle can be described in the following terms, although describing it as starting from a position of general profitability is purely arbitrary: the sequence could be entered at any point. 1. Insurance is generally highly profitable (hard market) 2. The level of profits attracts new entrants to the market and encourages existing insurers to write more business 3. To fill the extra capacity, premium rates are reduced to attract business 4. Eventually premium rates fall to the extent that insurance is generally loss-making (soft market) 5. Insurers leave the market in responses to the level of losses and insurers write less business 6. With restricted availability of insurance, premium rates increase 7. Back to stage 1

Question 130

Explain how the underwriting cycle affects market capacity [4]

Answer 130

An insurer's ability to write business is limited by the amount of capital it holds. While the prospect of an extremely profitable market will attract new capital, a profitable market in itself increases insurers' capital bases as retained profits increase capital holdings. Since the same effect happens to reinsurers, reinsurance will likely become more readily available, which increases insurers' ability to write business. The actual mechanisms that reduce the size of the market when it is unprofitable will be companies becoming insolvent, companies withdrawing as a reaction to unprofitability, reinsurance being less readily available.

Question 131

Suggests reasons why the underwriting cycle exists [5]

Answer 131

Insurance is an industry to which the barriers for entrants is fairly low. With sufficient capital and technical competence, the authorisation process can be very quick. Another key factor is the delay in writing business and knowing how profitable it is. Simplistic capital regimes may exacerbate the cycle. In many jurisdictions, at least until recently, the capital required to write an insurance policy depended on the premium. The economics of insurance business may also help to enforce the cycle. Insurers' overheads tend to be less variable than premium rates.

Question 132

Outline the key features of Lloyd's [3]

Answer 132

Lloyd's is a key player in the worldwide general insurance market and reinsurance market with some £29.9bn of GWP in 2016. It is licensed to underwrite business in over 70 territories and can cover risk in over 200 countries. Lloyd's accepts a variety of different business lines on both a direct and reinsurance basis. Lloyd's is not an insurer in its own right; it simply provides the necessary infrastructure to allow its underwriting members to conduct business.

Question 133

Briefly describe the history of Lloyd's [3]

Answer 133

- London was an important trading centre in the 17th century when Edward Lloyd's coffee house came to be recognised as a place for obtaining marine insurance from rich individuals (c. 1688) - In 1771 the business ceased being run from a coffee houses and become owned by a group of 'subscribers' (underwriters and brokers who had contributed to the costs of the new premises). The first committee of Lloyd's was established. - In 1871, Lloyd's was incorporated in the UK by an act of parliament - In 1906, Lloyd's gained reputation in the US when all policies relating to the San Francisco Earthquake were paid out in full - it also led to the development of non-proportional insurance - In 1925, a central guarantee fund was established - The 1990s saw major losses for Lloyd's leading to a process called 'reconstruction and renewal'

Question 134

Explain the roles of members, syndicates, managing agents, ILVs and members' agents within Lloyd;s [8]

Answer 134

Members - subscribe to a syndicate (which is a collection of one or more members who have agreed to back the underwriting activities of a particular underwriter for one specific calendar year. Liabilities or profit are allocated to each member in the proportion to their agreed participation. The majority of members nowadays are companies. Private members may have limited or unlimited liability, though no new unlimited liability members are admitted. Corporate members have limited liability and must be a separate legal entity to the managing agent (although often they are both owned by the same insurance group). Managing agent - operates each syndicate ILVs - legally, the syndicate only exists for one year at a time, and the roles of the managing agent, member and syndicate remain separate. These syndicates are known as Integrated Lloyd's Vehicles. The are still many syndicates with both corporate and private members who have no links with the managing agent: these are known as 'unaligned' syndicates. Members' agents - advise private members on which syndicates to be subscribed to and carry out much of the membership admin. Corporate members do not have a members' agent but private members must use one.

Question 135

Explain how the subscription system works in the London Market [6]

Answer 135

Subscription business is just insurance, or reinsurance, written on a coinsurance basis. The whole risk is divided up proportionally and each syndicate or insurer takes a specified share of the premium and claims. Failure by one underwriter to pay does not affect the liabilities of the others. Coinsurance in the London Market has traditionally been arranged through the slip system. This system differs from the personal lines insurance market.

Question 136

Explain the concept of three-year funding used at Lloyd's [6]

Answer 136

For much of the business written at Lloyd's, the long-tail nature of the liabilities implies that it can take some time before their true cost can be determined. Each syndicate year of account is therefore allowed to remain 'open', usually for a period of three years, before the profit or loss is finally determined for that year. During that time, premiums received on business written in the year are accumulated in a fund known as a premium trust fund (PTF) out of which claims and expenses are paid. PTFs are the premiums and other monies that members receive in respect of their underwriting at Lloyd's, held by their managing agents in trust for them them subject to the discharge of their underwriting liabilities. At the end of the three-year period, the managing agent would usually close the fund by estimating the value of the outstanding liabilities and reinsuring them into the subsequent open year of that syndicate. The reinsurance premium paid for this is known as the reinsurance to close (RITC). Once this transaction has occurred the managing agent can determine the final result on the closing year of account and distribute profits/losses. A YoA can be held unnaturally open for longer than three years if the liabilities cannot be reasonably quantified due to fundamental uncertainties.

Question 137

State what is meant by an SAO [1]

Answer 137

Each year, as at year end, the managing agent must produce a statement of actuarial opinion (SAO) for each open syndicate year. The SAO confirms that the technical provisions held for solvency are at least as large as the signing actuary's best estimate.

Question 138

Explain how capital is organised at Lloyd's in order that claims may be paid and solvency requirements met [4]

Answer 138

Since members are taking risks, they need to hold capital in case the PTFs turn out to be inadequate to pay all claims and expenses. Each member must produce the amount of capital specified by Lloyd's. The capital is held by Lloyd's in trust and Lloyd's has absolute authority to use it to pay claims or other liabilities arising from the member's activities at Lloyd's. The capital fund of a member is called the Funds at Lloyd's (FAL). Fal may be lodged in two main ways: assets or via a letter of credit. Individual members must demonstrate solvency to the regulator. In addition, Lloyd's in aggregate must demonstrate overall solvency to the PRA by holding assets centrally. The majority of these central assets consist of the New Central Fund (NCF) which may be used to meet claims if a member's FAL is insufficient. Therefore the total funds available to pay claims for the syndicates is the funds held by the syndicates, the members' funds at Lloyd's and the New Central Fund.

Question 139

Describe the functions of the Corporation of Lloyd's, the Franchise Board and the council of Lloyd's [3]

Answer 139

Corporation of Lloyd's - corporate entity financed by subscriptions from the members, which provides central premises, administrative staff and services to enable members to transact business. Franchise Board - acts as a Board for the executive of the Corporation. It fulfills the governance role for all decisions that can be delegated by the Council of Lloyd's and is Lloyd's version of the board of a company. Council of Lloyd's - the governing body responsible for the overall direction of Lloyd's. It consists of 6 working members, 6 external members and 6 nominated members whose appointment must be confirmed by the Governor of the Bank of England including the Chief Executive.

Question 140

State the aims of regulating the financial markets [3]

Answer 140

The principal aims of regulation are to: - correct market inefficiencies and promote efficient and orderly markets - protect consumers of financial products - maintain confidence in the financial system - help reduce financial crime The need for regulation of the financial market is seen to be greater than the need for regulation for most other markets primarily because of the importance of confidence in the financial system and the damage that would be done by a systemic financial collapse.

Question 141

Describe the costs associated with regulating the financial market [2]

Answer 141

Regulation has a cost. Regulators must attempt to develop a system which can achieve the aims specified above at a minimum cost so that the benefits, which are difficult to measure, outweigh the costs. Direct costs arise in administrating the regulation; indirect costs arise from changes in behaviour, both of consumers and regulated firms, to react to the regulations.

Question 142

Describe the three generic forms regulation can take [3]

Answer 142

Regulation can be prescriptive, with detailed rules setting out what may or may not be done. Alternatively, it can involve freedom of action but with rules on publicity so that third parties are fully informed about the providers of financial services. Finally, the regime can allow freedom of action but prescribe the outcome that will be tolerated.

Question 143

Describe the five types of regulatory regime [8]

Answer 143

Unregulated markets - it has been argued that the costs of regulation in some markets, especially those where only professionals operate, outweigh the benefits. Voluntary codes of conduct - these are vulnerable to lack of public confidence or to a few rogue operators refusing to cooperate, leading to a breakdown in the system. Self-regulation - organised by the participants without government intervention. The incentive is that regulation is an economic good that consumers will pay for and will benefit all participants. Statutory regulation - the government sets out the rules and polices them. This has the advantage that is should be less open to abuse than the alternatives and may command a higher degree of public confidence. Mixed regimes - in practice, many regulatory regimes are a mixture of the ones described above

Question 144

State the key objectives and advantages of regulating insurance companies [6]

Answer 144

Key objectives of regulation and supervision are to promote efficient, fair, safe and stable insurance markets and to benefit and protect policyholders. A sound regulatory system for insurance helps sustainable growth and healthy competition. A well developed insurance sector also helps to enhance overall efficiency of the financial system by reducing transaction costs, creating liquidity and facilitating economies of scale in investment. The insurance sector must operate on a financially sound basis in order to: - contribute to economic growth - allocate resources efficiently - manage risk - mobilise long-term savings

Question 145

List the disadvantages of regulation [4]

Answer 145

- the cost in terms of resource and finance to comply with and supervise the rules - the loss of business opportunities that arise from any restriction on a free market - the inability to maximise investment returns when there are controls on investment decisions - the amount of regulatory bureaucracy deterring new entrants - the difficulties and hence potential inaccuracies in complying with complex (risk-based) liability and capital calculations - the increased premium cost to the public arising from levies and the general increase in insurer expenses - the inability of companies to benefit from economies of scale and cost reductions due to anti-competitive legislation - the failure of insurance to reach certain sectors of the population due to the increased cost of and restrictions on methods of distribution