Chapter 10

Question 1

What is the role of credit rating agencies (CRAs) in insurance?

Answer 1

They assess the financial strength and creditworthiness of insurers.

Question 2

Why is a high credit rating beneficial for an insurance company?

Answer 2

It increases trust among policyholders, investors, and regulators, reducing the cost of capital.

Question 3

What are the three pillars of Solvency II?

Answer 3

(1) Financial requirements,
(2) Governance & supervision,
(3) Reporting & disclosure.

Question 4

What is the solvency margin in insurance?

Answer 4

The excess of assets over liabilities, ensuring an insurer can meet obligations.

Question 5

What does ORSA stand for in Solvency II?

Answer 5

Own Risk and Solvency Assessment.

Question 6

How does Solvency II differ from IFRS 17 in recognizing profits?

Answer 6

Solvency II allows immediate profit recognition, whereas IFRS 17 spreads profits over time.

Question 7

What is the purpose of stress testing in insurance?

Answer 7

To assess an insurer’s resilience to financial shocks and extreme scenarios.

Question 8

What is the risk-free rate used for in Solvency II?

Answer 8

It helps determine the present value of liabilities

Question 9

How do insurers use internal models under Solvency II?

Answer 9

For capital calculations, pricing, and investment decision-making.

Question 10

What is the main challenge of aligning Solvency II with IFRS 17?

Answer 10

Differences in risk adjustment, discount rates, and profit recognition.

Question 11

What role do actuaries play in ensuring financial strength?

Answer 11

They assess risks, calculate reserves, and support capital management.

Question 12

Why is governance important in Solvency II?

Answer 12

It ensures proper risk management, compliance, and transparency.

Question 13

What are the key planned reforms in Solvency II?

Answer 13

Adjustments in risk sensitivity, capital requirements, and investment strategies.

Question 14

How does liquidity premium impact insurance liabilities?

Answer 14

It adjusts the discount rate for illiquid liabilities, affecting solvency calculations.

Question 15

What is the role of the Prudential Regulation Authority (PRA)?

Answer 15

It oversees insurers’ financial health, solvency, and stress testing.

Question 16

What do credit rating agencies assess in insurance companies?
a) Customer satisfaction
b) Financial strength and creditworthiness
c) Marketing effectiveness
d) Claims processing speed

Answer 16

b) Financial strength and creditworthiness

Question 17

Which of the following is NOT a common credit rating category?
a) AAA
b) BB
c) ZZZ
d) BBB

Answer 17

c) ZZZ

Question 18

Why is a lower credit rating problematic for an insurer?
a) It increases borrowing costs and reduces investor confidence
b) It leads to higher customer satisfaction
c) It allows for better investment opportunities
d) It eliminates the need for regulatory oversight

Answer 18

a) It increases borrowing costs and reduces investor confidence

Question 19

What is the primary goal of Solvency II?
a) Increase insurer profits
b) Ensure insurers can meet obligations to policyholders
c) Standardize customer service processes
d) Eliminate all risk from insurance operations

Answer 19

b) Ensure insurers can meet obligations to policyholders

Question 20

Which pillar of Solvency II focuses on governance and risk management?
a) Pillar 1
b) Pillar 2
c) Pillar 3
d) None of the above

Answer 20

b) Pillar 2

Question 21

What does ORSA stand for?
a) Operational Risk and Solvency Assessment
b) Own Risk and Solvency Assessment
c) Outstanding Risk and Strategy Analysis
d) Official Risk Standards Act

Answer 21

b) Own Risk and Solvency Assessment

Question 22

What is the key difference between IFRS 17 and Solvency II?
a) IFRS 17 allows for immediate profit recognition
b) Solvency II recognizes profits immediately, while IFRS 17 spreads them over time
c) Solvency II does not account for liabilities
d) IFRS 17 does not apply to insurance companies

Answer 22

b) Solvency II recognizes profits immediately, while IFRS 17 spreads them over time

Question 23

What is included in Pillar 3 of Solvency II?
a) Capital reserves requirements
b) Governance and supervision rules
c) Disclosure and transparency requirements
d) None of the above

Answer 23

c) Disclosure and transparency requirements

Question 24

What is a solvency margin?
a) The amount of premiums collected annually
b) The excess of assets over liabilities
c) A measure of policyholder satisfaction
d) A type of insurance fraud detection tool

Answer 24

b) The excess of assets over liabilities

Question 25

Why do insurers use internal models under Solvency II? a) To calculate regulatory capital requirements b) To avoid compliance c) To eliminate financial risk d) To outsource risk management

Answer 25

a) To calculate regulatory capital requirements

Question 26

What is the role of actuaries in financial strength? a) Designing new insurance marketing campaigns b) Assessing risk, calculating reserves, and ensuring capital adequacy c) Selling policies directly to customers d) None of the above

Answer 26

b) Assessing risk, calculating reserves, and ensuring capital adequacy

Question 27

Which of the following is NOT a key factor in an insurer's financial strength? a) Investment strategy b) Claims handling efficiency c) Solvency margin d) Regulatory compliance

Answer 27

b) Claims handling efficiency

Question 28

What is one of the planned Solvency II reforms? a) Eliminating capital requirements b) Increasing flexibility in investment strategies c) Removing governance requirements d) Reducing transparency in financial reporting

Answer 28

b) Increasing flexibility in investment strategies

Question 29

How does liquidity premium impact insurance calculations? a) It increases liability values b) It adjusts discount rates for illiquid liabilities c) It has no impact on solvency calculations d) It only applies to short-term insurance contracts

Answer 29

b) It adjusts discount rates for illiquid liabilities

Question 30

What role does the PRA play in the insurance industry? a) Ensuring proper financial regulation and solvency compliance b) Setting customer service guidelines c) Selling insurance policies directly d) Managing investment portfolios

Answer 30

a) Ensuring proper financial regulation and solvency compliance

Question 31

Why is stress testing important for insurers? a) It increases sales b) It assesses financial resilience under extreme scenarios c) It replaces traditional risk management d) It only applies to small insurance firms

Answer 31

b) It assesses financial resilience under extreme scenarios

Question 32

What happens if an insurer fails stress testing? a) They must adjust risk strategies and capital reserves b) They immediately shut down operations c) They automatically receive higher credit ratings d) Nothing, as stress testing is optional

Answer 32

a) They must adjust risk strategies and capital reserves

Question 33

What is a key challenge of aligning Solvency II with IFRS 17? a) Differences in risk adjustment and discount rate usage b) IFRS 17 does not apply to insurers c) Solvency II ignores liabilities d) They are identical frameworks

Answer 33

a) Differences in risk adjustment and discount rate usage

Question 34

Which of the following factors is LEAST likely to influence an insurer’s credit rating? a) Market perception of the insurance sector b) The insurer’s claims settlement speed c) The insurer’s asset liability matching strategy d) The insurer’s exposure to catastrophe risks

Answer 34

B

Question 35

What does a downgrade in an insurer’s credit rating typically indicate? a) Increased regulatory capital requirements b) Reduced policyholder protection c) Higher funding costs and reduced market confidence d) Immediate insolvency

Answer 35

C

Question 36

What is the primary reason for Solvency II’s risk-based approach to capital requirements? a) To create a uniform regulatory framework b) To reflect each insurer’s specific risk exposure c) To simplify capital calculations for insurers d) To eliminate the need for internal models

Answer 36

B

Question 37

How does the Matching Adjustment impact an insurer’s solvency ratio? a) Increases solvency ratios by reducing liability values b) Decreases solvency ratios by increasing capital requirements c) Has no direct impact on solvency calculations d) Reduces the need for stress testing

Answer 37

A

Question 38

What is a key difference between Minimum Capital Requirement (MCR) and Solvency Capital Requirement (SCR)? a) MCR is risk-sensitive, while SCR is a fixed amount b) SCR is always higher than MCR and reflects risk exposure c) MCR is a voluntary requirement, while SCR is mandatory d) SCR only applies to life insurers

Answer 38

B

Question 39

Under Solvency II, what happens when an insurer’s own funds fall below its SCR but remain above the MCR? a) The insurer must submit a recovery plan to regulators b) The insurer is immediately placed under administration c) The insurer must cease underwriting new business d) There is no regulatory consequence

Answer 39

A

Question 40

Why is the Risk Margin necessary in Solvency II? a) It accounts for the cost of transferring liabilities in case of insurer failure b) It smooths out market fluctuations in capital requirements c) It ensures that an insurer’s assets exceed liabilities d) It reduces capital volatility during financial crises

Answer 40

A

Question 41

What is a major challenge in aligning Solvency II and IFRS 17? a) Differences in profit recognition timing b) IFRS 17 does not consider insurance risk c) Solvency II does not apply to general insurers d) IFRS 17 eliminates the need for regulatory capital

Answer 41

A

Question 42

Why do insurers apply the Volatility Adjustment under Solvency II? a) To adjust discount rates based on market conditions b) To reduce required capital buffers c) To increase reported profits d) To eliminate the need for stress testing

Answer 42

A

Question 43

What is the primary objective of the Ultimate Forward Rate (UFR)? a) To forecast short-term interest rates b) To establish a long-term equilibrium interest rate c) To ensure asset-liability matching d) To eliminate capital volatility

Answer 43

B

Question 44

Why is asset-liability matching critical in insurance? a) It minimizes liquidity risks and capital requirements b) It maximizes insurer profitability c) It eliminates market risks d) It is only relevant for life insurers

Answer 44

A

Question 45

What factor can trigger an increase in an insurer’s capital requirements under Solvency II? a) Decreased exposure to market risk b) Improved asset diversification c) Rising interest rates reducing liability values d) Higher claims volatility

Answer 45

D

Question 46

Q: An insurer is targeting an ‘AA’ rating to attract more corporate clients. What does this imply about their capital strategy? A) Low reserves and flexible pricing B) Use of Tier 3 capital for returns C) High-quality capital and conservative risk strategy D) Withdrawal from CRA review

Answer 46

Answer: C) High-quality capital and conservative risk strategy Explanation: Strong ratings demand robust capital adequacy and prudent risk management

Question 47

An insurer’s SCR is £10m and it holds £12m in qualifying capital. What does this imply? A) It meets Pillar 3 but fails Pillar 1 B) It is undercapitalised C) It has a surplus above regulatory requirement D) It needs an internal model

Answer 47

Answer: C) It has a surplus above regulatory requirement Explanation: Capital exceeding the SCR indicates regulatory strength​

Question 48

What would a ‘BBB’ rating suggest about an insurer’s financial strength? A) Very strong B) Weak and unreliable C) Adequate but possibly not sufficient for commercial risks D) Best in class

Answer 48

Answer: C) Adequate but possibly not sufficient for commercial risks Explanation: ‘BBB’ is considered “good” but may not meet the standards required for certain lines of business

Question 49

A company issues subordinated debt to meet capital needs. Which capital tier is most applicable? A) Tier 1 B) Tier 2 C) Tier 3 D) Equity only

Answer 49

Answer: B) Tier 2 Explanation: Subordinated debt is a typical Tier 2 capital instrument under Solvency II

Question 50

An internal model predicts a 0.5% probability of insolvency over one year. This is consistent with which capital requirement? A) MCR B) ORSA C) SCR D) Tier 3 limit

Answer 50

Answer: C) SCR Explanation: SCR must ensure resilience to 1-in-200-year events (99.5% confidence)​

Question 51

A credit rating agency spends a day with the insurer’s senior management. Why is this step important? A) To promote new products B) To confirm personal investment C) To assess management credibility and strategy D) To review marketing materials

Answer 51

Answer: C) To assess management credibility and strategy Explanation: Strategy and leadership quality impact rating outcomes​

Question 52

Q: A company’s capital includes primarily retained earnings. Which capital tier does this fall under? A) Tier 1 B) Tier 2 C) Tier 3 D) Off-balance sheet

Answer 52

Answer: A) Tier 1 Explanation: Retained earnings are high-quality, loss-absorbing Tier 1 capital​

Question 53

Which Solvency II pillar focuses on public disclosure of risks? A) Pillar 1 B) Pillar 2 C) Pillar 3 D) Capital Adequacy Framework

Answer 53

Answer: C) Pillar 3 Explanation: Pillar 3 mandates transparency to improve market discipline​

Question 54

A firm builds a matching adjustment portfolio for annuities. Which Solvency II function does this relate to? A) Reinsurance test B) Pillar 2 ORSA C) Market-consistent valuation D) Risk Margin exemption

Answer 54

Answer: C) Market-consistent valuation Explanation: Matching adjustments help reduce discount rate volatility under market valuation rules​

Question 55

The PRA requests a stress test to assess catastrophe readiness. This requirement falls under which Solvency II pillar? A) Pillar 1 B) Pillar 2 C) Pillar 3 D) SCR Tier assessment

Answer 55

Answer: B) Pillar 2 Explanation: Governance, ORSA, and stress testing sit under Pillar 2​

Question 56

Which component is used to calculate the market-consistent value of liabilities? A) Risk-free discount rate B) Historical claims average C) Maximum capital requirement D) Internal solvency model

Answer 56

Answer: A) Risk-free discount rate Explanation: Solvency II liabilities are discounted using risk-free rates + risk margin​

Question 57

What is the function of the ORSA report? A) To calculate gross written premium B) To forecast shareholder returns C) To assess future solvency under stress D) To provide internal audit reviews

Answer 57

Answer: C) To assess future solvency under stress Explanation: ORSA evaluates solvency in light of strategic and risk scenarios​

Question 58

A firm relies heavily on internal models. What risk must it manage? A) Over-compliance B) Model misuse or 'black box' dependency C) Regulator bias D) Excess capital

Answer 58

Answer: B) Model misuse or 'black box' dependency Explanation: Firms must understand, validate, and monitor internal models actively​

Question 59

An insurer holds mainly Tier 3 capital. What’s the risk? A) Excessive liquidity B) Higher loss absorption C) Poor default risk control D) Limited solvency capacity

Answer 59

Answer: D) Limited solvency capacity Explanation: Tier 3 has restricted loss-absorbing capacity and is limited in SCR use​

Question 60

Why would brokers prefer to place business with ‘A’ rated insurers or better? A) Better customer service B) Regulatory tax savings C) Greater security of claims payment D) Faster quote turnaround

Answer 60

Answer: C) Greater security of claims payment Explanation: Higher ratings reflect stronger financial ability to meet claims​

Question 61

Which is a Pillar 1 capital metric under Solvency II? A) ORSA B) MCR C) SFCR D) SM&CR

Answer 61

Answer: B) MCR Explanation: Pillar 1 covers SCR and MCR calculations​

Question 62

What’s a reason insurers voluntarily disclose their credit rating? A) To defer tax payments B) To improve marketing ROI C) To instil policyholder confidence D) To increase commission fees

Answer 62

Answer: C) To instil policyholder confidence Explanation: Ratings assure stakeholders of financial strength​