chapter 10

Question 1

What is the main purpose of a credit rating agency?

Answer 1

A: To assess a company’s financial strength and ability to pay debts.

Question 2

Name the four major credit rating agencies.

Answer 2

A: Standard & Poor’s, AM Best, Moody’s, Fitch.

Question 3

Why do insurers seek financial strength ratings?

Answer 3

A: To build trust, attract clients, and compare with other insurers.

Question 4

What does a high CRA rating indicate?

Answer 4

A: Low risk and strong ability to pay claims

Question 5

What does ERM stand for and why is it important?

Answer 5

A: Enterprise Risk Management; it shows how an insurer manages and controls risk.

Question 6

What does a rating of AAA usually mean?

Answer 6

A: Extremely strong, but may indicate overcapitalisation.

Question 7

Can CRAs still rate a company that withdraws from the process?

Answer 7

A: Yes, using publicly available information.

Question 8

List 3 components of the CRA analytical framework.

Answer 8

Capital adequacy

competitive position

liquidity (others include management, ERM, etc.)

Question 9

What is a limitation of CRA ratings?

Answer 9

A: They may react slowly to financial deterioration.

Question 10

What is a “risk appetite” in insurance?

Answer 10

A: A statement from the board on acceptable risks, target capital levels, and limits on potential losses.

Question 11

What are the 3 Pillars of Solvency II?

Answer 11

Pillar 1 – Financial requirements
Pillar 2 – Governance,
Pillar 3 – Reporting & disclosure.

Question 12

What does Pillar 1 require for valuing liabilities?

Answer 12

A: Market-consistent valuation using best estimates + a risk margin.

Question 13

What is the Risk Margin (RM)?

Answer 13

A: A buffer added to the best estimate of liabilities to reflect uncertainty.

Question 14

Name the three capital tiers under Solvency II.

Answer 14

Tier 1 (highest)
Tier 2
Tier 3 (lowest quality).

Question 15

What is the SCR confidence level?

Answer 15

99.5% – enough capital to survive a 1-in-200 year event.

Question 16

What is the MCR confidence level?

Answer 16

A: 85% – minimum acceptable level before regulatory action is taken.

Question 17

What happens if an insurer breaches the SCR?

Answer 17

A: It must take action to restore capital and may face regulatory intervention.

Question 18

How can insurers respond to inadequate capital?

Answer 18

A: Raise more capital or reduce capital requirements (e.g. by using reinsurance or safer investments).

Question 19

What are the two main ways to calculate the SCR under Solvency II?

Answer 19

A: Standard formula and internal model.

Question 20

What is the ‘use test’ for internal models?

Answer 20

A: It checks that the model is actively used in decision-making, not just for compliance.

Question 21

List two uses of internal models besides calculating SCR.

Answer 21

A: Pricing, investment selection, reinsurance planning, dividend decisions.

Question 22

What is ORSA?

Answer 22

A: Own Risk and Solvency Assessment – an internal process to evaluate current and future risks.

Question 23

What is reverse stress testing?

Answer 23

A: Identifying scenarios that would make the business model unviable.

Question 24

What reports are required under Pillar 3?

Answer 24

A: SFCR (public) and the Regulatory Supervisory Report (private).

Question 25

What is the PRA’s mobilisation scheme?

Answer 25

A: A phased entry option for new insurers with lighter requirements.

Question 26

What does the SM&CR regime ensure?

Answer 26

A: Senior managers are clearly accountable for governance and risk oversight.

Question 27

What happens if internal risk management is found insufficient under new rules?

Answer 27

A: PRA can require firms to make changes and increase oversight.

Question 28

What does Solvency II require insurers to have in terms of actuarial input?

Answer 28

A: An actuarial function performed by someone with actuarial/mathematical expertise.

Question 29

Name two key duties of the actuarial function under Solvency II.

Answer 29

A: Designing the internal model and assessing technical provisions.

Question 30

Why must insurers review their investment strategies under Solvency II reform?

Answer 30

A: Because there is greater eligibility and freedom in asset selection.

Question 31

What is the Matching Adjustment (MA)?

Answer 31

The Matching Adjustment (MA) is a rule that lets insurance companies adjust how they value their long-term financial promises (like pension payouts or life insurance claims). It helps insurers get credit for holding investments that match the timing of those future payouts. Why does this matter? Smooths financial ups and downs – Insurers don’t have to worry as much about market changes. Boosts financial stability – Companies can hold assets for the long term without sudden losses.

Question 32

Under Solvency II, when are profits recognised?

Answer 32

A: Immediately at contract inception.

Question 33

How does profit recognition under IFRS 17 differ from Solvency II?

Answer 33

A: Profits are recognised gradually over the life of the contract.

Question 34

What reporting challenge is posed by the difference in terminology between Solvency II and IFRS 17?

Answer 34

A: Insurers must maintain flexible systems to reconcile different definitions and reporting standards.

Question 35

Name one similarity between Solvency II and IFRS 17.

Answer 35

A: Both use a best estimate basis for future cash flow valuations.

Question 36

What must insurers implement to meet both Solvency II and IFRS 17 requirements effectively?

Answer 36

A: An integrated end-to-end framework for data, governance, and reporting.

Question 37

Why are Solvency II reforms important for insurers operating across the UK and EU?

Answer 37

A: They may need to adjust controls and systems to comply with differing rules in each jurisdiction.

Question 38

What are credit rating agencies paid to do?

Answer 38

They are paid by insurance companies to assess and publicly rate their financial strength—specifically their ability to meet insurance claims as they fall due.

Question 39

Explain the terms SCR and MCR.

Answer 39

SCR (Solvency Capital Requirement): The amount of capital required to withstand a 1-in-200-year event (99.5% confidence). MCR (Minimum Capital Requirement): The minimum level of capital required for an insurer to legally operate, with an 85% confidence level.

Question 40

What is an ORSA?

Answer 40

Own Risk and Solvency Assessment – A process where an insurer assesses its current and future solvency under normal and stressed conditions. It helps manage all risks and ensure long-term capital adequacy.

Question 41

Explain what an SFCR is.

Answer 41

Solvency and Financial Condition Report – A publicly disclosed annual report where insurers explain their solvency position, risk management, and compliance with Solvency II.

Question 42

What does the Solvency II Directive state about the actuarial function and insurance firms?

Answer 42

It requires insurers to have an actuarial function performed by qualified individuals with actuarial and financial mathematics knowledge. This function supports risk management and the development and use of internal models.

Question 43

What are the objectives of the Solvency II reform?

Answer 43

Simplify capital and reporting requirements. Encourage competition and market entry. Provide more flexibility and reduce unnecessary burdens. Tailor rules to UK market conditions post-Brexit. Improve investment freedom and governance frameworks.