Chapter 10: Risk and uncertainty

Question 1

Uncertainties faced by a general insurer can be considered under two main headings:

Answer 1

• Uncertainty as to the outcome of business already written
• Uncertainty as to the premiums the insurer needs to charge in future to achieve a desired outcome

Question 2

Uncertainties with determining premium rates required in the future:

Answer 2

• Uncertainties that affect the measurement of the financial outcome of the existing business
• Extent to which past experience will be relevant to the future
• Extent of any adjustments that need to be made to the experience of the recent past to allow for exceptional claims that have occurred or failed to occur
• Possible changes in assumptions required as projections have to be extended even further into the future
• The appropriate choice of rating factors and premium relativities

Question 3

Main elements that contribute to the main uncertainties faced by a general insurer:

Answer 3

• Those that affect the claims experience
• Those that affect expenses, including commission
• Those relating to the investments
• Business risks, including new business and lapse risk

Question 4

Uncertainties relating to the claims experience stem from:

Answer 4

• Variability of claims size at any one time and from one period to the next
• Reporting and settlement delays
• Types of policies written and cover provided
• Characteristics of policyholders, including possible anti-selection
• Attitude of policyholders towards claiming
• Crime rates
• Economic factors
• Judicial decisions
• Legislation
• Accumulations of risk
• Catastrophes
• Latent claims
• Currency risk
• Reinsurance risk
• Interpretation of wording
• Inflation and consequential rates of escalation of claims

Question 5

Main expense risks relate to:

Answer 5

• Commission
• Mix of business
• Changes in the progression of staff and accommodation costs
• Changes in professional and legal costs
• Changes in rates of inflation
• Doubts about the allocation of expenses

Question 6

Investment risks relate to:

Answer 6

• Market conditions
• Assets available for investment
• Timing of claim payments, in particular in relation to unfavourable conditions
• Poor investment management
• Liquidity
• Mismatching
• Security of assets
• The quantity of free assets
• Movements in asset values or currency rates

Question 7

Main types of business risks:

Answer 7

• Credit risk – failure of a 3rd party, e.g. policyholders, brokers, reinsurers, staff, suppliers
• Timing risk, with premiums or recoveries received later than expected or claims paid sooner
• Competition
• The insurance cycle
• New business and lapses
• Operational risks

Question 8

Types of operational (business) risks:

Answer 8

• Administration risk
• Compliance risk
• Event risk
• Fraud risk
• Governance risk
• Strategic risk
• Technological risk
• Pension scheme risk

Question 9

Group risks:

Answer 9

• Capital risk
• Reputational risk
• Group reinsurance risk
• Risks in centralised functions
• Political risk

Question 10

Implications of a low solvency margin:

Answer 10

• Subject to intervention from the supervisory authority (possible before the minimum level is reached)
• A loss of confidence in the market leading to a loss of business. The loss of confidence may also extend to the stock market, with falls in the share price
• A need to restrict business to prevent intervention by the supervisory authority. This will result in possible loss of profitable business
• Probably the need to purchase more insurance to increase protection against fluctuations
• More constrained investment policy