Chapter 4 - Market Security

Question 1

What is solvency?

Answer 1

Having more assets than liabilities - assets need to be equal or greater than paid + unpaid claims + operating costs

Question 2

What is the solvency margin?

Answer 2

The amount that assets exceed liabilities

Question 3

Why do insurers need to keep their assets above liabilities?

Answer 3

•To improve their ability to pay future claims

•Insurers need to know what value to place on its unpaid claims (calculating its reserves)

Question 4

What are the 2 categories of unpaid claims?

Answer 4

1. Those that are known
2. Those that are not known

Question 5

What is the ‘incurred but not reported’ (IBNR) figure?

Answer 5

•The additional amount that insurers need to reserve for future claims

•Volatile classes of business, e.g. aviation + marine, incur larger claims, so the starting calculation involves increasing premium + claims figure by 50%

Question 6

What are assets?

Answer 6

•Tangible/intangible items of value that a business owns/controls

•For insurers, this is the premiums + investment income

Question 7

What is capital?

Answer 7

The difference between assets + liabilities

Question 8

What are liabilities?

Answer 8

•Money owed to another person/organisation

•For insurers, this is their claims (paid + outstanding), reinsurance, + cost of running the business

Question 9

What is liquidity?

Answer 9

The ease w/ which assets can be converted into cash

Question 10

What are ratios?

Answer 10

The relationship between financial factors, which can be used to indicate profitability

Question 11

What is a loss ratio?

Answer 11

•The relationship between premium + claims

•A loss ratio less than 100% indicates profit on a pure loss ratio basis

Question 12

What is a combined ratio?

Answer 12

Compares operating costs + claims against premiums + investment income

Question 13

What is the aim of solvency II?

Answer 13

Ensure that EU insurers can pay policyholders claims when needed

Question 14

What are the 4 objectives of solvency II?

Answer 14

1. Better regulation
2. Deeper integration of EU insurance market
3. Enhanced policyholder protection
4. Improved competitiveness of EU insurers

Question 15

What are the 3 pillars of solvency II?

Answer 15

1. Quantitative requirements - insurers demonstrate they have adequate financial resources to cover exposed risks + engage in wide-ranging analysis of business risk
2. Supervisory review - insurers undertake an internal review (the ‘own risk + solvency assessment’ ORSA)
3. Disclosure - insurers disclose publicly more info than before

Question 16

What does the ‘own risk + solvency assessment’ (ORSA) involve for insurers as part of the ‘supervisory review’ pillar of solvency II?

Answer 16

1.Insurers identify, manage, + report the short/long term risks it faces or may face

2.insurers determine capital necessary for its overall solvency needs to be met

3. Insurers should do this review on ongoing basis

Question 17

What is the ‘solvency capital requirements’ (SCR) as part of the ‘quantitative requirements’ pillar of solvency II?

Answer 17

Insurers need to keep an amount of assets available in excess of its liabilities

•There is a lower amount known as the ‘minimum capital requirement’ (MCR) - if this level is breached, regulatory intervention is likely

Question 18

What are 6 examples of business risks faced by an insurer?

Answer 18

1. Credit/counterparty risk
2. Operational risk
3. Market risk
4. Liquidity risk
5. Group + capital risk
6. Enterprise risk

Question 19

What are examples of a credit/counterparty risk that could be faced by an insurer?

Answer 19

1. Premiums not being paid
2. Reinsurance claims not being recoverable as reinsurer is insolvent

Question 20

What are examples of an operational risk that could be faced by an insurer?

Answer 20

1. UWs writing risks or claims personnel settling claims outside their authority
2. Building they work in is damaged/can’t use
3. Market system not available for use

Question 21

What are examples of a market risk that could be faced by an insurer?

Answer 21

1. Investments failing
2. Exchange rate losses (when dealing w/ multiple currencies)

Question 22

What is an example of a liquidity risk that could be faced by an insurer?

Answer 22

Not being able to release investments quickly enough

Question 23

What is an example of a group + capital risk that could be faced by an insurer?

Answer 23

Different divisions writing lines on the same risk

Question 24

What is an enterprise risk that could be faced by an insurer?

Answer 24

Enterprise risk management (ERM) encompasses the wider ranging management of risks that can impact the entire business

Question 25

What does the Solvency II + Insurance (Amendments etc.) (EU exit) regulations 2019 ensure?

Answer 25

That provision of solvency II continued to work in UK, even though they’ve left EU

Question 26

What does the Financial Services + Markets Act 2023 do in regard to ‘Solvency II + Insurance (Amendments etc.) (EU exit) regulations 2019’?

Answer 26

It revokes the regulation + brings the responsibility for the control of the UK financial services industry back ‘in house’ to the UK, rather than following EU

Question 27

What is the role of the ‘European insurance + occupational pensions authority’ (EIOPA) as the EU supervisory body of Solvency II?

Answer 27

Increase the stability of the financial system + transparency of markets + financial products, + the protection of policyholders

Question 28

What is the FCA + PRA new objective under the Financial Services + Markets Act 2023?

Answer 28

Enhancing competitiveness + growth of UK financial services sector •They report to the government on how they’ve complied w/ their duty to advance this competitiveness + growth objective

Question 29

What is the Lloyd’s Central Fund, which is the final link in the Lloyd’s chain of security?

Answer 29

•It’s fed by contributions from all the written premium in the market + the basic rate of contribution for existing members is 0.35% for 2024 •It assists the demonstration is solvency + is controlled by the Council of Lloyd’s

Question 30

What is syndicate level assets, which is the 1st link in the Lloyd’s chain of security?

Answer 30

•The premiums received for the written business, which are held in trust funds •These funds are the 1st source of money to pay claims, so syndicate must be able to access + liquidate this quickly

Question 31

What is Members Funds at Lloyd’s (FAL), which is the 2nd link in the Lloyd’s chain of security?

Answer 31

•If 1st link of funds is inadequate , then go here •It’s the funds deposited by the members at Lloyd’s of becoming an investor in the market •Amount each member provides in order to support their UW is calculated by the Solvency Capital Requirement (SCR) of each syndicate •The Corporation of Lloyd’s reviews each SCR + uplifts it by a % to ensure there’s sufficient capital available - this uplift is the syndicate’s Economic Capital Assessment (ECA)

Question 32

What are the 3 links in the Lloyd’s chain of security?

Answer 32

1. Syndicate level assets - i.e. the premiums received 2. Member’s Funds at Lloyd’s (FAL) 3. Central assets - i.e. Lloyd’s Central Fund

Question 33

What are rating agencies and what are examples of them?

Answer 33

Organisations who rate insurers + reinsurers, + publish their results for the public •E.g. Standard + Poor’s, Fitch, A.M. Best, + Moody’s

Question 34

What info do rating agencies report?

Answer 34

1. Independent opinions of an insurer’s strength - they consider an insurer’s ability to pay claims, their business profile, + their operating performance 2. Wider financial market intelligence - including risk evaluations, investment research, + credit ratings to their clients •Lloyd’s is rated as a single marketplace, but insurance companies are rated individually •Ratings = A, A*, AAA, etc

Question 35

What are the ratings from rating agencies used for?

Answer 35

•Buyers of insurance/reinsurance use them to consider the best market to use • So, broker will consider the rating of an insurer + the terms being offered •Brokers + insurers have security committees which check ratings of insurers + reinsurers

Question 36

What is the impact of a decrease in an insurer’s rating from rating agencies?

Answer 36

Insurer will probably lose business, unless there’s a general downgrading across the market, so the impact is neutralised