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Flashcards in Feldblum Deck (40)
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1

Problem with early/traditional pricing procedures

(Feldblum)

used fixed UW profit provisions that became less credible & useful with time

2

Reasons to seek more accurate pricing models (3)

(Feldblum)

1. TVoM - pricing model should reflect timing & magnitude of CFs
2. competition and expected returns - price depends on degree of competition in the market
3. rate base - traditional profit margins are ROS, but ROE is more appropriate

3

Different POV for insurance transactions (2)

(Feldblum)

1. insurer and policyholder (focus in traditional ratemaking)
2. equity provider and insurer (focus in IRR model)

4

Insurer and policyholder view of insurance transactions (market, transaction, prices, and profits)

(Feldblum)

transactions occur in the product market

PH pays premiums and insurer is obligated to indemnify losses

prices are influenced by supply & demand of insurance

profits are only related to premiums & losses

5

Equity provider and insurer view of insurance transactions (market, transaction, return, and profits)

(Feldblum)

transactions occur in the financial market

shareholders invest in insurer & receive a return on their investment

returns are driven by insurance risk

profits are related to assets/equity only and only consider premiums/losses/expenses to the extent they impact shareholder transactions

6

Relationship between different POV for insurance transactions (2)

(Feldblum)

1. supply of insurance depends on cost insurers pay to obtain capital & returns achievable by investors
2. expected returns in the financial market depend on insurance risk & consumer demand for insurance

7

Decision rule for the IRR model

(Feldblum)

accept opportunities where IRR > cost of capital

8

Internal rate of return (IRR)

(Feldblum)

IRR = rate of return needed to set PV(CFs) = 0

(alternatively to set PV(cash inflows) = PV(cash outflows))

9

Initial cash outflows at policy inception from equity-holder's viewpoint (2)

(Feldblum)

1. portion of premium is used to pay expenses (not invested)
2. surplus is committed

10

Surplus impacts on equity flows & IRR (2)

(Feldblum)

1. base/amount of surplus
2. timing of commitment

11

Timing of surplus commitment and tail length comparisons (2)

(Feldblum)

if surplus base is premium, no distinction b/w required surplus for long vs. short-tailed LOB

if surplus base is reserves, long-tailed LOB require more surplus compared to short-tailed LOB (b/c surplus is committed for a longer amount of time)

12

General relationship between surplus and IRR

(Feldblum)

increase in required surplus reduces IRR

13

Equity CFs at time 0 (5)

(Feldblum)

1. PH pays premium to insurer
2. insurer pays expenses
3. insurer posts reserves
4. insurer commits surplus
5. equity holders pay insurer to cover shortfall

14

Equity CFs after time 0 (5)

(Feldblum)

1. insurer collects investment income
2. insurer pays losses
3. insurer reduces reserves
4. insurer releases surplus
5. excess returns are returned to equity holders

15

Initial loss reserves

(Feldblum)

initial loss reserves = expected losses

16

Required surplus at time t

(Feldblum)

required surplus(t) = loss reserve(t) / (reserve / surplus)

17

Required assets at time t

(Feldblum)

required assets(t) = required surplus(t) + loss reserve(t)

18

Ending assets at time t

(Feldblum)

ending assets(t) = required assets(t)

19

Equity flow (EF) at time t from insurer's and equity holder's POV

(Feldblum)

EF(t) = required assets(t) + payments(t) - beginning assets(t)

from shareholder's POV = - EF(t) from insurer's POV

20

Base options for surplus allocations for IRR model (2)

(Feldblum)

1. premiums
2. reserves

21

Timing of surplus commitment and surplus allocation base (2)

(Feldblum)

1. premiums - surplus is committed at policy inception and released at expiration
2. reserves - surplus is committed when losses occur or when UPR established and released as losses are paid

22

Steady state reserves

(Feldblum)

reserves at any point in time in a steady state environment

SS reserves = WP * LR * average time from loss to payment

23

Risks surplus protects the insurer against (7)

(Feldblum)

1. asset risk
2. pricing risk
3. reserving risk
4. asset-liability mismatch risk
5. catastrophe risk
6. reinsurance risk
7. credit risk

24

Asset risk

(Feldblum)

risk that financial assets depreciate

25

Pricing risk

(Feldblum)

risk that losses and expenses > expected

26

Reserving risk

(Feldblum)

risk that reserves may not be enough to cover ultimate loss payments

27

Asset-liability mismatch risk

(Feldblum)

risk that changes in interest rates impact assets and liabilities differently

28

Catastrophe risk

(Feldblum)

risk that unforeseen losses depress insurer returns

29

Reinsurance risk

(Feldblum)

risk that reinsurance recoverables will not be collected

30

Credit risk

(Feldblum)

risk that agents will not remit premium balances or insureds will not remit retro premiums