Flashcards in Feldblum Deck (40)

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1

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Problem with early/traditional pricing procedures

(Feldblum)

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

2

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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

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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

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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

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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

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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

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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

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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

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Surplus impacts on equity flows & IRR (2)

(Feldblum)

###
1. base/amount of surplus

2. timing of commitment

11

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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

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General relationship between surplus and IRR

(Feldblum)

### increase in required surplus reduces IRR

13

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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

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Initial loss reserves

(Feldblum)

### initial loss reserves = expected losses

16

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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

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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

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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

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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

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Pricing risk

(Feldblum)

### risk that losses and expenses > expected

26

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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