Insurance MFI Flashcards
(158 cards)
1
Q
How is underwriting risk for an insurance company quantified?
A
Using the Solvency Index:
Solvency Index = (Applied Risk Loading + Available Own Funds) / (Riskiness of Portfolio)
, where the riskiness of portfolio refers to the standard deviation of the probability distribution of claims
2
Q
Underwriting risk is a larger source of risk in:
A) Non-life
B) Life
C) Reinsurance
D) Depends
A
Underwriting risk is a larger source of risk in non-life insurance.
In life insurance, firms are able to utilize a wider and more reliable statistical basis of mortality tables, while, in most cases, the benefits are determined in advance (valued contract). This makes life insurance less exposed to underwritings gaps.
3
Q
Who is most exposed to Longevity Risk? A) Non-Life B) Life C) Policyholder D) Reinsurer Why?
A
Life insurance companies are more exposed to longevity risk: life contracts are long-term contracts, and premiums are determined in advance for the whole period. This could expose the insurer to the effect of long-term (decreasing) mortality trends. This is known as “longevity risk”.
4
Q
Which techniques/features can help a non-life insurer mitigate underwriting risks?
A) Legal limitations: randomness, indemnity principle
B) Portfolio selection: the creation of portfolios that optimize the insurability criteria (large number, independence, homogeneity
C) Contractual limitations
D) Premium determination based on “experience” rating
E) Reinsurance
F) All of the above except legal limitations
G) All of the above
A
G) All of the above
5
Q
The following statement is NOT true for a reinsurance contract:
A) Reinsurance allows the insurer to replace uncertainty of claims volatility with a known cost (reinsurance premium)
B) By using reinsurance, the insurer can decrease the riskiness of its portfolio and optimize its solvency index
C) In a reinsurance transaction, the insurer seeking reinsurance is known as the REINSURER, while the company assuming a part of the risk is known as the CEDING COMPANY
D) The reinsurance creates NO relationship between the policyholder and the reinsurer.
A
NOT TRUE -> C) In a reinsurance transaction, the insurer seeking reinsurance is known as the CEDING COMPANY, while the company assuming a part of the risk is known as the REINSURER
6
Q
What is NOT a main purpose of reinsurance for the ceding company?
A) Increasing of insurance capacity
B) Improving quantitative harmonization of portfolio
C) Elimination of moral hazard and adverse selection
D) Improving segmentation and diversification of risks
A
WRONG: C) Elimination of moral hazard and adverse selection
7
Q
Which of the following is NOT a source of market risk?
A) Interest rate risk: risk of losses due to changes in the term structure of interest rates
B) Equity risk: risk of losses due to changes in the market prices of equities
C) Spread risk: deterioration of the credit standing of issuers of financial instruments
D) Real estate risk: risk of losses due to changes in the market prices of real estate
E) Exchange risk: risk of losses due to changes of currency exchange rate
A
C) Spread risk: deterioration of the credit standing of issuers of financial instruments is not a source of market risk, but a source of COUNTERPARTY RISK
8
Q
Which of the following is not a source of “asset risk” for an insurance company?
A) Market risk
B) Longevity risk
C) Counterparty risk
D) Liquidity risk
A
B) Longevity risk is a source of UNDERWRITING RISK, not asset risk
9
Q
Why is decreasing (persistently low) interest rates an issue for insurance companies?
A
Due to the (normally) longer duration of insurance liabilities cash flows compared to those of assets (negative duration gap), insurers are particularly exposed to a decrease in interest rates and particularly affected by persistently low-interest-rate scenarios (current scenario).
10
Q
Which of the following types of reinsurance offers the largest protection to the ceding company? A) Quota share (proportional) B) Excess loss (non-proportional) C) Surplus (proportional) D) Stop loss (non-proportional)
A
D) Stop loss (non-proportional) offers the largest degree of protection to ceding company
The reinsurer is bound to pay when a loss on the entire portfolio exceeds a certain amount. It is actually insurance against the poor performance of the insurance process related to that portfolio
11
Q
What is reinvestment risk?
A
Due to the nature of the insurance business model, liabilities typically have a longer duration than assets, which results in a negative duration gap (DA-DL*D/E+D).
When invested assets do not have at least the same term as the expected liabilities’ cash-out flows, insurers are obliged to REINVEST. Currently, due to low/negative interest rates, insurers are investing at interest rates that are too low (reinvestment risk).
12
Q
What is a peril? A) the policyholder B) the insured in a reinsurance contract C) the event of damage (fire) D) the damage (burned-down house)
A
C)
Peril: aleatory event impacting the risk unit and create some kind of damage (but not the damage itself)
Example: if we have a risk that a policyholder’s house will burn down, the peril is the fire.
13
Q
What is NOT true about “pure risk”?
A) Uncertain events that in the event of occurrence produces negative effects
B) Event that could generate either loss or a profit (upside and downside risk)
C) Underlying category (line of business) incl. property risk, liability risk and personal risk
A
WRONG: B) Events that could generate either a loss or a profit are defined as “speculative risks” - not pure risk, which concerns only the downside risks
14
Q
In the context of pure risk, an underlying category is LIABILITY risk. What characterizes this specific line of business?
A) Deals with things that are owned by an individual. E.g., the house, car, jewelry, etc.
B) Deals with protection against claims resulting from injuries and damage to OTHER people or property
C) Deals with a person. E.g., death, injury, other need for medical attention, etc.
A
B) Liability risk deals with protection against claims resulting from injuries and damage to OTHER people or property.
Property risk: deals with things that are owned by an individual. E.g., the house
Personal risk: deals with a person. E.g., death, injury, other need for medical attention, etc. to the policyholder
15
Q
The insurance process has two fundamental features: select two:
A) Transferring risk
B) Sharing losses
C) Retaining the risk
D) Reduction of the possibility/ intensity of pure risk
A
The process has two fundamental features:
- Transferring risk: from one individual to a group of individuals
- Sharing losses: all members of the group (portfolio) pay a premium, which is how the losses of those hit by the unfortunate event are covered.
WRONG: retain risk means doing nothing, while reducing the intensity/possibility of risk occurrence refers to the policyholder’s carefulness (Not a part of the insurance process)
16
Q
What is NOT a characteristic of the a posteriori probability?
A) the probability of an uncertain future event computed based on an empirical study of past experience
B) it is an actuarial concept
C) It helps the insurance company determine premium price
D) It is the MOST accurate way to estimate the probability of an adverse event
A
WRONG: D) It is useful in determining the probability of occurrence, since it provides with basis for forecast.
BUT, it is less accurate than a priori probability computation
A priori probability: the probability based on the underlying conditions that cause the event
(e.g. the probability of heads turning up when tossing a coin is ½), which can be assumed as
the BEST estimate of the probability that the event will occur in the future
17
Q
How is the Law of Large numbers linked to A Priori probability and A Posterior probability?
A
The observed frequency of an event (A Posteriori probability) more nearly approaches A Priori probability as the number of trials approaches infinity.
After observing the proportion of the time that the various outcomes have occurred within a large sample of risk units over a long period of time, under essentially the same risk exposure conditions, it is possible to construct a probability distribution. The A Priori probability assigned to the event can be approximated by the mean of the probability distribution.
This is the probability at which the outcome is expected to occur in the future.
18
Q
Why may the Law of Large Numbers improve the estimation of future probability of occurrence of events?
A
Only in this the presence of both large PAST SAMPLE SIZE and large SIZE OF THE GROUP of risk units in a portfolio, the law of large numbers could allow for quite accurate estimations of the future; smaller dispersion of the individual value from the mean of the probability distribution, and more stable risk conditions.
With the law of large numbers applied, things will in a large degree continue to happen in the future as they have happened in the past.
19
Q
What does “stability of conditions” mean?
A
Stability of Conditions refers the when things continue to happen in the future as they have happened in the past - which allows for more accurate predictions of the probability of certain events’ occurrence.
The stability of conditions can be achieved when the estimate of past events’ occurrence is accurate thanks to the law of large numbers.
20
Q
What is the problem with self-insurance? Choose 2
A) does not require a risk evaluation process
B) losses are never fully covered
C) losses are difficult to predict, and the self-insurer may save up a wrong amount of funding
D) poses opportunity costs for the self-insurer
A
Correct: C and D
The problem with this strategy is that the self-insuring individual doesn’t know how much to set aside as risk provision to fund possible losses, which eventually leads to opportunity costs of the capital parked, and the risk that the saved-up amount is not enough to cover the expenses connected to the damage.
Therefore, self-insurance is NOT EFFICIENT/ EFFECTIVE
21
Q
Which of the following characteristic of an “unfunded mutual insurance plan” is WRONG??
A) Firms with similar risks of loss and are relatively uncorrelated pool together their risk
B) All units split evenly any accident costs that the participants might incur
C) Entails greater counterparty risk than funded mutual insurance plans
D) Entails smaller counterparty risk than a funded mutual insurance plan
A
WRONG: D)
An unfunded mutual insurance plan entails higher counterparty risk than funded mutual insurance plans, because in the former case, the participants have not made advance payments for the expected future losses - thus, some may choose not to pay if the event occurs.
22
Q
What is NOT a characteristic of a FUNDED mutual insurance plan?
A) All participating parties agree to make an advance payment for predicted future losses for the group
B) The type of risk management pooling seen in the insurance business
C) Has no drawbacks
D) Each participant exchanges an uncertain loss for a certain cost (the advance payment)
A
WRONG: C)
The drawback of a funded mutual insurance plan is that the payment of any participant is independent of whether any given individual will actually incur a loss (the cost is certain). Meanwhile, it can be very difficult to predict future losses in advance, which may lead to wrong estimation of the advance payment amount necessary
23
Q
What does a “Pooling agreement” mean?
A
Multiple parties (2+) agree to execute risk pooling - that is, each party agrees to pool their resources and split evenly the accident costs that may arise within the pool of participants.
24
Q
What is NOT a benefit of risk pooling?
A) reduction of expected loss per party
B) reduction of standard deviation for the probability distribution of the group as a whole
C) higher predictability of future loss events as the number of participants increases
A
WRONG: A) reduction of expected loss per party is NOT the case. Typically the expected loss per party is independent of the number of participants in the pool and independent of whether the risk is pooled at all.
With pooling, and due to the law of large numbers, the standard deviation of the probability distribution will decrease for the group as a whole, and this decrease is further intensified as number of participants in the pool increases.
25
What are NOT a condition for efficient pooling? Choose 1-3
A) Independence: the occurrence of loss for one party must not affect the probability of occurrence for others in the pool
B) Equal distribution: all risk units are exposed to similar risks (type and intensity)
C) Experience rating: the premium paid by each individual affects the price of future premiums to be paid by that individual
D) Normal distribution
WRONG: C) Experience rating is a method to avoid/ decrease adverse selection issues - but NOT a precondition for efficient pooling.
D) Normal distribution is a potential effect that arises as the pooling agreement becomes larger (more participants) - thus, it is a product, NOT a condition for efficient pooling.
26
As a pooling arrangement becomes larger (more participants), which are the two effects that will occur?
1. Law of large numbers: Standard deviation of each participant’s cost gets closer to zero. I.e., the risk of gaps between expectations and actual occurrence becomes lower for each participant.
2. Approaching normal distribution: The probability distribution becomes more and more bell shaped until it eventually equals a normal distribution
27
Is pooling not beneficial if the two conditions (independence and similarity in terms of risk) are not met?
Pooling will still be beneficial if the two criteria for efficient pooling are not met.
Pooling will still decrease the standard deviation of average loss when the number of participants increases.
The participants do NOT need to be INDEPENDENT, but they MUST NOT be PERFECTLY CORRELATED - i.e., they must be SUFFICIENTLY INDEPENDENT and SUFFICIENTLY SIMILAR in terms of probability distributions.
The two conditions are NOT NECESSARY for pooling to be beneficial, but the more they are true, the more is the efficiency of the pooling.
28
Explain the effect that CORRELATION between risk units in a portfolio has on risk reduction.
Risk is not reduced when losses are perfectly positively correlated; risk is reduced only when there is less than perfect positive correlation, but not as much as when losses are fully uncorrelated and completely independent.
29
As the number of participants in the pooling arrangement increases, what is NOT the case?
A) The probability of extreme outcomes (very high or low average loss) decreases
B) The probability that the average losses (amount paid by each participant) will be close to the expected loss increases
C) The probability distribution of each risk unit's cost becomes more bell-shaped
D) Decreases the expected loss
E) Non of the above
WRONG: D) expected loss is NOT decreased - only the probability that the losses materializing will be closer to the expected average loss - that is, the predictability of correct contribution (premium) increases.
30
How is a pool's expected loss calculated?
Expected loss = probability of occurrence*loss if occurred*number of participants
31
A pooling risk management strategy transforms a pure risk for individuals into a speculative risk for the insurance company. Why?
Insurance companies require a premium that is higher than the amount of expected losses in the pool. I.e., they have higher coverage, while the insurer’s probability for positive payout (profit) becomes larger.
I.e., the negative side of the speculative risk for the pool decreases.
32
What does it mean that insurance companies have an "inverted production cycle"?
Inverted production cycle: revenues precede costs in the production cycle of insurance companies. This means that liquidity is less important since revenues are generated before costs are incurred.
However, risks are connected to whether your revenue is large enough to cover losses that occur in the future, making the loss estimation essential.
33
What is NOT a characteristic for a pure risk to be insurable?
A) a large number of homogeneous and independent units
B) The loss produced by the risk must be measurable
C) The loss must be fortuitous or accidental
D) Must be a result of a catastrophic event
WRONG: D) In principle, the process does not work well if a loss is produced by a catastrophic event (loss incurred by a larger percentage of units at the same time). Such a loss makes many exposure units dependent on each other, and NOT INSURABLE
The following must be true in order for a pure risk to be fully insurable:
- There must be a sufficient LARGE NUMBER of HOMOGENEOUS (similar probability distribution) and, independently exposed units.
- The loss produced by the risk must be definite or MEASURABLE.
- The loss must be fortuitous or ACCIDENTAL
34
Why may insurers deviate from the theoretically optimal risk pooling and premium?
Often, insurers accept a lower insurance performance of the portfolio in exchange for the faster and wider acquisition of financial resources (premiums) to invest.
Meanwhile, competition pressure can prevent an accurate selection and pricing of the risk units or even push to underwrite risks which are not fully insurable.
35
What is a cross-subsidization strategy? And why can it be useful?
A cross-subsidization strategy could be implemented between different lines of business to create diversification.
i.e., performing well in one line of business can be used to compensate for less optimal performance in another line of business.
This strategy may be implemented to reduce the adverse effects of suboptimal pooling (choosing risk units that deviate from theoretical optimal)
36
Which are the two key risks for insurance companies?
A) Insurance risk
B) Default risk
C) Moral Hazard
D) Investment risk
A and D:
Insurance risk: the possibility that the actual risk experience of the portfolio is more costly than the estimation made when the advance payment was determined – i.e., the pool of premiums is not sufficient to cover the pool of losses.
Investment risk: the possibility that the return on the investment activity is negatively or not sufficient to achieve the expected targets (e.g., to compensate expected insurance losses), or lower than any estimation made in the calculation of the advance payment.
37
What are the consequences of the inverted production cycle?
A) Importance of correct pricing
B) Premiums should be invested temporarily
C) The insurance activity must be controlled by public authorities
D) All of the above
D) All of the above
38
Why is correct pricing important in insurance given the inverted production cycle?
Correct pricing is crucial since it determines the success of the insurance company business. Wrong determination of premium exposes the insurance to the risk of being unable to cover the expenses actually materializing.
39
What is meant by "premiums should be invested temporarily" in the context of an inverted production cycle?
Premiums should be invested temporarily: insurance companies have a large time span from the receival of advanced payment to their payment obligation arise – which leaves these companies with immense capital resources that must be allocated in investments to generate an additional source of profit or to be more competitive in premium pricing (efficient asset allocation allows room for lower premium price)
40
Why must the insurance activity be controlled by public authorities as a consequence of the inverted production cycle?
Since insurance companies collect premiums and invest this capital, they are essentially investing and managing financial resources that are not owned by the insurer, but by the policyholders. I.e., the asset allocation should fit the need of the policyholder in terms of potential future claims.
41
The inverted production cycle is a source of "the typical risk"/ "underwriting risk" for an insurer - what is this risk?
The underwriting risk for the insurer is NOT related to the uncertainty of whether an adverse event will occur, but to the possibility of differences (GAPS) between the actual damage in the portfolio of risk units and the estimated damage that is at the basis of premium calculation. I.e., they risk that the premiums received are not high enough to cover the amount of claims.
42
What does it mean when a gap (in the context of underwriting risk) is "normal"? How is this normal gap managed?
Normal gaps: normally, you can easily have to a certain extent of a gap between the estimation of the actual loss. Due to this, insurance companies always add a certain amount (risk loading) on top of the best estimate of potential losses, when determining the premium
43
What does it mean when a gap (in the context of underwriting risk) is "systematic"? How is this systematic gap managed?
Systematic gap: is when the gap is always in the same direction – either positive or negative. In this case, the insurer can draw the conclusion that the premium best estimate is wrong, and there is a need to reprice the premium price.
44
What does it mean when a gap (in the context of underwriting risk) is "exceptional"? How is this exceptional gap managed?
Exceptional gap: e.g., when the gap is consistently positive (or 0), but suddenly, it becomes negative in a given year.
Here, the countermeasure is to set aside a certain amount of cash as a cushion in the good years for such events when they occur in a bad year.
45
What is NOT a factor affecting the frequency and intensity of gaps?
A) Homogeneity (similarity) between risk units
B) Number of risk units
C) Independence among risk units
D) Stability of conditions
E) All of the above
All answers are correct - they are the factors affecting the frequency and intensity of gaps.
46
Why are insurance companies sometimes forced to perform imperfect portfolio selection?
Normally, a number of difficulties and constraints do not allow selecting the ideal risk units to be included in the portfolio (portfolio selection)
Examples include competitive or financial pressures, leading to necessary imperfect selection of risk units in the portfolio.
47
Which of the following is NOT an action that an insurance company can implement to reduce its underwriting risk?
A) Contractual conditions and limitations
B) Specific pricing methods
C) Reinsurance
D) All of the above
D) All of the above
After having selected the units, insurers can (e.g., under imperfect portfolio selection) implement actions to reduce the riskiness of the portfolio (the underwriting risk). In particular:
• Contractual conditions and limitations
• Specific pricing method
• Reinsurance
48
What is "insurable interest" in the context of an insurance contract?
Having an insurable interest means that the purchaser of insurance coverage must be at risk to sustain economic losses (pure risk) as a precondition for receiving a benefit (a compensation) under insurance of that risk.
Insurable interest is required for a contract to be considered an insurance contract.
49
What does "reimbursement of expenses" mean in the context of insurance contract benefits?
Reimbursement of expenses: the contract provides that in case of the occurrence of a given adverse event, the insurer will compensate the policyholder for up to a certain amount/percentage of the loss incurred by the policyholder
E.g., a policyholder can get medical expenses reimbursed by the insurer up to a certain amount/%.
50
What does "indemnity" mean in the context of insurance contract benefits?
Is a contract where the amount of compensation in event of damage is determined by an estimation of the loss. Different from reimbursement expenses, these losses can be difficult to quantify.
E.g., if a policyholder has had a car crash, the amount of damage is firstly estimated by the insurance company, before determining what the policyholder should receive as compensation
51
What does "forfeiture amount" mean in the context of insurance contract benefits?
Forfeiture amount: a contract where, in case of a damage event, the compensation paid to the policyholder is pre-determined. There is no need to make an estimation of the loss since the compensation amount has already been determined in the contract.
52
In life insurance, what type of benefit is typically received by the policyholder?
Forfeiture amount: a contract where, in case of a damage event, the compensation paid to the policyholder is pre-determined. There is no need to make an estimation of the loss since the compensation amount has already been determined in the contract.
This is the typical type of benefit that a policyholder will receive in life insurance, since it would be very difficult to determine the value of a life in the event of a death.
53
Which type of benefit is typically common in non-life insurance?
A) Reimbursement of expenses
B) Forfeiture amount
C) Indemnity
D) A + B
E) A + C
E) A + C
Reimbursement of expenses and indemnity are often the structure of benefits in non-life insurance, while forfeiture is more often the structure in life insurance.
54
What are two features that make insurance contracts aleatory (random)?
The two essential features that make the insurer’s obligation random are the
- AMOUNT: the monetary size of what the insured party gets if the insurance contract pays off.
-TRIGGER: determines if and when this amount should be paid.
In order for a contract to be “random”/ aleatory, and therefore to be recognized as insurance, the trigger and/or the benefit amount of the insurance contract must be based on an uncertain event, where the uncertainty has not been fully resolved at the policy’s inception.
55
What is the "principle of indemnity"?
The principle of indemnity states that the insurer agrees to pay no more than the actual amount of the loss borne by the policyholder.
The purpose of the principle of indemnity is to reduce moral hazard - prevent the policyholder from deliberately profiting from a loss.
56
What are the two overall types of insurance contracts based on the structure of benefit payment?
A) Valued contract
B) Forfeiture contract
C) Indemnity contract
D) Peril contract
Insurance contracts can be classified into two classes:
- Valued Contract: the amount that the insurer pays is pre-established at the time the inception of the contract, without any regard to the actual amount of loss caused by the event.
- Indemnity Contract: the amount that the insurer pays is determined after the occurrence of a loss, and the amount paid equals or is proportionate to the value of the loss.
57
What is "adverse selection" in the context of portfolio selection?
Adverse selection: When an insurer cannot distinguish between a “good” and a “bad” unit (in terms of riskiness), the premium charged will be based on some average estimation across both types of customers.
58
What does moral hazard mean in the context of insurance?
Moral hazard: arises from hidden action. Insurance contracts may lessen the policyholder's attention to risk prevention, knowing that compensation will be paid in case of the event happening.
59
Which of the following actions can be taken by the insurance company to decrease the risk of adverse selection? Select 1-5
```
A) contractual clauses
B) individual ratings
C) experience rating
D) deductibles
E) class rating
```
B) individual ratings
C) experience rating
E) class rating
Are tools that allow for more precise risk rating
60
What is "individual rating" in terms of risk rating methodologies?
In principle, the best methodology would be to asses each risk unit individually, where pricing of premium is based on the actual loss experience of the specific risk unit.
This is, however, very time-demanding and perhaps infeasible in reality.
61
What is "class rating" in terms of risk rating methodologies?
Class ratings: for practical reasons, faster methodologies than individual ratings are necessary. With class ratings, the insurance company first defines classes for a given risk based on a risk proxy of risk intensity, then classifies the risk units (policyholders) into the most fitting class ratings.
62
What is "experience rating" in terms of risk rating methodologies?
```
Experience rating is a way to limit any inaccuracy of “class rating”.
Under this method, risks are priced based on class rating, but in the following periods, the price is somehow adjusted based on the actual loss experience of the specific risk unit.
```
63
Which of the following actions can be taken by the insurance company to decrease the risk of moral hazard? Select 1-6
```
A) Deductibles
B) Franchises
C) Experience rating
D) Exclusions
E) Class rating
F) Policy limits
```
```
Correct measures for limitation of moral hazard:
A) Deductibles
B) Franchises
D) Exclusions
F) Policy limits
```
64
What is a characteristic of a fixed deductible? Select 1-5
A) a contractual provision of a specified amount where if the claim is above this limit, the insurer pays the amount above the limit (selvrisiko)
B) can be straight: apply to any single loss
C) can be aggregate: apply to the sum of all losses occurring during a specified period.
D) Measured in % terms
E) a contractual provision of a specified amount where if the claim is above this limit, the insurer pays the entire amount of loss
F) primarily used in non-life contracts
G) primarily used in life contracts
A FIXED DEDUCTIBLE is:
A) a contractual provision of a specified amount where if the claim is above this limit, the insurer pays the amount above the limit (selvrisiko)
B) can be straight: apply to any single loss
C) can be aggregate: apply to the sum of all losses occurring during a specified period.
F) primarily used in non-life contracts
65
What is a characteristic of a percentage deductible? Select 1-7:
A) a contractual provision of a specified percentage where if the claim is above this limit, the insurer pays the amount above the limit (selvrisiko)
B) is be a fixed quantity
C) is a percentage of the loss
D) a contractual provision of a specified percentage where if the claim is above this limit, the insurer pays the entire amount of loss
E) primarily used in non-life contracts
F) primarily used in life contracts
A PERCENTAGE DEDUCTIBLE is:
A) a contractual provision of a specified percentage where if the claim is above this limit, the insurer pays the amount above the limit (selvrisiko)
C) is a percentage of the loss
E) primarily used in non-life contracts
66
What is true about "Franchise" in the context of contractual provisions?
Select 1-4
A) a threshold is determined, and the claim amount must exceed this in order for the insurer to be liable for the entire amount
B) a threshold is determined, and the claim amount must exceed this in order for the insurer to be liable for part of the amount
C) reduces moral hazard
D) eliminates small claims that are expensive to handle and process
E) reduces the premium price paid by policyholders
F) mostly used in non-life insurance
In a franchise (contractual provision for non-life)
A) a threshold is determined and the claim amount must exceed this in order for the insurer to be liable for the ENTIRE amount
C) reduces moral hazard
D) eliminates small claims that are expensive to handle and process
E) reduces the premium price paid by policyholders
F) mostly used in non-life insurance
67
Why do deductibles and franchises reduce the premium paid by the policyholder? Is this good?
Reduce premiums paid by the insured:
Contracts including the provisions such as deductibles and franchises are less expensive than if the policyholder was to be fully compensated for the loss from every adverse event.
It is beneficial since the premium price becomes more competitive, while the insurance company also saves money through these provisions.
68
What are the benefits for the insurance company in the context of contractual provisions: deductibles and franchises?
A) Elimination of small expensive-to-handle claims
B) Reduction of premiums paid by the policyholder
C) Reduction of moral hazard - removing policyholders' incentive to "profit from a damage"
D) Reduction of adverse selection
All of the options are correct, except reduction of adverse selection.
69
What is NOT true about a policy limit?
A) It is a contractual provision
B) an upper limit of the amount of coverage
C) allows for easier determination of premium price since worst case is known
D) always used in property insurance due to the indemnities otherwise being potentially unlimited
E) always used in liability insurance due to the indemnities otherwise being potentially unlimited
F) Mostly apply to life insurance
WRONG:
- D) policy limits are always used in LIABILITY insurance due to the indemnities otherwise being potentially unlimited.
- F) policy limits are mostly (exclusively) used in non-life insurance - NOT LIFE INSURANCE
70
What is the rationale for having "exclusions" as a contractual provision?
A) Avoid losses for a risk unit to be positively correlated to the losses of another unit: This explains why losses from war, nuclear accidents, and catastrophic events like floods and earthquakes often are excluded
B) When coverage is not needed by the typical buyer - i.e., exclusion of events that are too specific and does not apply as a risk to the portfolio as a whole
71
What of the following is NOT a characteristic of life insurance contracts?
A) Valued contracts
B) A combination of protection and investment
C) Amount of compensation (benefit) is pre-determined prior to the occurrence of the event
D) Timing of the uncertain event is certain
E) Long-term contract
F) Can be surrendered before maturity (but after minimum x years)
WRONG: D) Timing of the uncertain event is UNcertain
72
It easier to get access to relevant statistics when determining the probability of a future event in life insurance.
True or false?
True.
The number and the quality of these data can allow the calculation of quite accurate probabilities, such as mortality in life insurance contracts as opposed to non-life
73
In life insurance, two classes of events trigger the compensation - what are these two classes?
Death: such contracts protect the beneficiary (e.g., family) from the risk of death of the policyholder (insured) and the consequent loss of income.
Survival: : such contracts protect the policyholder from the “risk” of living too long, providing a lump sum or a regular income from a certain date
74
Following is NOT true about Term Insurance:
A) it is a type of life insurance covering the event of a need for resources at retirement (survival)
B) the insurer will pay a fixed amount upon death of the policyholder to beneficiaries (e.g. family)
C) has always a definite time frame (e.g. 10Y).
D) the time of payment and the occurrence of the payment is uncertain for the insurer
WRONG: A) it is a type of life insurance covering the event of DEATH - not survival.
75
Following is NOT true about whole-life insurance:
A) it is a type of life insurance where benefit payment is triggered by the death of the insured
B) a fixed amount is paid by the insurer in the event of death
C) the duration of the contract corresponds to the life of the policyholder - no expiration
D) the timing of payment and whether the benefit payment will occur is uncertain
WRONG: D) the timing of the payment is uncertain, BUT the occurrence of the payment at some point is certain
76
Following is true about Pure Endowment Insurance:
A) it is a type of life insurance where benefit payment is triggered by the death of the insured
B) The policyholder pays a premium in exchange for an agreed-upon benefit amount (one amount) if the insured is alive after a stated maturity.
C) the insurer pays annuities to the policyholder as long as he/she is alive beyond a preset date.
TRUE: B)
In a Pure Endowment Insurance contract, the insured pays a premium at policy issue (or a sequence of periodic premiums, from policy issue onwards), and will get an agreed amount at the stated maturity if he/her is alive at that specified date of time.
77
What is NOT a characteristic of an annuity (life insurance)?
A) it is a type of life insurance where benefit payment is triggered by survival
B) the insured receives a fixed or with-profit annuity from a certain date as long as the policyholder is alive
C) payout provides a regular income that starts around at retirement age
D) all of the above are true
D) All of the options are true.
In an annuities contract, the insurer will pay out either fixed or with-profit annuities from a certain date until the insurer is alive. Pay-out usually starts around retirement age. The survival does not post a loss, but a financial need that is covered with this insurance.
78
Is it possible for a policyholder to be insured against death AND survival?
Yes/No
Yes - a combination of death and survival insurance exists, where the policyholder is insured to be paid a certain amount given death within e.g., 10 years, and meanwhile, the policyholder will also receive a certain amount given survival beyond the 10 years.
79
How is premium payment structured in life insurance contracts? Choose 1-3
A) Single premium: one-off payment at the beginning of the contract
B) Recurring premium: premium payments whenever the policyholder wishes
C) Annual or regular premiums: premiums paid at regular intervals
All of the three payment structures can be the case in life insurance premium payment: annual/regular, single and recurring
80
In a "traditional" life insurance contract, the following is NOT true:
A) benefit received by the policyholder can be "fixed or "with profit"
B) time-value of money is considered by the insurer in the benefit payment
C) the policyholder bears the investment risk - if investments go south, benefit payout decreases
WRONG: C) the policyholder bears NO investment risk: a minimal return is guaranteed in a with-profit contract, and the total return is guaranteed in a fixed contract.
81
What is the difference between a fixed and with-profit contract? (Both are underlying structures of a "traditional" life insurance contract)
In a fixed contract total return is guaranteed, and there is no participation in excess profits that the insurer makes in its asset allocation.
In a with-profit, a minimum return is guaranteed, but policyholders also participate in excess profits from investments (so-called bonuses)
82
In "linked" life insurance contracts, the following is true:
A) The policyholder bears the investment risk: if the investor (insurer) is not able to generate enough investment return compared to the market rate, benefit payment is relatively lower
B) Unit-linked and Index-linked contracts' popularity is negatively correlated with market interest rates
C) The need for consideration of the mortality or survival of the policyholder is minimized since the contract is designed such that the benefit payment will be similar in any case (death vs survival).
D) Linked contracts are more expensive than traditional contracts because you have asset management costs
E) All of the above
E) All of the above are true for linked life contracts.
83
What is the difference between unit-linked contracts and index-linked contracts?
Unit-linked products: the value of the benefit is linked to the value of an underlying mutual fund. The monetary value of the return depends on the value of the unit at the time of the payment.
Index-linked products: same as unit-linked, but the value of the benefit is linked to an underlying financial index.
84
In what sense is the insurance company exposed to investment risk in a "with-profit" contract?
Since there is a minimum financial guarantee in a with-profit contract, the insurer (investor) risks that the return from investment is lower than the guaranteed interest rate to policyholder - so it has to cover the gap using its own financial resources
85
What is true about a "surrender"
A) it is an important element of life insurance contracts
B) allows the policyholder to end the contract before its term and encash the benefit as provided in the contract for earlier encashment
C) penalties are envisaged in the event of surrender right execution
D) introduces an additional uncertainty (surrender risk) for the insurer in terms of timing of payments (liquidity problems)
E) All of the above
E) All of the above
86
What is surrender risk?
Surrender risk is the uncertainty that is faced by life insurance companies, stemming from the uncertainty of whether and how many policyholders will surrender (terminate the contract before maturity). This may cause cash flow and liquidity problems.
87
Following is NOT true about "fair premium"
A) sufficiently covers expected benefits and other expenses incurred by the insurer + provide with a fair return on invested capital
B) seldom the actual premium charged by the insurer
C) a premium reflecting what SHOULD theoretically be charged on an insurance policy
D) takes into consideration competitional pressures in the market and demand/supply forces
D) the fair premium NEGLECTS any market forces - it is simply a theoretically correct premium to be charged, but is often infeasible due to competitive pressures
88
```
Fair insurance premium is determined by which components? choose 1-4
A) Expected benefit costs
B) Investment income
C) Expense loading
D) Investment loading
E) Risk loading
```
Fair premium is comprised of:
Expected benefit costs, investment income, expense loading and risk loading
NOT INVESTMENT LOADING
89
Expected benefit costs is NOT:
A) based on estimates of the cost of potential claims in the future
B) the amount necessary to cover all estimated future losses (claims)
C) estimation of expected benefit costs is equal to the product of expected frequency and intensity of loss, which corresponding probability distribution should be assessed separately.
D) In life insurance, expected benefit costs should also assess the timing of occurence since maturity is long
E) Expected benefit cost in non-life is calculated as:
-> E(B) =E(frequency) + E(intensity)
WRONG: E:
Estimation of expected benefit costs is equal to the PRODUCT of expected frequency and intensity of loss, which corresponding probability distribution should be assessed separately.
E(B) =E(frequency) * E(intensity)
90
How is statistical premium P per risk unit calculated? You are given following information:
- "n" risk units = 20
- "r" claims = 5
- "D" total amount of claims = 50
```
P = (r/n)*(D/r)
P= (5/20)*(50/5) = 2.5
```
91
What is discounted expected benefit costs?
When the premium price is determined based on the expected future benefit costs, taking into consideration time-value of money.
That is, the premium price is lower than the expected benefit costs because the advance payment is worth more than the same amount in benefit payments in the future.
92
How is discounted expected benefit cost calculated?
The size of the discount of the expected benefit cost depends on:
- The interest rate which is used (guaranteed to policyholders)
- The length of the period which the premium is related to
P=Benefit Payment/(1 + r)^t
93
Why does pricing the premium based on discounted expected benefit costs pose an additional risk to insurers?
The size of the discount of the expected benefit cost depends on:
- The advance interest rate which is used (guaranteed to policyholders)
- The length of the contract period which the premium is related to (pay-off tail)
So, there is a risk that the pre-determined interest rate which has been guaranteed to policyholders is higher than the actual return earned on the insurer's investment.
94
What is investment risk in insurance?
When the premium calculation takes into consideration time-value-of money (the expected benefit costs in the future is discounted to today's term), it results in the premium price paid today being lower than the estimated claim costs. The insurer does this because it believes that it can generate an investment return that will cover the higher benefit amount in the future.
Investment risk is the risk that the insurer is unable to achieve the estimated investment return, and the guaranteed interest rate to policyholders is therefore higher than the achieved investment return - the insurer looses money.
95
Investment risk is a significantly larger risk for life-insurers than for non-life insurers
True/False?
TRUE:
The investment risk could end up to be the most significant risk for insurers, in particular for life insurers.
This is because the term of life contracts are much longer, which entails more uncertainty of market developments and investment returns as rates change over e.g., 10 years.
96
Is investment risk larger in with profit contracts or traditional fixed contracts?
Other thing being equal, in "with profit contracts", the investment risk for insurers is LOWER than in traditional fixed contracts, as the interest rate “transferred” to the policyholder is not fixed at inception and normally is not guaranteed in a "with profit"
97
What is NOT true about Expense Loading?
A) the insurance premium must be able to cover all of the administrative costs connected to the insurance business - this is the expense loading
B) is typically higher for life-insurers than non-life insurers due to the loss adjustment expenses
C) calculated on the basis of administrative costs, incl. general, distributing and loss adjustment expenses
WRONG: B) administrative costs (and therefore expense loading) are typically higher in non-life insurance lines, due to the presence of loss adjustment expenses
98
Following is NOT a category of administrateive costs included in expenses loading:
A) General Expenses
B) Loss Adjustment Expenses
C) Asset Management Expenses
D) Distribution Expenses
WRONG: C) is not a category of administrative expenses.
General: salaries, office rent, and other expenses that are NOT directly linked to insurance business
Distribution: commissions paid to brokers and intermediaries who distribute policies to the policyholders - directly linked to insurance business
Loss adjustment expenses: costs associated with processing claims (compensation to loss adjusters)
99
What is risk loading?
```
Risk loading (or profit loading) is a source of expected profit and a cash cushion decreasing exposure to losses.
It is obtained by the insurer charging premiums in EXCESS of discounted expected benefit costs and administrative costs. This extra amount is profit/risk loading.
```
100
Which of the following factors affect risk/profit loading NEGATIVELY?
A) magnitude of the pool
B) correlation in benefit payment across policyholders
C) homogeneity of riskiness among risk units
D) the pressure of competitors
E) the return required by capital providers
(-) Magnitude (size) of the pool
(+) Correlation in benefit payments across policyholders
(-) Homogeneity of riskiness among risk units
(-) the pressure of competitors
(+) the return required by capital providers
101
What is NOT a purpose of risk/profit loading?
A) to cover GAPS between actual and best estimate of claims
B) to increase the homogeneity of the risk units in a portfolio and thereby reduce risk
C) to provide an additional source of expected profit for insurer
WRONG: B) risk loading does not increase the homogeneity of the risk units in a portfolio
102
Calculate the fair premium of the following group:
- contract term: 1Y
- interest rate: 10%
- administrative expenses: 20% of expected claim payment
- profit loading requirement: 5% of expected claim payment
- Claim probability distribution: 10%=10k & 90%=0k
Expected benefit costs = (0.01)*10,000=1000
Discoutned expected benefit costs = 1000/(1.1)^1 =909.09
Expense loading = 0.2(1000) = 200
Profit loading = 0.05(1000)=50
Fair premium = 909.09+200+50=1,159.09
103
The differences between the estimation of the fair premium and the actual cost experienced are the main source of losses AND profits for the insurer
True/False?
GAPS between expected benefit costs, expenses loading and profit loading and the actual amount of these three amounts realized is the source of LOSSES and PROFITS for the insurer.
104
IT innovations and big data have significantly helped insurance companies in two ways - which 2?
A) to more optimally select the risk units to be included in the portfolio
B) to calculate more accurate prices associated to risks
C) improved the ability to detect moral hazard
D) improved insurability of all risk units
IT and big data impact insurance companies positively by allowing for:
A) more optimal selection of the risk units to be included in the portfolio
B) more accurate calculation of prices associated to risks
Note: only in extreme cases will IT impact the insurability of certain risk units
105
What is the main source of risk for life-insurance companies?
The estimation of financial assumptions used in the financial guarantee --> investment risk
The risk that the insurer is unable to meet the financial guarantees because the investment return is lower than what it has released in terms of interest guarantees to policyholders.
Therefore, it is of significant importance that discount rate or other interest guaranteed (guaranteed profit allocation) is estimated properly and accurately. This is the main source of risk for life-insurance.
106
How do the following components affect the solvency index (the risk of the insurer)?
A) risk loading
B) size of "own funds"
C) the riskiness of portfolio
A) Risk loading (+): the higher the risk loading, the higher the solvency index, and the higher the security that the gap of estimated and actual claims is minimized
B) Size of "own funds" (+): this is the equity of the company - the higher the own funds, the higher the ability for insurer to cover unexpected losses - the higher the solvency index
C) Riskiness of portfolio (-): this is inversely correlated with solvency index, measured by st. dev of the claims probability distribution. The higher the risk, the lower the solvency index
107
Which of the components of the solvency index can best be adjusted by the insurer to achieve its intended solvency index?
A) Applied risk loading
B) Available own funds
C) Riskiness of portfolio
CORRECT: C) Riskiness of portfolio
Each of these factors have some constrains:
A) RISK LOADING: the insurer cannot increase the premium infinitely due to competitive pressures, demand, supply etc.
B) AVAILABLE OWN FUNDS: insurer cannot infinitely increase its own funds by asking shareholders.
C) PORTFOLIO RISK: is the component that the insurer has better ability to adjust. This can be reduced by e.g., using reinsurance.
108
Explain how reinsurance can imrpove quantitative harmonization of a portfolio
The theoretically optimal portfolio selection (homogeneity of claim probability distribution; uncorrelated risks; large size) is difficult to achieve in practice. Thus, insurers can transfer the excess of risks of certain policyholders to a reinsurer, leaving the retained portfolio more harmonized from a quantitative POV.
109
What are the TWO main types of reinsurance contracts?
```
A) Faculative contract
B) Valued contract
C) Indemnity treaty
D) Index-linked contract
E) Automatic treaty
F) traditional contracts
```
A) Faculative contract: the risks are considered INDIVIDUALLY by both parties. Each risk is submitted by the ceding company to the reinsurer for acceptance or rejection, and the ceding comp is not bound to submit the risks in the first place.
E) Automatic treaty: the reinsurer agrees in advance to accept a portion of the gross line of the ceding company/ a portion of certain risks in a portfolio. The ceding comp is obliged to cede a portion of the risk to which the automatic treaty applies. Here, a portion of ALL RISKS IN A PORTFOLIO is covered. This is most normal.
110
What does NOT characterize a proportional reinsurance contract?
A) the premium paid by ceding company is a share of the original premium paid by the policyholder of the insurance
B) An underlying category of a proportional contract is called "quota share"
C) An underlying category of a proportional contract is called "surplus"
D) the premium paid by ceding company is a share of its benefit cost estimation
D) the premium paid by ceding company is a share of the original premium paid by the policyholder of the insurance - NOT a share of the insurer's benefit cost estimation
111
What is NOT true about a quota share contract?
A) it is an underlying category of a proportional reinsurance contract
B) The direct insurer and the reinsurer agree to share the amount of each risk on some percentage basis
C) This contract increases the reinsurance capacity of the insurer
D) This contract allows for better segmenting of portfolio for the insurer
E) This contract allows for quantitative harmonization of the portfolio
A Quota share structure (of a proportional reinsurance contract) E) DOES NOT allow for quantitative harmonization of the portfolio
112
Assume the following scenario: a ceding company pays 20% of its received premium in exchange for transferring 20% of each risk in a portfolio to reinsurer.
What contract is this?
A) Surplus structure of proportional reinsurance contract
B) Quota share structure in proportional reinsurance contract
C) Excess loss structure of "non-proportional" insurance contract
D) Stop loss structure of "non-proportional" insurance contract
B) Quota share structure in proportional reinsurance contract
Here, a percentage of the premium is paid to reinsurer --> proportional
The risk shared is on a percentage basis --> quota
113
The reinsurer agrees to accept some AMOUNT of insurance on each risk in excess of a specified net retention. This type of contract increases the harmonization of the portfolio, increases insurance capacity and segmenting the portfolio.
Premium is paid as a percentage of insurance premium received by the ceding comp by policyholders
What contract is this?
A) Surplus structure of proportional reinsurance contract
B) Quota share structure in proportional reinsurance contract
C) Excess loss structure of "non-proportional" insurance contract
D) Stop loss structure of "non-proportional" insurance contract
A) Surplus structure of proportional reinsurance contract
114
How is the reinsurance premium in a proportional reinsurance contract calculated?
A) The premiums and claims that originate from the direct insurance contract are both divided between insurers and reinsurers in proportion to a certain share of the value of the risk unit.
B) The premium and the losses are not shared proportionally, but the reinsurers commit to paying the value of claims that exceed a certain VALUE. In a non proportional reinsurance contract, the calculation of the reinsurance premium is NOT necessarily a share of the premium of the insurance contract
Proportional: the premiums and claims that originate from the direct insurance contract are both divided between insurers and reinsurers in proportion to a certain share of the value of the risk unit.
115
How are the reinsurance premium in a non-proportional reinsurance contract calculated?
A) The premiums and claims that originate from the direct insurance contract are both divided between insurers and reinsurers in proportion to a certain share of the value of the risk unit.
B) The premium and the losses are not shared proportionally, but the reinsurers commit to paying the value of claims that exceed a certain VALUE. In a non proportional reinsurance contract, the calculation of the reinsurance premium is NOT necessarily a share of the premium of the insurance contract
Non proportional reinsurance: the premium and losses are not shared proportionally, but the reinsurers commit to paying the value of claims that exceed a certain VALUE. In a non proportional reinsurance contract, the calculation of the reinsurance premium is NOT necessarily a share of the premium of the insurance contract
116
Excess loss as an underlying treaty in a non-proportional reinsurance contract is characterized by:
A) reinsurer must pay only when a loss on a SINGLE CLAIM exceeds a certain amount
B) it is more protective for ceding company than a proportional reinsurance contract
C) reinsurer must pay when the loss of a WHOLE PORTFOLIO of certain risks exceeds a certain amount.
D) It is insurance against the poor performance of the insurance process related to the portfolio
A and B are correct:
A) Excess loss: the reinsurer is bound to pay only when a loss on a SINGLE CLAIM exceeds a certain amount. It is more protective for the ceding company than the proportional reinsurance because it works also against a wrong determination of the premium.
NO: D) It is insurance against the poor performance of the insurance process related to the portfolio - this is the case of a "Stop loss" treaty
117
Why is an excess loss (non-proportional reinsurance contract) more protective for ceding company that a proportional reinsurance contract?
An Excess loss (type of non-proportional reinsurance) is more protective for the ceding company than the proportional reinsurance, because it works against a wrong determination of the premium -> in the proportional reinsurance, the sufficiency or insufficiency of the premium is shared between ceding company and reinsurer
118
"Stop loss" is different from "excess loss" as an underlying treaty of a non-proportional reinsurance contract in terms of...
Choose 1-3
A) Coverage: stop loss covers a whole portfolio while excess loss covers single claims
B) Stop loss is non proportional while excess loss is proportional
C) Stop loss insures the ceding company to a larger extent from poor performance of the insurance process related to the portfolio (premium determination and portfolio selection)
A) TRUE: stop loss covers a whole portfolio while excess loss covers single claims
B) FALSE: Stop loss and excess loss are both non-proportional
C) TRUE: Stop loss insures the ceding comp to a larger extent from poor performance of the insurance process related to the portfolio (premium determination and portfolio selection)
119
Spread risk is a:
A) Market risk
B) Counterparty risk
C) Liquidity risk
Spread risk is a counterparty risk. It refers to the deterioration of credit standing of issuers of financial instruments
120
Interest rate is most important in:
A) Life
B) Non-life
C) Reinsurance
A) Life insurance:
Interest rates are particular important in life insurance due to the potential presence of financial long-term financial guarantees
121
What is the immunization target?
The immunization target is reached when a change in assets (liabilities) occurs due to interest rate is exactly offset by the inverse change of liabilities (assets). This can be achieved by perfect immunization with no duration gap
122
Insurance companies tend to have:
A) positive duration gap
B) negative duration gap
C) depends
A) Insurnace companies tend to have a negative duration gap due to the (typically) longer duration of liabilities cash flows compared to asset cash flows
123
If an insurance company has a negative duration gap, is it then exposed to increase or decrease in interest rates?
A negative duration gap exposes the insurer to interest rate DECREASES due to the component of reinvestment (at lower rates) - this is the reinvestment risk.
124
Which of the following is NOT an area that is of focus by the supervisory authority in insurance?
A) Commitments of the insurer towards policyholders is computed properly
B) Insureres must be reinsured to minimize risk of failing to meet obligations
C) Liabilities to policyholders are backed by properly managed assets
D) Insurer has an adequate amount of capital (own funds) to reasonably cover unexpected unfavorable circumstances
WRONG: B) Insureres DONT HAVE TO be reinsured to minimize risk of failing to meet obligations - they can and should
125
What is NOT true about technical reserve?
A) It is a portion of premiums set aside after contract conclusion
B) It is a portion of an insurer's "own funds"
C) The purpose of it is to cover future expected residual obligations and expenses
D) The size of the technical reserve is adjusted over time taking into consideration change in circumstances since the estimation at inception
E) The technical reserve amount is invested in assets (mostly liquid) to generate a concurrent profit
The technical reserve is a portion of premiums set aside after contract conclusion - therefore, B IS WRONG: it is NOT a portion of an insurer's "own funds"
126
If assumptions used to estimate the technical reserve have become more pessimistic, and the required amount in the reserve increases (goes beyond that provided by the premiums), the residual amount in the technical reserve is funded by the “own funds” (shareholders equity), since premium cannot be repriced after contract conclusion.
True/False?
TRUE
127
```
Which of the following are the underlying categories for "Pure premium" in life-insurance?
A) Paid benefits
B) Technical reserves
C) Margin
D) Loading
E) Unearned premium reserve
```
Pure premium: either used for payment of benefits or technical reserves:
- Paid Benefits: claims that have already been made
- Technical Reserves: claims that have not yet been incurred but is expected to in the future
128
On the balance sheet, technical reserve is reported as:
A) asset
B) liability
Since technical reserve constitutes the amount of money that the insurance firm must have to set aside to cover future benefits, technical reserves are a liability for an insurance company.
129
```
Which of the following are the underlying categories for "Pure premium" in non-life insurance?
A) Unearned premium reserves
B) Technical reserves
C) Paid loss
D) Loss Reserves
E) Expenses
```
Pure premium in non-life consists of:
- Paid loss: claims reported, settled and paid
- Loss reserves: incurred (happened) but not paid
- Unearned premium reserves: the expected cost for future claims (still to occur)
130
Which of the following is most difficult to estimte when calculating loss (claim) reserve in non-life?
A) Claim settled but unpaid
B) Claims reported but not settled
C) Claims incurred but not yet reported
C) Claims insurred but not yet reported is most difficult to calculate, since the insurer does not know about the claims yet. This component is incl. in technical reserve because even thought we don't know the amount, we know there is an amount.
131
The technical reserve is most significant in life-insurance compared to non-life
True/ False?
FALSE: In life insurance, the technical (especially claim) reserve is very insignificant: the time that is necessary to settle the claim is very short, because the contract is a valued contract (= no need for calculating the right indemnity) when a claim has been reported
132
The Solvency II regime adopted the prudent-man approach. What is NOT true about the approach?
A) it is based on rigid quantitative restrictions on investment choices for insurers
B) rules are more qualitative in nature
C) suggests that it is up to the firm management rather than regulators to determine the investment policy
D) poses requirements on corporate governance and managers of firms.
WRONG: A) the prudent-man principle is NOT it is based on rigid quantitative restrictions on investment choices for insurers - it is move away from this rigidness that was the case in Solvency I
133
Solvency II seeks to overcome the limitations of Solvency I - one of the main driving elements is "a market-consistent (realistic) approach for valuing all assets and liabilities" - what does this mean, and what is the disadvantage of it?
A market consistent approach for asset and liability valuation means that all assets and liabilities should be reported at the transfer value/ fair value.
Disadvantage: ongoing valuation of B/S, where market changes are incorporated can lead to quite volatile B/S.
134
Solvency II's first pillar requires assets and liabilities to be valued at curret/ fair/ transfer value to determine a "market consistent" valuation of available capital which can be used to cover unexpected losses beyond those estimated in technical provisions. How is available capital calculated?
Avaiable capital (Solvency II) = Assets (transfer value) - Liabilities (transfer value)
135
Following is NOT true about Solvency Capital Requirement (SCR) under Solvency II:
A) calculated based on potential loss given a company's assets and liabilities
B) based on an adverse scenario assumption calibrated to confidence interval 99.5% VAR
C) If available capital is below SCR, ultimate supervisory action will be triggered
D) SCR > minimal capital requirement
C) WRONG:
If available capital is below SCR, supervisory intervention will be triggered - but NOT ULTIMATE SUPERVISORY ACTION (which refers to company liquidation)
136
Following is NOT true about Minimal Capital Requirement (MCR) under Solvency II:
A) calculated on as simple factor basis (% of B/S items)
B) MCR > Solvency capital requirement (SCR)
C) MCR is within 25%-45% of the SCR
D) If available capital (AC) is below MCR, ultimate supervisory action will be triggered - firm to be liquidated/ taken off market
WRONG: B)
MCR > Solvency capital requirement (SCR)
INSTEAD: C) MCR is within 25%-45% of the SCR
137
Solvency II introduces new public disclosure requirements (pillar 3) with the aim of fostering market discipline
What is meant by market discipline?
A) the capability of market operators, by having more complete and accurate information, to reward the companies that better manage their risks
B) the ability for the supervisory authority to monitor firms' risk management
C) help the supervisory determine any capital add-on required for the firm
Market discipline principle:
A) the capability of market operators, by having more complete and accurate information, to reward the companies that better manage their risks
138
Under Solvency II, the technical provision is calculated based on three steps. Which?
A) Determine the amount and timing of all cash outflows from insurance contracts in force
B) Discounting cash flows using risk-free rate provided by EIOPA to get the "best estimate"
C) Adding a risk margin to the best estimate
D) Add a risk loading amount to the best estimate
E) Alle of the above
F) A+B+C
G) A+B+D
F) A+B+C
139
What is TRUE about the discount rate used in technical provision calculation (Solvency II). Choose 1-4
A) It has a significant impact on the value of the technical provision
B) It is crucial to determine the available capital of the company
C) It is crucial to determine the solvency ratio (AC/SCR)
D) It is based on the risk-free rate regularly set by EIOPA for each currency
All of the above are correct
140
What is the TRUE about the "risk margin" in the technical provision calculation (Solvency II)?
A) To take into account the uncertainty of the best estimate
B) The value of the technical provision= best estimate + risk margin
C) The risk margin amount depends on the uncertainty about the insurer's liabilities because it considers the value of SCR necessary to support the run-off of liabilities.
D) The risk margin is calculated by determining the cost of providing an amount of eligible own funds (capital) equal to the Solvency Capital Requirement (SCR) necessary to support the run-off of the insurance obligations during the lifetime thereof.
E) All of the above
D) All of the above
141
Calculate the solvency ratio for the following firm:
MV of asset = 150
MV of liabilities = 113
SCR = 19
Solvency Ratio = (Assets before stress - Liabilities before stress)/ SCR
Solvency Ratio = (150 - 113)/ 19 = 1.95
142
```
Calculate the SCR for following company:
BEFORE STRESS:
MV of asset = 150
MV of liabilities = 113
AFTER STRESS:
MV of assets = 129
MV of liabilities = 111
```
SCR = change in available capital after the stress test:
SCR= (Assets before stress - Liabilities before stress) - Assets after stress - Liabilities after stress
SCR = (150-113)-(129-111) = 19
143
Solvency II provides for the possibility for firms to adjust or replace the results of a standard method SCR with a more company specific calculated to better reflect the individual risk profile using a "internal model". This is however subject to supervisory approval.
TRUE/ FALSE
TRUE
144
It is always better to use an "internal model" for calculating SCR.
TRUE/ FALSE
FALSE: while an internal model reflects much more accuracy in terms of the firm-specific risk and SCR requirement, such models are very complicated.
Therefore, there might be a need for the company to apply a simpler calculation if risks are not significant, since this is less expensive for the firm.
145
Following is TRUE about the MCR: Choose 1-5
A) It is always higher than the SCR
B) It is an objective calculation approach that is easily adjustable
C) Companies can, by supervisory approval, calculate the firm-specific MCR
D) Breach of MCR triggers ultimate supervisory action
E) MCR works as a safety net against potential model errors (model risks)
NO: A) It is NOT higher than the SCR (it is always lower)
YES: B) It is an objective calculation approach that is easily adjustable
NO: C) Companies canNOT, by supervisory approval, calculate the firm-specific MCR
YES: D) Breach of MCR triggers ultimate supervisory action
YES: E) MCR works as a safety net against potential model errors (model risks)
146
Following is NOT true about Investment Regulation (Solvency II):
A) There are no predetermined limits or constraints on investments
B) The insurer is prohibited from investing in too risky assets
C) All risks undertaken by the insurer (incl. investment risk) is reflected in capital requirements
D) Companies should follow the "prudent man" principle when choosing investment allocation
NO: B) The insurer is prohibited from investing in too risky assets.
The insurer can take on as much risk as they like (following prudent man/ person). Also, because investment risk is reflected in capital requirements, the film has the corresponding necessary capital coverage.
147
Which of the following is(are) shortcomings of Solvency II?
A) High complexity
B) Unequal treatment of companies in different countries
C) Too flexible
D) Volatile B/S and SCR due to principle of market valuation of assets and liabilities
CORRECT:
A) High complexity
D) Volatile B/S and SCR due to principle of market valuation of assets and liabilities
148
The ORSA is a specific report that should be sent to supervisors by insurers (under Solvency II). The purpose of ORSA is:
A) to support internal business decisions in terms of risk implications
B) reporting to supervisors how the company measures and assess its risk in accordance with its risk profile
C) Both
C) Both
149
The analysis of the ORSA helps supervisors check whether the risk profile of a company is appropriately captured by the SCR calculation and hence consider any need for adjustment to the capital requirement (e.g., capital add-on need)
TRUE/ FALSE
TRUE
150
What is true about "capital add-on"?
A) it refers to Supervisors requirement of the company to inject additional capital
B) capital add-on is temporary if it is due to deficiencies in governance and internal control of the company, increasing risk of losses
C) deviation between the actual risk profile and the assumptions underpinning the standard approach to SCR can give rise to capital add-on
D) All of the above
D) All of the above
151
The available capital (AC) expresses what the insurer would have available of “own fund” if all assets and liabilities were to be liquidated at market value any point in time
TRUE/ FALSE
TRUE
152
If assets and liabilities are traded in deep and liquid market, they valued at their market value.
If assets and liabilities are not traded in deep and liquid market: the “mark to model” approach is instead utilized, modelling the value using as far as possible market information.
TRUE/ FALSE
TRUE
153
The "best estimate" is: choose 1-5:
A) based on the sum of all cash outflow projections
B) based on probability-weighted future cash flows related to existing contracts
C) is the PV of either A or B
D) the discount rate for DCF is determined by each firm individually
E) the discount rate for DCF is set by EIOPA (the risk-free rate)
B) based on probability-weighted future cash flows related to existing contracts
C) is the PV of either A or B
E) the discount rate for DCF is set by EIOPA (the risk-free rate)
154
In life insurance, when calculating the "best estimate", the CF projections should separate "guaranteed benefits" from "discretionary benefits" in with profit contracts.
TRUE/ FALSE
TRUE
The discretionary part determine a reduction of the SCR, as it is assumed that in stressed conditions the insurer can reduce the profits allocated to policyholders
155
The standard calculation approach of SCR includes measurement of all quantifiable risk which all assets and liabilities of a firm (total balance sheet approach) are exposed to, based on EU average market data.
TRUE/ FALSE
TRUE
156
BLANK
black
157
What does it mean that the resulting capital charge in SCR for each risks is calculated by aggregating a "correlation matrix" approach? Choose 1-3
A) allows for diversification between not fully correlated risks - to take into account the correlation of risks
B) a way for regulators to "reward" firms with risk diversification
C) the corresponding SCR is higher for a company with one line of business than for a company of same magnitude with multiple lines of businesses
All of the above
Correlation matrix is a way for the regulation to reward firms’ diversification of risks.
All equal, firm A with only one line of business will have a larger SCR than another firm B of the same dimension with different lines of businesses because in the latter, the risk is more diversified, which is rewarded by a lower SCR.
158
Capital requirement calculated for each risk is reduced, where relevant, to take into account potential reduction or elimination of liabilities in a stressed situation
An example is:
A) Technical provision for "with profit" life contracts (policyholder bears investment risk)
B) Deferred tax liabilities
C) Both
C) Both
Technical provision for “with profit” life contracts (discretionary future profit for policyholder participations). In a loss situation, the firm could reduce the allocation of profit, compared with the allocation which was assumed in the calculation of technical provisions (implicit reduction of technical provisions).
B) Deferred tax liabilities are lower in a loss situation, which also decreases liability value used in SCR calculation
