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Study > Section 2.1 > Flashcards

Section 2.1 Flashcards

1
Q

Just some extra notes from questions:

Are Advance Premiums a liability or asset?

If a portion of AB are non admitted, how does this impact surplus? How does this impact net income?

A

AP are a liability

Decreases surplus, but doesn’t impact Net Income Unless the agent’s balances are written/charged off. This is part of Other Income

Feldblum Surplus

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2
Q

Why do we bother with financial strength ratings at all?

A

for policyholders:
- financial strength ratings help buyers assess an insurer’s ability to pay claims
- if the potential policyholder is an insurer seeking reinsurance, the insurer may require the reinsurer have a high rating

for P&C insurers:
- a high rating can help insurers get business
- a financial strength rating by a rating agency can uncover potential solvency issues without involving a regulator (benchmark financial strength without regulatory intervention)

for Reinsurers:
- same as for insurers plus
- some insurers must place business with highly rated reinsurers
- a reinsurer may not be able to renew treaties without a good rating

Feldblum Ratings

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3
Q

Who does financial strength ratings?

A

A.M. Best:
- has the most experience with financial strength ratings of insurers

Moody’s:
- focuses more on debt ratings (versus overall financial strength ratings)

S&P (Standard & Poor’s):
- focuses more on debt ratings (versus overall financial strength ratings)

Feldblum Ratings

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4
Q

How are financial strength ratings done?

A

All 3 agencies use something called interactive rating as an overall methodology but they differ in their specific rating or capital model

Feldblum Ratings

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5
Q

How do rating agencies ensure consistency across insurers?

A
  • standard information-gathering & assessment guidelines
  • ratings are related to economic capital
  • analysis & final rating should be issued by separate bodies.

Feldblum Ratings

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6
Q

Describe shortcomings of rating agencies

A

conflict of interest
- rating agencies are paid by the companies they rate (how dumb is that?!!!)

history of unreliability
- rating agencies have given high ratings to companies that then went bankrupt. (Enron Scandal in 2001)

Feldblum Ratings

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7
Q

Identify the legislative response to criticism of rating agencies

A

law now requires extensive DISCLOSURE of rating agencies’ methods to help users understand ratings

Feldblum Ratings

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8
Q

Why might rating agencies prefer stability over responsiveness in their rating methodology?

A
  • stability increases trust in ratings
  • being too responsive might mean responding to statistical noise (versus signal)

Feldblum Ratings

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9
Q

What is the broad description of ‘interactive rating’?

A

a comprehensive qualitative & quantitative evaluation of an insurer’s ability to pay claims (financial strength)

Feldblum Ratings

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10
Q

Describe the 5 steps of the interactive rating process

A

Research: by ratings analysts (insurer submits proprietary info)
Meeting: between rating analysts & insurer’s senior management for presentations
Proposal: the rating analyst leader proposes a rating (insurer may submit further info)
Decision: by ratings committee
Publication: to public & fee-paying subscribers

Feldblum Ratings

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11
Q

What drawbacks does interactive rating have?

A

Time-consuming: requires extensive meetings with senior management (note that it takes a while, not super reactive)
Intrusive: insurer must provide detailed operational info
Expensive: insurer must pay for rating agencies to do the interactive ratings

Feldblum Ratings

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12
Q

If interactive ratings are such a royal pain, why do insurers bother with them?

A

Unrated insurers: agents are wary of unrated insurers
Solvency assessment: 3rd parties such as regulators or investors may rely on a rating agency’s assessment
Efficiency: agents, underwriters, regulators don’t have the expertise to evaluate the financial strength of an insurer

An example where a rating is important is reinsurance because if downgraded to below investment grade, a reinsurer may not be able to renew its treaties and thus lose business.

Feldblum Rating

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13
Q

If rating agency concludes that an insurer’s financial strength has changed in a material way, what reporting options are available?

A
  • downgrade or upgrade insurer’s rating
  • change the outlook (do not upgrade or downgrade)
    → rating agencies hesitate to change ratings too quickly to avoid angering paying clients and to maintain consistency & reputation

Feldblum Ratings

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14
Q

Describe the (quantitative) capital models of each rating agency

A

Rating Agency / General Description / Detailed Description / Other

A.M. Best / Expected Policyholder Deficit / EPD = (Pure Premium for Treaty) / (Market Value of Reserves) / Selection: choose required capital so that EPD = 1%

Moody’s / stochastic cash flows to model economic capital / repeated simulations of loss distributions of separate risks / Time Horizon: project cash flows until liabilities are settled

Standard & Poor’s / PB (principles-based) models & ERM practices / evaluate insurer’s (ERM, internal capital model) / Rating: weighted avg of (S&P, insurer) capital assessment

Feldblum Ratings

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15
Q

How did A.M. Best divide insurers based on financial Strength?

A

May be outdated, they have new system.

Old way:
* Secure: likely to meet their obligations (divided furthur into 3 sub-levels)
* Vulnerable: May not meet their obligations in adverse scenarios (divided furthur into 7 sub-levels)

Feldblum Ratings

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16
Q

What are A.M. Best’s Credit Quality ratings for bonds?

A
  • Investment Grade: 4 levels + sublevels
  • Non-Investment Grade: 4 levels + sublevels

Feldblum Ratings

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17
Q

Briefly describe three differences between NAIC RBC requirements and rating agency capital requirements.

A
  • Rating agency incudes risks not in RBC such as catastrophe risk
  • RBC worst case year vs. rating agency may use value at risk or expected policyholder
    deficit (EPD)
  • RBC is a fixed formula and rating agency may use stochastic economic capital models
  • RBC has one model used for all companies but rating agencies models differ so the rating
    agency model used for different companies may differ when a different rating agency is
    used for each
  • RBC can cause regulatory action but rating agency does not have this power
  • RBC is a transparent public formula while rating agency uses opaque proprietary formula
  • RBC is the same for all lines vs. rating agency which may vary by line
  • Regulator is stakeholder for RBC while stakeholder for rating agency is consumer, agent,
    investor
  • RBC is quantitative formula while agency also uses qualitative information from interview
    process
  • RBC based on public data; rating agency uses confidential data
  • Regulator is stakeholder for RBC while stakeholder for rating agency is consumer, agent,
    investor (if related to conservatism of RBC and/or going concern of rating agency)
  • RBC changes infrequently based on model law while rating agency can adapt and change
    in response to emerging issues
  • RBC does not consider reserve adequacy, but rating agency does
  • RBC does not discount reserves, but rating agency uses a conservative discount rate

Feldblum Ratings

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18
Q

Summarized RBC vs rating agencies

A

Method:
- rating agencies may use stochastic model & qualitative considerations
- RBC uses a fixed formula, quantitative only

regulatory action:
- rating agencies have no regulatory authority
- RBC results can initiate regulatory action

Data:
- rating agencies use confidential company data
- RBC uses public data

All risks:
- rating agencies can include any relevant risks
- RBC is constrained by the given formulas

Feldblum Rating

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19
Q

Identify an advantage of the capital model used by A.M. Best

A
  • models individual risks then combines risks using a covariance adjustment (similar to RBC)
  • sets capital level so that EPD (Expected Policyholder Deficit) = 1%
  • GOOD because tail risks are modeled better than RBC’s ‘worst-case’ approach

Feldblum Ratings

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20
Q

Identify an advantage of the capital model used by Moody’s

A
  • uses a stochastic cash flow model
  • GOOD for complex multivariate risks

Feldblum Ratings

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21
Q

Identify an advantage of the capital model used by Standard & Poor’s

A
  • uses a weighted average of it’s own model & a company model
  • GOOD because it incorporates company knowledge of risks to the final rating

Feldblum Ratings

22
Q

Describe how state regulators & A.M. Best differ in their evaluation of capital adequacy (2)

A

quantitative vs qualitative data:
- state regulators mainly use RBC, which uses quantitative data only
- A.M. Best incorporates qualitative data

capital requirements:
- state regulator (RBC) uses RBC formula
- A.M. Best uses a 1% EPD (Expected Polyholder Deficit)

Feldblum Ratings

23
Q

Describe procedures for monitoring solvency recommended by the NAIC

A

RBC formula:
- calculate capital requirements with possible regulatory action

IRIS ratios:
- allocate state regulatory resources based on IRIS results

Financial Statements:
- use annual/quaterly statements for consistent comparisons across companies & time

Feldblum Ratings

24
Q

Identify similarities & differences between ‘interactive ratings’ & ‘public ratings’

A

similarities:
- both use public financial statement info
- both disclose rating to public

differences:
- interactive ratings are more costly & time-consuming than public ratings
- interactive ratings use confidential company information (public ratings using publicly availabe info)

Feldblum Ratings

25
Q

What is insurance score?

What is credit score?

A

An insurance score is a numerical score assigned to an insurance risk based on a risk’s underlying characteristics. And a credit score is an example of an insurance score that uses attributes found in a credit report.

Credit scores are highly predictive of claims costs, but many people think their use is unfair. The use of credit scores as a rating variable is banned in many jurisdictions

Kucera Credit

26
Q

What specifically would insurers like to use credit scores for?

A

as an U/W criterion
for assignment to tiers
as a rating variable

some insurers / jurisdictions only use credit score on renewals if it results in a LOWER RATE for the insured

Kucera Credit

27
Q

What are some arguments for and against the use of credit scores?

A

Statistical significance (in predicting expected loss costs)
Manipulation (credit scores are difficult to manipulate because they are calculated by 3rd party companies, not self-reported)
Objective (credit scores are based on numerical data so they are objective)
Removal (removing credit scores won’t change aggregate premium, provided an off-balance is applied)
e (doesn’t stand for anything, I needed the “e” to spell Alice’s favorite snack)

Frequency (credit score is correlated only with frequency, not with severity of claims)
Errors (50% of credit reports have errors, sometimes due to identity theft)
Economic downturns (downturns in economy may have a disparate credit impact on vulnerable populations)
Discriminatory (credit scoring may lead to rates that are unfairly discriminatory - see below for details)

Kucera Credit

28
Q

What concerns might a regulator have regarding credit scores in an economic downturn?

A
  • an unwarranted increase in aggregate premiums if the average credit score got worse
  • a distributional shift in individual premium that doesn’t reflect true cost differences (losing you job doesn’t mean you’ll have more car accidents)

Actuarial response:
We can apply an off-balance factor to keep the aggregate premium unchanged.

Regarding individual premiums, we can stop using credit score (at least temporarily) and redo the classification analysis after the economy has stabilized (this may incur a significant lag time however)

Kucera Credit

29
Q

Identify attributes correlated with credit score

A
  • # of inquiries into opening new accounts
  • # accounts 30+ days past due
  • socioeconomic status
    • impulse control (may be addicted to retail therapy)

Kucera Credit

30
Q

On what ‘levels’ can credit score impact occur?

A

AGGREGATE company premium level
INDIVIDUAL premium level

USE/PROHIBITION of credit scores doesn’t necessarily affect aggregate premium (even if individual premium is redistributed)

31
Q

Identify actions state a regulators can take to limit use of credit-scores

A

BAN use of credit scores
LIMIT use of credit scores to U/W
ALLOW for renewals if it reduces premium charged

Kucera Credit

32
Q

Identify examples where credit scoring can be unfairly discriminatory

A

age: young people don’t have a long credit history, elderly people use credit less often (both may result in a lower credit score)
poor families: may use cash versus credit (you need to use credit to get a good credit score)
recent immigrants: may not have access to credit (you need to use credit to get a good credit score)
moral/religious beliefs: certain belief systems may discourage use of credit (you need to use credit to get a good credit score)

McCarty Credit

33
Q

Define ‘cost-based’ rates

A

rates that VARY BY individual risk or expected loss costs

McCarty Credit

34
Q

Identify necessary conditions for rates to be ‘equitable’ according to McCarty

A

CONDITION 1:
- should NOT have disparate impact on protected classes (race, religion,..)

CONDITION 2:
- should be a CAUSAL LINK & under control of individual

McCarty Credit

35
Q

What is the purpose of the Nonadmitted & Reinsurance Reform Act of 2010?

A

create a better surplus lines tax payment and regulatory system

Emmanuel Excess Lines

36
Q

Briefly describe how NRRA accomplishes its purpose

A

limits regulatory authority of surplus lines to the customer’s home state

establishes federal standards for surplus lines regarding: premium taxes, insurer eligibility, commercial purchaser exemptions

Emmanuel Excess Lines

37
Q

Identify the key provisions of NRRA discussed in the Emmanuel reading

A
  • 1-state compliance (only an insured’s home state can regulate the placement of surplus lines)
  • uniform eligibility standards (for an insurer to sell surplus lines coverage)
  • ECPs or Exempt Commercial Purchasers (a diligent search is not required for sophisticated commercial purchasers)
  • national producer database (producers must be in a database to collect licensing fees from a surplus lines insurer)

Emmanuel Excess Lines

38
Q

Describe the key provision of NRRA: 1-state compliance

A

insured’s home state has exclusive authority to regulate the placement of nonadmitted insurance (which includes surplus lines) ← shout-out to TF!
- only home state can require a broker’s license to sell nonadmitted insurance
(but note that WC is an exception)
- only home state can collect premium taxes

Emmanuel Excess Lines

39
Q

Describe the key provision of NRRA: uniform eligibility standards

A

states are empowered to create uniform eligibility standards for surplus lines insurers but all are currently using the NRRA default standards

U.S. domiciled insurers (also called foreign insurers because they are foreign to all but the home state)
==> must have ≥ 15m in capital & surplus (or the state minimum if it’s higher)
==> must be authorized to write in its domiciliary jurisdiction

non-U.S. domiciled insurers (also called alien insurers, not foreign insurers!!!)
==> if insurer is listed in the Quarterly Listing of Alien Insurers, states may not prohibit placing insurance with them
(this list is also called the “IID” list because it’s maintained by the NAIC’s International Insurer’s Department)

Emmanuel Excess Lines

40
Q

Describe the key provision of NRRA: Exempt Commercial Purchaser (ECP)

A

definition of ECP: any person purchasing commercial insurance that:
* employs a NRRA-qualified risk manager
* has paid aggregate commercial premiums ≥ $100,000 (in past 12 months)
* the person’s company is “large” (high net worth ≥ ~20m or high revenues or lots of employees,…)

the related NRRA provision is:
states cannot force a broker to do a diligent search if the purchaser is an ECP and:
==> the broker has disclosed to the purchaser that coverage may be available in the admitted market (which is better regulated)
==> the purchaser has then instructed the broker to purchase insurance in the nonadmitted market

 *A diligent search determines whether coverage can be found in the admitted market, which is generally better because the admitted market is better regulated.*

Emmanuel Excess Lines

41
Q

Describe the key provision of NRRA: national producer database

A

this database (or another national equivalent) is for the licensure & renewal of surplus lines brokers
the specific NRRA requirement is that:
==> if a state doesn’t participate in such a database then they cannot collect licensing fees (which would suck)

Emmanuel Excess Lines

42
Q

Describe surplus lines laws generally

A
  • there is very little regulation regarding forms & rates (compare that with auto insurance which is very highly regulated)
  • surplus lines regulation is focused mainly on brokers (not the surplus lines insurers)
  • brokers must perform a diligent search before exporting business from the admitted market to the nonadmitted surplus lines market
    ==> or the broker can instead use an “export list” which is a list of coverages deemed to be unavailable through the admitted market
  • brokers submit tax and other filings

Emmanuel Excess Lines

43
Q

Identify 2 methods of accessing the nonadmitted market

A
  • surplus lines (use a local licensed broker to buy coverage from a nonadmitted insurer in your home state)
  • independent procurement (also called direct placement)

Emmanuel Excess Lines

44
Q

What is independent procurement / direct placement?

A
  • when a U.S. citizen leaves their home state (goes to an insurer outside their home state) to insure a risk located in their home state
  • and the purchase is either directly from an unauthorized insurer or a broker not licensed by the home state

Emmanuel Excess Lines

45
Q

Describe a legal precedent related to home state regulation of independent procurement

A

Case: State Board of Insurance v. Todd Shipyards Corporation
Facts:
the buyer purchased property coverage from an out-of-state unauthorized insurer
the only connection between the buyer and the home state was the location of the covered property in the home state
Issue:
can the home state tax or otherwise regulate the transaction
Ruling:
under McCarran-Ferguson, the home state could not tax or regulate the transaction
because federal laws applying exclusively to insurance supersede state laws

Emmanuel Excess Lines

46
Q

What is a wholesale broker?

A

an intermediary broker between a “regular” retail broker and an insurer
(they place business brought to them by retail brokers and have no contact with the insured)

Emmanuel Excess Lines

47
Q

How is licensing of a wholesale broker different from that of a “regular” retail broker?

A

The wholesale broker must have a license in the home state of each insured they place with an insurer

Emmanuel Excess Lines

48
Q

How are the licensing requirements of wholesale brokers being addressed?

A

2015 legislation established the National Association of Registered Agents and Brokers or NARAB
* it’s a 1-stop national licensing system for brokers operating outside of their home state
* requires submission of an application and adherence to strict standards

Emmanuel Excess Lines

49
Q

Identify criteria a surplus lines insurer must generally satisfy to become a Domestic Surplus Lines Insurance Company (DSLI)

A
  • PHS ≥ 15 million (Policyholder Surplus)
  • insurer is an eligible surplus lines insurer in a jurisdiction other than its state of domicile
  • the insurer’s board of directors passes a resolution seeking to be a domestic surplus lines insurer in the state of domicile
  • insurance commissioner approval and issuance of certificate of authority

Emmanuel Excess Lines

50
Q

A start-up company has proposed entering a state as a surplus lines carrier to compete with admitted carriers by offering similar coverage on a direct-to-consumer basis. Identify 4 surplus lines regulatory requirements and briefly describe why this start-up may or may not meet those requirements.

A

surplus/capital requirements
there is a minimum capital requirement (can vary by state)
→ a start-up may have troubling raising enough capital
authorization/licensing requirement
insurer must be authorized in domiciliary jurisdiction
→ we are not told if the start-up has been authorized
coverage must be declined by admitted market
unless insured is an ECP (Exempt Commercial Purchaser) they must first perform a diligent search for an admitted insurer
→ start-up would only be able to write business with exempt commercial purchasers (market may be small)
must meet managerial requirements (mentioned in Porter.2-Devlpt in the section on surplus lines)
ensures surplus lines carrier can meet customer’s needs
→ start-up management may be inexperienced (may not satisfy this requirement)

Emmanuel Excess Lines

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