Underwriting

What is money laundering?

Money laundering is a process by which the illicit source of assets obtained of generated by criminal activity is concealed to obscure the link between the funds and the original activity. Money laundering requires an underlying, primary, profit making crime (such as corruption, drug, trafficking, market manipulation, fraud, tax evasion, etc) along with the intent to conceal the proceeds of the crime or to further the criminal enterprise. Money laundering is a process of converting cash or property which is derived from criminal activities to give it an appearance of having been obtained from a legitimate source.

Define burning cost.

Burning cost is defined as the actual past reinsured losses to a ceding company's subject matter premium (written or earned) for the same period.

The 'marketing mix' process involves making decisions on

product, price , promotion and distribution

What is meant by the term 'claim triangulation'?

'Claim triangulation' is the term used to describe a table which charts the movement of total incurred losses from an original policy period over subsequent periods. It demonstrates the number of claims reported and the incurred loss, i.e. the total paid and outstanding claims at a given point in time, yearon-year for consecutive periods of insurance. It therefore reflects the development of the claims experience

List and explain briefly what claim triangulation is used for.

1. Analyse the development pattern of losses over time and project the accuracy of early estimates and/or the likely total paid incurred based on any movement in value of the original estimate. 2. Forecast the claims experience of a risk based on its past experience - an underwriter, often in conjunction with an actuary, will analyse trends in both claim reporting (when claims are reported) and movements in the incurred loss in the mature periods of the triangulation (periods where all the claims are settled or reliably reserved) and then use the findings to develop the claims experience of underwriting periods, which are not fully matured. 3.Compare data at specific points in time and determine whether the claims experience is improving, deteriorating or remaining reasonably constant - By comparing the claims experience for different periods at the same time in their development, the underwriter can establish how well or otherwise a risk is running. Adjustments to the data should be made for large claims, inflation, etc so data is being compared on a like-for-like basis.

State five disadvantages of facultative reinsurance.

1. As risks are considered individually, the reinsured cannot be certain of the placement of facultative insurance and could affect its ability to underwrite the underlying risk. 2. The administration involved in facultative insurance is labour and cost-intensive and any delay in issuing a policy can create problems with both intermediaries and clients 3. The ceding company has to disclose complete information regarding the original underwriting terms and conditions. This may be a problem if the reinsurer is also a competitor in the market. 4. There is a possibility of the reinsurer exercising a certain amount of influence over the insurer's underwriting by asking it to improve risk offered or unduly influencing its assessment of the premiums on the original risk 5. The insurer may lose control over the handling of the risk 6. If used extensively, facultative insurance can undermine any potential profit in an account 7. Time factor - the insurer will not want to cover until they are certain that reinsurance arrangemnets are in place, so the insurer cannot make instant decisions on the acceptance of business

Explain the roles of an underwriter

1. Assess the risk that people bring to the pool 2. Decide whether or not to accept the risk or how much to accept 3. Determine the terms, conditions and scope of cover to offer 4. Calculate suitable pricing.

What are the factors to consider when underwriting international business?

1. Dealing with foreign currencies 2. Interpretation of policy coverage and words may differ due to different legal systems 3. Exposure to catastrophic weather not often experienced 4. Political and cultural barriers, especially communication skills 5. Lack of underwriting experience in the overseas market 6. Lack of technical and competent employees 7. Entry barriers created for foreign insurer

What are the main steps that an insurer can take to mitigate the impact of the underwriting cycle?

1. Design the portfolio so that it contains a mix of business that is less cyclical (e.g. include more Life) or is exposed to a different cycle (e.g. business from other countries). 2. Price business to make an acceptable profit throughout the cycle and have the conviction to refuse to write business when the rates are low 3. Use reinsurance to even out the peaks and troughs 4. Convert fixed costs to volume-based costs by outsourcing

What are the major external influences, which an insurer has to consider when planning the underwriting strategy?

1. Economic trend 2. Political influences 3. Weather related events 4. Long term industrial disease 5. Pandemics 6. Emerging risk 7. Technology risk

What must the pricing of a risk premium include?

1. Expected claims cost 2. An estimate for outstanding claims that are not settled within the year 3. Provide a reserve for future losses, both in terms of frequency and severity 4. Meet all expenses such as salaries, office costs, advertisements and commissions 5. Provide a profit for the company.

State the two main approaches to calculating a pure risk premium.

1. First principles pricing; 2. Burning cost pricing

Explain the key regulatory objective of Bank Negara Malaysia in relation to the insurance sector.

1. Foster fair and professional conduct of financial institute 2. Striving to protect the rights and interests of financial consumers 3. Keeping a close watch on the solvency and market conduct to enhance professional standards and consumer confidence to the insurance sector 4. Promoting monetary and financial stability conducive to sustainable growth of the economy

What understanding in terms of capital management must an insurer have in order to maintain company's solvency?

1. How much capital it has at one time 2. How much capital it needs to support its targeted volumes and lines of business 3. How much capital it needs to meet both current and future regulatory capital requirements 4. What it plans to do in the event of having - too much capital for its planned business volumes - too little capital for its plans

State five advantages of facultative reinsurance.

1. Individual risk are considered on their own merit, so a suitable premium can be negotiated rather than having to consider it as part of an overall portfolio of risks 2. It can increase the reinsured's competitive edge 3. Insurer is able to increase its capacity beyond its treaties that offer insufficient automatic cover 4. Risk excluded from the insurer's treaty insurance can be insured 5. Treaty insurance could be protected by facultative insurance of particular risks to ensure a better overall results and lower premiums in the long term. This arrangement can insure a loss exposure with a typical characteristics and thereby maintain the favorable loss experience of the primary insurer's treaty insurance and any associated profit-sharing arrangements. 6. Insurer might benefit from the expertise and experience of the facultative reinsurer.

Provide examples of insurance fraud.

1. Inflation actual claims 2. Misrepresenting facts on an insurance application 3. Submitting claims for injuries and damages that never occurred 4. Demanding compensation for services never rendered and equipment never delivered 5. Staging accidents

What are the main drivers that may affect the amplitude or wavelength on the underwriting cycle?

1. Investment returns 2. State of the economy 3. Reaction to major claims 4. Capital 5. Political influences 6. Changes to legislation or judicial decisions

Describe 3 ways the government have chosen to intervene in the insurance market.

1. Legislation - Passing specific law regarding insurance (e.g. licensing, capital requirement, mandatory insurance) 2. Regulation - The framework of centrally determined legal requirement and guidance to govern the way insurance company conduct their business, with the overall objective of maintaining an effective and efficient market. 3. Direct Participation - Involvement in some areas of social insurance provision (e.g. SOSCO, workers compensation insurance)

What are the factors to be considered when selecting retention?

1. Maximum retention for primary insurer 2. Minimum amount sought by reinsurer 3. Minimum retention sought by reinsurer 4. Co-participation provisions

Describe the 3 money laundering activities.

1. Placement - Physical deposit of proceeds derived for illegal activities 2. Layering - Separating the illicit proceeds from their sources through transactions that disguise the audit trail and provide anonymity 3. Integration - Integrating the laundered proceeds into the economy as normal funds

Illustrate the general nature of moral hazard in the three scenarios below: 1. Pre-inception 2. Post-inception 3. Post-loss

1. Poor maintenance of premises or vehicle 2. Poor health and safety management 3. Poor or inadequate training 4. Poor management of site, staff and operations 1. Attitude to surveyor's recommendation for risk improvements 2. Response to requests to visit premises and timely payment of premium 3. Timely production of any declaration required for premium adjustment 1. Timely notification of the loss with full details of the circumstances leading to the loss 2. Readiness to assist the insurer to determine the value of loss 3. Exaggerating the value of loss 4. Provision of accurate records of the loss to facilitate speedy loss settlement

What are the areas that catastrophe modelling is used to assist insurers and reinsurers to make decisions?

1. Pricing catastrophe or event excess of loss reinsurance 2. Planning and forecasting 3. Reserving, through the assessment of the impact of major catastrophe events 4. Capital assessment and allocation - internally to set profit targets and externally to satisfy regulators 5. Designing and arranging reinsurance protection

Explain briefly the functions of reinsurance.

1. Provides protection against unexpected material loss 2. Maintains the stability of insurer's results by spreading risk throughout a variety of geographical areas 3. Increases capacity by permitting the insurer to accept more business than it is comfortable with than a gross level 4. Protects against large catastrophe losses and increases stability in results by smoothing the net loss experience of the insurer from year to year 5. Provides cash flow advantages since the insurer can make a cash call upon the reinsurer when losses occur. 6. Provides security by relieving the insurer of some of the uncertainty of loss 7. Provides technical assistance because of their considerable expertise built 8. Facilitates the withdrawal of insurers from the market segment

List and explain briefly four actions an insurer may take when competition is aggressive, prices are depressed and profitability is non-existent.

1. Pull out of the market - when prices fall below a level that the insurer considers to be prudent, it may opt to stop writing that line of business; 2. Reduce income - the insurer may opt to reduce its market share whilst prices are low; 3. Focus on retaining business at a profitable level - a rigorous risk selection process may be implemented to retain and attract only those risks where the insurer feels an adequate premium is charged and a profit can be made; 4. Lower prices - to compete.

List the 8 types of excess of loss insurance.

1. Risk 2. Catastrophe 3. Per policy 4. Per occurrence 5. Stop loss / aggregate 6. Clash 7. Umbrella 8. Spread

State the categories of the principal underwriting functions.

1. Selection of insureds 2. Policy wordings 3. Other clauses such as conditions, warranties, endorsement, deductibles, excesses 4. Policy limits

List five factors the underwriter needs to consider as part of the risk setting process.

1. Subject matter; 2. Exposure/size; 3. Scope of cover; 4. Other market rating factors; 5. Historical claims experience; 6. Large and catastrophe claims; 7. The future and trends; 8. Expenses; 9. Claims handling costs; 10. Reinsurance costs; 11. Levies and taxes; 12. Intermediary remuneration.

What are the objective of an insurer when drafting policy wording?

1. To provide extent of cover the insurer is willing to give 2. To meet policyholders' needs 3. To compare favorable terms and conditions with competitors 4. To achieve satisfactory balance between risk exposure and premium charged 5. To satisfy legal requirement 6. To provide clarity to the claim department to enable swift settlement without any dispute

How are capital markets used as an alternatives to traditional and non-traditional reinsurance?

Capital markets have emerged as tools that primary insurers can use to finance risk as an alternative to insurance. Instead of purchasing reinsurance to cover its potential liabilities, the primary insurer uses traded security instruments to finance insurance risks.

Explain facultative reinsurance.

Facultative means optional, so both parties to the reinsurance of individual risk have a choice as to whether to enter into the contract or not. Each risk is a separate reinsurance contract

Name the two main basic categories of reinsurance.

Facultative, treaty

Describe the characteristic of a hard market.

Higher insurance premiums More stringent underwriting criteria, which means underwriting is more difficult Reduced capacity, which means insurers write less policies Less competition among insurance companies.

Discuss briefly the consequences of insurance companies being too aggressive or too conservative in their underwriting duties.

If they are too aggressive, greater-than-expected claims could cut into their company earnings. If they are too conservative, they will be out-priced by the competition and lose business.

Name 3 intermediaries in the insurance market.

Insurance broker, insurance agents, financial consultant

Describe the characteristics of a soft market.

Lower insurance premiums, to increase market share Loosening of underwriting standards Increased capacity, which means insurers write more policies More competition among insurance companies

What is meant by the term 'Maximum Capacity' of an insurer?

Maximum capacity means the maximum amount of exposure that an insurer is willing or is able to accept. This limit will be stated in the company's underwriting guidelines.

Explain why insurers try to avoid underwriting risks that exhibit the characteristics of poor moral hazard.

Moral hazard involve attitude and ethical conduct of the insured can be avoided altogether by declining to insure the risk. These are intangible , human aspects of a risk, which are more difficult to assess. They include potential for fraudulent claims, carelessness and poor management. Moral hazards can be difficult to correct or improve. As it is seldom possible to mitigate or control the risk associated with poor moral hazard (via policy cover, terms, conditions and restrictions), insurer try to avoid writing risks that display the characteristics of poor moral hazard.

What is moral hazard?

Moral hazard is the condition that increases the likelihood of a person causing or exaggerating a loss.

What are physical hazards?

Physical hazards are the tangible factors that arise out of the nature of the risk itself. It concerns physical environment, and its impact could increase the frequency or severity of loss.

How can physical hazard be managed?

Physical hazards can be managed through risk improvement, policy terms, conditions, premium rates and deductibles.

Explain premeditated frauds.

Premeditated frauds are caused by deliberate criminals. The insurance coverage is effected with the specific intention of committing fraud or deliberately engineering events to enable fraudulent claims to be made against a third-party's policy. Although these people are aware that insurance fraud is a crime, their only concern is how lucrative the fraud might be and what the chances of detection are.

What is reinsurance?

Reinsurance is the transfer of insurance risk from one insurer to another, through a contractual agreement under which the reinsurer agrees, in return for reinsurance premium, to indemnify the primary insurer for some or all the financial consequences of the loss covered by the reinsurance contract.

Standard deviation measures ___________________ due to factors both specific to the firm, and to factors outside the firm's control.

Return variability

How is risk management used in the micro and macro level in the insurance company?

Risk management is used in the micro level in the pricing of individual insurance policy, and at the macro level in the management of insurance companies and the regulation of the industry.

Explain how the standard deviation is interpreted?

Statistically, when dealing with normally distributed variables, approximately 67% of all observed values will be within one standard deviation of the mean (average), and approximately 95% of the observed values will be within two standard deviations of the mean.

What is meant by Estimated Maximum Loss (EML)?

The Estimated Maximum Loss (EML) is an estimate of the maximum loss that can be sustained by the insurer on a single risk. The estimate can ignore 'remote coincidences' even if they are possible. This means that if something is considered particularly unlikely to happen, it should be ignored for the EML calculation.

The underwriter is concerned with the terms of acceptance of risks and the premium required.

The objective is to ensure that each risk accepted will make a profit. The riskier the business accepted, the greater will be the capital required to support the risk, or the return on the premium must be higher.

What is the main difference between insurance pricing and the pricing function in other industries?

The price of insurance must be based on prediction. In insurance, unlike other industries, the cost of production is not known when the contract is sold, and it will not known until sometime in the future when the policy has expired.

Explain briefly how burning cost is calculated.

The pure burning cost can then be calculated from this information by expressing the losses the reinsurer would have been liable for, as a percentage of the premium income being protected. The burning cost ratio is an experience-based insurance rating method used to determine rates for excess of loss reinsurance.

What is the purpose of underwriting to the insurer?

The purpose of underwriting is to help the insurer maintain the solvency so that coverage and service may be provided to the policyholders. (An underwriting profit should result from the process)

Briefly explain IBNR and IBNER claims.

The term IBNR (Incurred But Not Reported) describes incidents that have happened but where the claims have yet to be reported. Underwriters need to make provision for them when forecasting future claims. Estimates of IBNR are generally subject to a greater degree of uncertainty. IBNER (Incurred But Not Enough Reserved) relates to claims that have been reported to the insurer and although the insurer has opened a reserve within its books, the value of the reserve proves to be inadequate in relation to the final settlement of the claims.

What are the two basic types of distribution? How are they plotted in a graph?

There are two basic types of distributions. a) Discrete: A discrete variable has only discrete values. b) Continuous: A continuous variable can have any value. This distinction is important when we plot the distribution oin a graph. Discrete variables can be plotted for each point as a bar, whereas continuous variables are better plotted as curves.

How does having a good database information help to combat fraud?

They provide a way of verifying the information provided by claimants They allow an insurer to assess whether claimants have a history of suspicious or similar claims They provide a mechanism by which insurers can exchange claim history

Define underwriting.

Underwriting is the process of hazard recognition and evaluation, selection of insureds, pricing and determination of policy terms and conditions

In determining the riskiness of an asset, how do investors quantify the precision of their estimates?

When examining an asset, the more volatile its price the more risky it is considered to be. The expected return on the asset is an estimate of future returns. However, the actual return may not equal the expected return. For this reason, investors and managers would like to have an idea of how good their estimate might be. To help quantify the precision of their estimates, they use two concepts, variance and standard deviation. For the purpose of statistical measurement, variance is used for proxy for risk. Risk is essentially the standard deviation of return on an asset portfolio. The standard deviation is a measure of how far from the expected value the actual outcome might be.

Why are variance and standard deviation calculate based on historical returns instead of future predictability?

When historical data is available, investors can examine how the investment has performed in the past and use that as an indication of how it will perform in the future. By using historical returns on asset prices, investors can calculate the variance of past returns. It must be noted that this method does not provide an absolute basis for determining the riskiness of the asset. Past returns are not always reliable indicators of future results. Nonetheless, calculating variance and standard deviation based on historical returns is often the preferred method, because it relies on historical fact, as opposed to unquantified speculation regarding the future.