Chapter 5~Insurer ownership, financial and operational structure

If a reinsurer decides to accept policies from primary insurer "case by case" basis, then this is a type of insurance agreement called:

facultative

If a primary insurer and reinsurance firms sign a contract to share 50% of both losses and premiums, then this contract is called:

proportional (pro-rata)

The benefits of an insurance company holding more capital include:

reduced risk of insolvency

In a reinsurance facultative contract, which one of the issues might arise?

reinsurer may have incentive to select low risk insurance policies and leave high risk insurance policies with the primary insurer

*Correct*? a. "Surplus notes" issued by mutual insurers. b. Insurer Capital = Policyholder Liabilities - Assets. c. Reinsurance causes an insurer to hold more capital and increases its insolvency risk. d. With a facultative reinsurance contract, a ceding insurer sells multiple insurance contracts to the reinsurer.

"Surplus notes" issued by mutual insurers.

*Incorrect*? a. When an insurer buys reinsurance, it is giving up some of its potential underwriting profit to the reinsurer. b. All the answers are correct. c. If the capital level of an insurance firm stays constant, the probability of insolvency increases with increasing correlation among insurance losses. d. Diversifying across product lines for insurers increases risk of insolvency. e. If a reinsurer agrees to pay a primary insurer's losses greater than $250 million in exchange to receive an annual premium, then this contract is called excess-of-loss contract.

. Diversifying across product lines for insurers increases risk of insolvency.

(TRUE or FALSE?) "Surplus notes" issued by stock insurers.

F

(TRUE or FALSE?) Corporate names have unlimited liability at Lloyd's of London.

F

(TRUE or FALSE?) Gramm-Leach-Bliley Act (1999) created a legal structure to separate companies in the insurance, securities, and commercial banking industries.

F

(TRUE or FALSE?) Higher underwriting risk reduces the amount of capital needed (for an insurance firm) for a given level of insolvency risk.

F

(TRUE or FALSE?) If a reinsurer agrees to pay a primary insurer's losses greater than $250 million in exchange to receive an annual premium, then this contract is called excess-of-loss contract.

F

(TRUE or FALSE?) Investing in stocks is a major method that is used by insurers to reduce insolvency.

F

(TRUE or FALSE?) Non-proportional contracts are also known as pro rata contracts between an insurer and reinsurer.

F

(TRUE or FALSE?) Providing a cushion for meeting unexpected fluctuations in the book value is one of the reasons for insurers to hold common stock investments.

F

(TRUE or FALSE?) Reinsurance is insurance for investment banks and commercial banks.

F

(TRUE or FALSE?) The most common type of insurance company in the U.S. is reciprocal insurance company.

F

*Incorrect*? a. Catastrophe bonds allow insurers to share catastrophe risk with institutional investors who are not reinsurance companies. b. Higher underwriting risk reduces the amount of capital needed (for an insurance firm) for a given level of insolvency risk. c. All the answers are correct. d. When an insurer buys reinsurance, it is giving up some of its potential underwriting profit to the reinsurer. e. "Surplus notes" issued by mutual insurers.

Higher underwriting risk reduces the amount of capital needed (for an insurance firm) for a given level of insolvency risk.

Catastrophe bonds are:

Issued by insurers or reinsurers to institutional investors with high interest rates and principal and interest payments may not be paid back if a catastrophe occurs

*Incorrect*? a. Protecting against the loss of franchise value is one of the reasons for insurers to hold 'adequate' economic capital. b. All the answers are correct. c. The majority of insurers have vulnerability to interest rates because of their substantial investments in fixed-income securities (mostly bonds). d. Diversifying across product lines is a method that is used by insurers to reduce insolvency. e. Life-health insurers experience more variability in claims costs than property-Liability insurers.

Life-health insurers experience more variability in claims costs than property-Liability insurers.

Which one of the following combinations of investment assets is more appropriate for a Property & Casualty firm?

Municipal bonds (31%), Corporate bonds (23%), Common and preferred stocks (26%), and the rest is other assets.

*Incorrect*? a. Insurer liabilities is equal to the present value of expected payments on policies already sold. b. The purchase of reinsurance reduces underwriting risk. c. All the answers are correct. d. Catastrophe bonds allow insurers to share catastrophe risk with institutional investors who are not reinsurance companies. e. Stock companies are owned by policyholders who do not participate in management and who enjoy limited liability.

Stock companies are owned by policyholders who do not participate in management and who enjoy limited liability.

*Incorrect*? a. In a proportional reinsurance contract, the premium and the claims costs will be shared between the primary insurer and reinsurer in the same proportion. b. Gramm-Leach-Bliley Act (1999) created a legal structure to separate companies in the insurance, securities, and commercial banking industries. c. All the answers are correct. d. Stock insurers are owned by stockholders. e. Non-proportional contracts are also known as the excess-of-loss contracts between an insurer and reinsurer.

Stock insurers are owned by stockholders.

(TRUE or FALSE?) Ceding insurer refers to the insurance firm that buys insurance coverage from a reinsurer.

T

(TRUE or FALSE?) Insurance firms can reduce variability in underwriting risks by diversifying across geographical areas and across lines of business.

T

(TRUE or FALSE?) Insurer liabilities is equal to the present value of expected payments on policies already sold.

T

(TRUE or FALSE?) Lloyd's of London is a marketplace for transacting insurance business.

T

(TRUE or FALSE?) Property-Liability insurers experience more variability in claims costs than life-health insurers.

T

(TRUE or FALSE?) Stock insurers accumulate capital through retained earnings and by issuing new bonds and new stock.

T

(TRUE or FALSE?) The Financial Modernization Act of 1999 (a.k.a Gramm-Leach-Bliley Act) broke down the regulatory barriers against a single financial institution providing banking, investment, and insurance services.

T

(TRUE or FALSE?) The types of securities that insurers invest most heavily in, on average, is medium to long term fixed income securities.

T

(TRUE or FALSE?) Two largest liabilities of the insurers are loss reserves and unearned premium reserves.

T

(TRUE or FALSE?) With a reinsurance treaty contract, the reinsurer does not have right to refuse the multiple insurance contracts that are ceded by the primary insurer.

T

*Incorrect*? a. Reinsurance is the purchase of insurance by an insurer. b. The major investments held by property-liability insurers are mortgages and real estate. c. Lloyd's of London is a marketplace for transacting insurance business. d. Reinsurance is a method that is used by insurers to reduce insolvency.

The major investments held by property-liability insurers are

A participant, "name," in Lloyds of London market invested her $200 million savings with the lead underwriters running the syndicates (groups) of aviation ($40 million), marine transportation ($100 million), and oil rigs ($60 million). If the unlucky outcome occurs where losses amounts to more than $230 million at the end of the year, then:

The names have unlimited liability and she will be assessed for the shortfall of $30 million

*Correct*? a. Insurers cannot diversify by engaging in reinsurance transactions. b. The owners of the insurance organizations that conduct business at Lloyd's of London are called reciprocals. c. All the answers are incorrect. d. Insurers can diversify price and credit risks by purchasing reinsurance. e. With a facultative reinsurance contract, the reinsurer has right to refuse the insurance contracts and evaluates each contract case-by-case basis.

With a facultative reinsurance contract, the reinsurer has right to refuse the insurance contracts and evaluates each contract case-by-case basis

*Correct*? a. Reinsurance can substitute for capital and allow an insurer to hold less capital without increasing its insolvency risk. b. All the answers are incorrect. c. Reinsurance is insurance for investment banks and commercial banks. d. Insurers cannot diversify by selling policies in different geographical locations and in different lines of business. e. Economic capital is the difference between the book value of assets and the book value of liabilities.

a. Reinsurance can substitute for capital and allow an insurer to hold less capital without increasing its insolvency risk.

Diversification of underwriting risk can be achieved by:

a. establishing a large pool of policyholders b. selling a variety of property/liability and life/health insurance policies c. selling insurance policies for every geographical region of the U.S. and the world d. selling a variety of commercial and personal lines of policies *ALL*

Lloyd of London is:

an insurance exchange similar to NYSE that provides opportunity to its members to participate in underwriting activities in syndicates (groups)

*Incorrect*? a. Mutual insurers accumulate capital primarily through retained earnings, but in some cases mutual insurers issue surplus notes (bonds). b. Having a greater level of capital for an insurance company does not affect the likelihood of insolvency, all else equal. c. Insurer liabilities is equal to the present value of expected payments on policies already sold. d. Reciprocal insurer is owned by its policyholders.

b. Having a greater level of capital for an insurance company does not affect the likelihood of insolvency, all else equal.

*Correct*? a. Reciprocal insurer is owned by its stockholders. b. Lloyd's of London is a marketplace where individual names have unlimited liability and corporate names have limited liability. c. Insurer Capital = Policyholder Liabilities - Assets. d. All the answers are incorrect. e. Gramm-Leach-Bliley Act (1999) created a legal structure to separate companies in the insurance, securities, and commercial banking industries.

b. Lloyd's of London is a marketplace where individual names have unlimited liability and corporate names have limited liability.

*Incorrect*? a. With a facultative reinsurance contract, the reinsurer does not have right to refuse the multiple insurance contracts that are ceded by the primary insurer. b. When an insurer buys reinsurance, it is giving up some of its potential underwriting profit to the reinsurer. c. All the answers are correct. d. Insurers can diversify insolvency risk by purchasing reinsurance. e. Lloyd's of London is a marketplace where owners are called "names" the names contribute capital to syndicates.

b. When an insurer buys reinsurance, it is giving up some of its potential underwriting profit to the reinsurer.

Mutual insurer ownership happens by

buying mutual insurer's insurance policies

*Correct*? b. Reinsurance causes an insurer to hold more capital with increased probability of insolvency. c. Gramm-Leach-Bliley Act (1999) created a legal structure for affiliations among companies in the insurance, securities, and commercial banking industries. d. Lloyd's of London is a large incorporated company where stockholders are called "names" the names receive dividends. e. In the case of mutual insurance companies, stockowners are the residual claimants and have limited liability.

c. Gramm-Leach-Bliley Act (1999) created a legal structure for affiliations among companies in the insurance, securities, and commercial banking industries

*Correct*? a. An insurance company which is owned by its stockholders is called a mutual insurer. b. All the answers are incorrect. c. In a proportional reinsurance contract, the premium and the claims costs will be shared between the primary insurer and reinsurer in the same proportion. d. Stockholders of mutual insurance companies are the residual claimants, have usually limited liability and therefore they cannot be assessed, and the mutuals cannot raise capital by issuing equity. e. Reciprocal insurer is incorporated and managed by the board of directors representing stockholders.

c. In a proportional reinsurance contract, the premium and the claims costs will be shared between the primary insurer and reinsurer in the same proportion.

Stock insurers:

cannot distribute their earnings as premium reductions

If a reinsurer agrees to pay primary insurer for the losses in excess of $50 million arising from a pool of 10,000 homeowners policies over a year (up to $50 million of losses is paid by the primary insurer), then this is a type of insurance called:

catastrophe excess of loss

*Correct*? a. With a facultative reinsurance contract, a ceding insurer sells multiple insurance contracts to the reinsurer. b. All the answers are incorrect. c. Lloyd's of London is the largest insurance company in the world. d. Economic capital is the difference between the market value of assets and the market value of liabilities. e. Protecting loss reserves of the insurance firm is the main reason for insurers to hold minimum amount of economic capital.

d. Economic capital is the difference between the market value of assets and the market value of liabilities

*Incorrect*? a. Reinsurance is a method that is used by insurers to reduce insolvency. b. All the answers are correct. c. The difference between an insurer's market value of assets and its market value of liabilities is called economic capital. d. Reciprocal insurer is owned by its stockholders. e. Insolvency risk is reduced by insurer capital.

d. Reciprocal insurer is owned by its stockholders.

*Correct*? a. If a reinsurer agrees to pay a primary insurer's losses greater than $250 million in exchange to receive an annual premium, then this contract is called excess-of-loss contract. b. Reinsurance is insurance for investment banks and commercial banks. c. All the answers are incorrect. d. Reinsurance is the purchase of insurance by an insurer. e. Reinsurance for insurers increases the risk of insolvency.

d. Reinsurance is the purchase of insurance by an insurer.

*Incorrect*? a. The benefits of an insurance company holding more capital include reduced risk of insolvency. b. Protecting against the loss of franchise value is one of the reasons for insurers to hold 'adequate' economic capital. c. All the answers are correct. d. In a proportional reinsurance contract, the premium and the claims costs will be shared between the primary insurer and reinsurer in the same proportion. e. Diversifying across product lines for insurers increases risk of insolvency.

e. Diversifying across product lines for insurers increases risk of insolvency.

*Correct*? a. Lloyd's of London is a firm that sells exotic insurance to businesses. b. The difference between an insurer's book value of assets and its book value of liabilities is called economic capital. c. All the answers are incorrect. d. Protecting loss reserves of the insurance firm is the main reason for insurers to hold minimum amount of economic capital. e. If a reinsurer agrees to pay 20% of primary insurer's losses in exchange to receive 20% of the primary insurer's total premiums, then this contract is called a pro rata contract.

e. If a reinsurer agrees to pay 20% of primary insurer's losses in exchange to receive 20% of the primary insurer's total premiums, then this contract is called a pro rata contract

*Correct*? b. Lloyd's of London is a firm that sells exotic insurance to businesses. c. The major investments held by life-health insurers are municipal bonds. d. Reciprocal insurer is owned by its stockholders. e. Insurers can diversify insolvency risk by purchasing reinsurance.

e. Insurers can diversify insolvency risk by purchasing reinsurance.

The difference between an insurer's market value of assets and its market value of liabilities is called:

economic capital

Which of the following represent a solvent insurer?

losses + expenses < premiums + investment income

Economic capital (surplus) refers to

market value of insurer's assets - market value of insurer's liabilities

An insurance company which is owned by its policyholders is called a:

mutual insurer

If a reinsurer agrees to pay the primary insurer for the losses in excess of $50 million and up to $120 million arising from a single marine insurance policy (up to $50 million of losses is paid by the primary insurer), then this is a type of insurance agreement called:

non-proportional (excess-of-loss)

If a stock insurer goes bankrupt, then the claims on its assets will be at this order:

policyholders, bondholders, stock holders

If a mutual insurer goes bankrupt, then the claims on its assets will be at this order

policyholders, surplus notes holders

In a reinsurance treaty contract, which one of the issues (problems) might arise?

primary insurer may select high risk policyholder and share them with the reinsurer