FIN:3400 CH 7 REVIEW
What is the balance sheet equation?
Assets = Liabilities + Owners' Equity
Briefly discuss the two principal types of financial reserves needed to be maintained by property and casualty insurers.
(a) The assets of an insurance company are primarily financial assets. An insurance company invests premium dollars and retained earnings. These assets back the insurer's liabilities and help to generate investment income. Specific assets held include bonds, common stock, preferred stock, real estate, and mortgage-backed securities. Two additional asset categories for life insurance companies are life insurance policy loans and separate account assets. (b) Liabilities are more difficult to measure because one of the largest liability items, loss reserves, is not known for certain. Loss reserves are an estimated value, but the actual loss experience could be different from the expected loss experience
For the past calendar year, a property insurer reported the following financial information for a specific line of insurance: Premiums written $25,000,000 Expenses incurred 5,000,000 Incurred losses and loss-adjustment expenses 14,000,000 Earned premiums 20,000,000 a. What was the insurer's loss ratio for this line of coverage? b. Calculate the expense ratio for this line of coverage. c. What was the combined ratio for this line of coverage?
(a) The loss ratio is 70 percent. The loss ratio is the ratio of incurred losses and loss-adjustment expenses to earned premiums. Incurred losses and loss-adjustment expenses are $14 million, and earned premiums are $20 million. The ratio, $14 million divided by $20 million, is 0.70 or 70 percent. (b) The expense ratio is 20 percent. The expense ratio is the ratio of expenses incurred to written premiums. Expenses incurred were $5 million, and premiums written at $25 million. The expense ratio is $5 million divided by $25 million, or 20 percent. (c) The combined ratio is 90 percent. The combined ratio is the sum of the loss ratio and the expense ratio (0.70 + 0.20 = 0.90).
Briefly describe the following methods for determining a class rate: a. pure premium method b. loss ratio method
(a) The pure premium is that portion of the gross rate needed to pay losses and loss-adjustment expenses. The pure premium can be determined by dividing the dollar amount of incurred losses and loss-adjustment expenses by the number of exposure units. A loading for expenses is then added to the pure premium to determine the gross premium. (b) Under the loss ratio method, the actual loss ratio is compared to the expected loss ratio, and the rate is adjusted accordingly. The actual loss ratio is the ratio of incurred losses and loss adjustment expenses to earned premiums. The expected loss ratio is the percentage of the premium that is expected to be used to pay losses.
In the context of rate making, explain the meaning of: a. rate b. exposure unit c. pure premium d. gross premium
(a) The rate is the price per unit of insurance. (b) The exposure unit is the unit of measurement used in insurance pricing. For example, in fire insurance, the exposure unit is $100 of coverage. (c) The pure premium refers to the portion of the rate that is needed to pay losses and loss adjustment expenses. (d) The gross premium is the gross rate multiplied by the number of exposure units. The gross rate, in turn, is the pure premium plus the loading for expenses, profit, and other contingencies
Explain the following methods of merit rating: a. schedule rating b. experience rating c. retrospective rating
(a) Under schedule rating, each exposure is individually rated, and debits and credits are applied based on the physical characteristics of the exposure to be insured. (b) Experience rating means that the insured's past loss experience is used to determine the premium for the next policy period. (c) Retrospective rating means the insured's loss experience during the current policy period determines the actual premium paid for that period.
a. Why are property and casualty insurance companies required to maintain loss reserves? b. Briefly explain the following methods for determining loss reserves: 1. judgment method 2. average value method 3. tabular method c. What is the incurred-but-not-reported (IBNR) loss reserve?
1. (a) Property and casualty insurers are required to maintain certain loss reserves. A loss reserve is the estimated cost of settling claims that have already occurred but have not been paid as of the valuation date. Most specifically, the loss reserve is an estimated amount for: (1) Claims reported and adjusted but not yet paid (2) Claims reported and filed but not yet adjusted (3) Claims incurred but not yet reported to the company (b) (1) Under the judgment method, a loss reserve is established for each claim. This method is used when the number of claims in a particular line of insurance is too small or the variation in claims is too large to assign an average value to each claim. (2) Under the average value method, an average value is assigned to each claim. This method is used when the number of claims is large, the average amount of each claim is relatively small, and the claims are quickly settled. (3) Under the tabular value method, loss reserves are determined for certain claims for which the amounts paid depend on the length of life, duration of disability, remarriage of the beneficiary, and similar factors. The loss reserve is called the tabular reserve because the duration of the benefit period is based on data derived from mortality, morbidity, and remarriage tables. (c) The IBNR reserve is the loss reserve for claims that have already occurred but have not been reported. As of a specified date, such as December 31, a certain number of claims have already occurred but have not yet been reported to the insurer.
What risks should be taken into account when calculating a life (re)insurer's solvency capital requirements?
In life insurance, a policy reserve is defined as the difference between the present value of future benefits and the present value of future net premiums. Policy reserves or legal reserves are a formal recognition of a company's obligation to pay future benefits. Also, the reserve is a legal test of the company's solvency, since the company must hold assets equal to its legal reserves and other liabilities.
Based on the following information, determine Mutual Life Insurance Company's gain from operations before income taxes and dividends to policyholders: Total premium income $20,000,000 Licenses, taxes, and fees 580,000 Death benefits paid 6,000,000 Net investment income 3,000,000 Commissions paid 5,900,000 General insurance expense 2,500,000 Surrender benefits paid 800,000 Annuity benefits paid 1,600,000
The gain from operations before dividends and taxes equals total revenues minus total expenses. Mutual Life Insurance Company's total revenues are $23.0 million (total premium income plus net investment income). The company's total expenses are the sum of each of the other listed items: death benefits paid, commissions paid, surrender benefits paid, licenses/taxes/fees, general expenses, and annuity benefits paid. These cash outflows total $17.38 million. Therefore, the company's gain from operations before dividends and taxes was $5.62 million.
What are the major categories of expenses for a life insurance company?
The major expenses for a life insurance company are benefits paid (death benefits, health benefits, annuity benefits, matured endowments, and policy surrenders), claims expenses, commissions, premium taxes, and general insurance expenses
What are the major expenses of a property and casualty insurance company?
The major expenses for a property and casualty insurance company are loss payments, loss adjustment expenses, commissions, premiums taxes, and general expenses.
Based on the following information, determine the policyholders' surplus for XYZ Insurance Company: Total invested assets $50,000,000 Loss reserves 40,000,000 Total liabilities 70,000,000 Bonds 35,000,000 Unearned premium reserve 25,000,000 Total assets 90,000,000
The policyholders' surplus is equal to total assets minus total liabilities. Total assets are $90 million and total liabilities are $70 million. Therefore, the policyholders' surplus is $20 million
A large casualty insurer writes a substantial amount of private passenger auto insurance. An actuary analyzed claims data for a specific class of drivers for a recent 1-year policy period. The claims data showed that the insurer paid out $30 million for incurred losses and loss-adjustment expenses for each 100,000 cars insured for 1 year. Based on the pure premium method, calculate the pure premium.
The pure premium is $300. The pure premium is that portion of the gross rate needed to pay losses and loss-adjustment expenses. The pure premium is determined by dividing the dollar amount of incurred losses and loss-adjustment expenses by the number of exposure units. Incurred losses and loss-adjustment expenses are $30,000,000. The number of exposure units is 100,000 cars insured for one year. The premium is $30,000,000 divided by 100,000, or $300
What are the major regulatory objectives that must be satisfied in insurance rate making?
The rates charged by insurers must meet certain regulatory objectives: they must be adequate, not excessive, and not unfairly discriminatory.
What are the major business objectives?
The rating system must also meet certain business objectives: rates should be easy to understand, stable, responsive, and encourage loss prevention
What are the three major sections of a balance sheet?
The three major sections of a balance sheet are the assets, liabilities, and owners' equity. Assets are items of value that the company owns. Liabilities are what the business owes. Owners' equity (called policyholders' surplus) is the difference between the assets and the liabilities. Owners' equity is the amount that would remain if a company paid off all of its liabilities using its assets. Owners' equity is not observed directly, and is the "balancing" item on the balance sheet.
What are the two major sources of revenue for a property and casualty insurance company?
The two major sources of revenue for a property and casualty insurance company are the premiums that it earns for providing insurance coverage and investment income generated from its portfolio of invested assets.
