Deck 11: Insurance Companies: Overview, Operations, and Performance Analysis

Question 1

Discuss the concept of risk pooling for insurance and the use of actuaries in insurance.

Answer 1

Insurance allows the spreading of financial risks across a large pool of individuals or companies, allowing the transfer of risk, so funds are available to meet unplanned financial catastrophe risks. Premiums are set to be able to have sufficient funds to cover risks. By pooling risks, insurers can pay smaller premiums.
Insurance companies employ actuaries in finance and probability to predict the probability and severity of different risks, taking into consideration expected returns on investments and claim costs and lapse rates, as well as administrative and marketing expenses and a profit markup to determine appropriate premiums. If future claims are higher than expected, insurance companies suffer losses. So setting premiums is very important for the insurance industry. Some risks are uninsurable. If they are too frequent or have huge risks. Companies may need to self-insure such a risk, if the risk is cost prohibitive to pass on to an insurance pool.

Question 2

Discuss the concept of adverse selection in insurance and ways to reduce this risk.

Answer 2

Adverse selection occurs when individuals who are more likely to take risks and, hence, to receive insurance benefits are the ones who are most likely seek out insurance. Since insurance is based on the theory of pooling risks, pools of individuals with varying risks are needed to be able to have funds available for those needing payouts for adverse events. To reduce adverse selection risk, insurance firms often offer better rates for group insurance, such as everyone working in a business, to avoid adverse selection problems. Other ways to reduce this risk include lower premiums for individuals with lower risks to entice them to be in the insurance pool (i.e., such as non-smokers, individuals with excellent safety records, and reductions for taking precautions).

Question 3

Discuss the concept of moral hazard in insurance and ways to reduce this risk.

Answer 3

Moral hazard occurs when an individual who owns an insurance policy fails to take proper precautions to avoid losses, because losses are covered by insurance. Examples include failing to lock car doors to avoid car theft, failing to tie up a boat properly when bad weather such as a hurricane is expected, and generally failing to take safety precautions to avoid losses. To reduce moral hazard, insurance companies require a deductible, whereby the insured has to pay a given amount of any loss before the insurance company will pay anything, thus, giving the insured a stake in the loss as an incentive to be proactive against losses. Also, insurance companies often have terms in contracts to reduce risk, such as requirements that a roof is up to a regulatory standard, a sprinkler system to protect against fires, and other precautions in a building, among others.

Question 4

Give an overview of different insurance operations and different aspects that are included:

Question 5

Discuss insurance company revenues and when profits are made.

Question 6

How are insurance companies organized in the U.S. and how might this affect a firm's risk-taking activities and what trends have occurred?

Question 7

Give an overview of respectively life insurance company and P/C insurance company income statements.

Question 8

Discuss the key financial ratios for insurance companies and how they are calculated.

Question 9

Discuss differences in life insurance company investments versus P/C insurance company investments and special considerations.

Question 10

Why is capital important for insurance companies, and how do capital ratios differ for life insurance companies versus P/C companies?

Question 11

What is the difference between Statutory versus GAAP Accounting for U.S. P/C Insurance Companies?

Question 12

Explain what policyholders' surplus is for insurance companies.

Question 13

Discuss reinsurance, catastrophe bonds, and other alternative risk-spreading mechanisms.

Question 14

Discuss how microinsurance is used in developing countries and emerging markets.

Question 15

Discuss the different characteristics of whole life insurance, term life insurance, and how their premiums are determined.

Question 16

Discuss variable life and universal life insurance policies and their characteristics.

Question 17

What are other products that life insurance companies offer?

Question 18

Discuss the regulation of insurance companies in the U.S.

Question 19

What are recent new regulations for insurance companies passed after the U.S. Subprime Loan Crisis?

Question 20

Discuss U.S. risk-based capital requirements for insurers.

Question 21

Discuss regulatory monitoring for solvency for U.S. insurance companies and Guaranty Funds for Insurance Companies.

Question 22

Discuss climate change risks for insurance companies and activities to reduce or mitigate these risks.

Question 23

Actuarial calculations are used by insurance firms to assess:

A) The probable cash outflows for claims.
B) The premium payments needed to pay claims and make a target level of profit.
C) To determine whether individuals qualify to be policyholders.
D) Both a. and b.
E) Both a. and c.

Question 24

The pure premium for a life insurance policy is equal to:

A) The face value of the policy divided by the mortality rate.
B) The face value of the policy multiplied by the actuarially determined probability of a claim and then taking the present value of this amount using as the discount rate the expected rate of return to be earned on premium payments.
C) The face value of the policy plus the operating expenses of the policy divided by the mortality rate.
D) The face value of the policy plus the risk premium divided by the probability of a claim.

Question 25

Reinsurers are used by property/casualty insurers:

A) To earn additional income by accepting some risk in return for a share of the reinsurer's premiums
B) To reduce the total risk level of their policy obligations
C) To increase fee income by acting as brokers between policyholders and reinsurers
D) All of the above

Question 26

Statutory Accounting differs from GAAP accounting because it:

A) Requires more conservative reporting of revenue
B) Allows more flexible reporting of revenue
C) Is used for internal rather than external purposes
D) None of the above

Question 27

Property/casualty insurers' asset portfolios are likely to differ from life insurers because of:

A) Greater investment in municipal securities
B) Greater investment in shorter and intermediate term securities
C) Greater investment in long-term securities
D) Both a and b

Question 28

The long tail in liability insurance refers to the fact that:

A) The present value of the stream of payments by the insured is lower than their face value.
B) Claims may not be reported until many years after the period of coverage.
C) Liability policies are usually written for more than one calendar year.
D) None of the above.

Question 29

The law of large numbers suggests that:

A) The larger the pool of the insured, the greater the ability to predict losses.
B) As the number of insured increases, actual losses approach expected losses.
C) It is not the probability of a specific loss that is so important, but rather the ability to predict total losses for a group.
D) All of the above.

Question 30

The combined ratio is an important measure of the performance of property/casualty insurers because:

A) It indicates the profits (losses) from underwriting and from underwriting and from the securities portfolio.
B) It indicates the profits (losses) resulting after underwriting expenses are netted against premium and investment income.
C) It indicates the combined profits (losses) on underwriting health and automobile policies.
D) It includes both loss expenses and operating expenses relative to premiums earned.
E) None of the above.

Question 31

The Net Underwriting Margin (NUM) is a key ratio for insurance
companies indicating whether or not an insurance firm has made an underwriting profit with premium earned greater than total policy expense as a percentage of total assets.

Question 32

Property/Casualty insurance companies are often under statutory accounting standards set by individual states, and tend to invest in intermediate term maturity securities, to hold greater liquid assets and have a larger equity to asset ratio on average than life insurance companies.

Question 33

A P/C insurance company has a loss ratio of 75% and an expense ratio of 30%. Which of the following statements is true?

A) The combined ratio is 105% indicating a net underwriting gain of 5%.
B) The combined ratio is 105% indicating a net underwriting loss of 5%.

Question 34

U.S. insurance companies are regulated solely by the Federal government.

Question 35

A life insurance company has policy expenses of $10 million, premium income of $8 million, and total assets of $20 million, what is the company's net underwriting margin (NUM)?

A) 10%
B) -10%
C) 20%
D) -20%

Question 36

A P/C insurance company has loss expenses of $6 million, operating expenses of $5 million, total premiums earned of $10 million, and total premiums written of $12 million. The firm has an average investment yield of 6%. What is the firm's combined ratio and appropriate overall profitability ratio?

A) 102% and 4%
B) 102% and 8%
C) 102% and 6%
D) None of the above

Question 37

P/C insurance firms are not concerned about climate change risks.

Question 38

In response to climate change risks, many insurance companies have:

A) Hired senior climate change scientists focusing on atmospheric perils
To assist in catastrophic risk management and analytics to assess underwriting risks and conduct research.
B) Increased efforts to make the public aware of climate change and potential
Damage and ways to reduce this damage with more prudence in the use of land, better planning, and stronger building codes.
C) Expressed concerns and lobbied for full disclosure of climate change risks.
D) Developed innovative projects to help developing countries to adapt to climate change and to invest in renewable energy and assisted clients in risk
Management for climate change including protecting the environment.
E) All of the above.

Question 39

Almost all segments of the insurance industry are affected byclimate change including a rise in death rates for life insurers, greater health issues and diseases for health insurers, and large property losses with increased risk of wildfires in some regions, rainstorms and flooding, and greater frequency of serious storms and hurricanes.

Question 40

Which of the following are examples of some insurance company efforts to help mitigate global warming:

A) Consulting with business policyholders concerning liability risks and adaptations to global warming to ensure they do not cause harm, such as potential emission reduction programs, energy conservation projects and carbon project risk management.
B) Providing incentives to policyholders to reduce their green footprints.
C) Reducing greenhouse gas emissions through sustainable practices for their insurance companies.
D) Initiating special policyholders for green building insurance coverage.
E) All of the above.

Question 41

Core competencies for the insurance industry that make the industry uniquely positioned to understand climate change and seek solutions for minimizing its impacts include which of the following:

A) Competencies in risk management and finance
B) Experience with weather related damages and consulting with property owners and businesses on ways to reduce these risks
C) Experience in underwriting insurance for weather related damages
D) Hiring senior climate scientists in atmospheric perils for catastrophic risk management and analytics to assess underwriting risk and conduct research
E) All of the above

Question 42

Important concepts in insurance do not include which of the following:

A) Risk pooling
B) Adverse Selection Risk
C) Moral Hazard Risk
D) All of the above

Question 43

Characteristics of whole life insurance do not include which of the following:

A) Whole life has a fixed annual premium paid every year by a policyholder.
B) Whole life policies build up cash values based on the earning for excess premiums that can be cashed in, in lieu of maintaining full death protection, or against which low rate loans can be made.
C) Whole life premiums get larger over an individual's life with age.
D) Part of the annual premium is for insurance and the excess over the average actuarial amount needed to cover claims is invested at a fixed annual rate established at the time the policy is written.

Question 44

Which of the following is false concerning term insurance?

A) Term life insurance has no excess premium or savings vehicle or accumulated cash value.
B) Term insurance is for a long-term, such as 20 years.
C) Term insurance premiums for individual policies often rise as a person ages.
D) Term policies are frequently offered as group plans or part of employee benefit packages which with risk pooling often offer lower average rates.

Question 45

Variable life insurance policies are like whole life insurance policies requiring a fixed premium over a policyholder's lifetime, but excess premiums earn variable rates rather than fixed rates of return based on a policyholder's choice of investments, passing on investment risk to the policyholder. A minimum death benefit is specified on the policy, but no maximum, with the actual payment to beneficiaries depending on yields earned on excess premiums.

Question 46

The U.S. National Association of Insurance Commissioners (NAIC) in attempting to estimate the capital needed by a firm to safely absorb the losses to which it is subject for property/casualty companies includes which of the following risk categories:

A) Investment or asset risk
B) Credit risk, such as reinsurance
C) Off-balance sheet risk, such as separate accounts
D) Underwriting risk, such as the loss ratio and reserve adequacy
E) All of the above

Question 47

Advantages of microinsurance products for developing countries and emerging markets does not include which of the following:

A) Higher premium costs
B) Lower premium costs
C) Protection provided to a larger market
D) With higher volume, lower costs and more efficient administration
E) Policies that are at times offered with a small loan, with premiums set at a small percentage of the loan amount