C16nBUSINESSnINSURANCEnREALnEXAMnQUESTIONSnANDnCORRECTnANSWERS//ALREADYnGRADEDnA+
5nWaysnInsurance ncompaniesnspreadnriskn-nanswer--
Share nrisknwithnotherninsurance ncompaniesn(fornverynlarge nrisk,nseveralninsurersnsubscribentonpercentage n
ofnrisk)
-Reinsure nthe nrisk
-deductible
-spreadnrisknoverndiverse ngeographicalnregionn(softennrisknofnlocalizedndisasters)
-
formnrisknpoolsn(syndicatesnofninsurance nandnreinsurancencompanies,norganizedntonunderwrite nparticularn
risk)
Twonprinciplesnofninsurance n-nanswer-1.nPremiumsnofnthe nmanynare nusedntonpaynthe nlossesnof nthe nfew
(riskntransferredntoninsurer,ndeductible,ncompanynsharesnandnspreadsnrisk,ngeographicnspreadnof nrisk,nfor
mingnrisknpools)
Premiumnshallnbe ncommensurate nwithnthe nrisk
(Capitalnmeetsnprobabilitiesnofnloss,npremiumsnmustnbenadequatentonpaynfuturenclaims,nfierce ncompetitio
n,nadverse nselection,nlongnandnshortntailnlines,ntime ngapsninnpricing)
ShortntailnandnLongntailncomparedn-nanswer-
Tailnrefersntonthe namountnof ntime nbetweennthe nincidentnandnthe ndeterminationnofnclaim
-Shortntail-
linesnare nthosenwherentheninjurynornothernharmnbecomesnknownnquicklyn(relativelynshortnperiodnof ntime n
betweenneventnandnresolution)
-Longntail-linesnfeature nclaimsnseparatednfromnthe ncircumstancesnthatncausednitnbyn10,n15,n20nyrsnornmore
-tonprice nrisksntime ngapsnmustnbe nconsiderednfornlong-tailnlines
-tonpaynclaimsnfromnmanynyearsnago
-tonpaynfornclaimsninnthe nfuture nwithntoday'snpremium
Negative nconsumernperceptionsnofnindustrynandnhowntonimprove n-nanswer--
pricesngonup/downnasncapacityntightening
-leftncustomersnwithnpoornopinion
-medianportraysnnegative nimage n(politicatiansnpromise ntondonsomethingnaboutnrates)
-insurersnwantntoneducate ninsurance npeople naboutnhowninsurance nindustrynworks
-
cannprovide nmoreninformationnonnquestionsnlike n(goodnrisknvsnbad,nhownisnanrisknpriced,nwhynratesngonup,n
whynanprofitable nindustrynbenefitsneveryone0
,-feelnifnanclaimnnotnmade,npremiumnshouldnbe nreturned/reduced
-presentnservicesninnpostitive nlight
-insurance nprotectionnintangible
-
10nwaysninsurance naffectsnsocietynandneconomyn-nanswer--
banksnwillingntonissue nmortgagesnonnbuildingsnthatnare ninsured
-developersnwillingntonadvance nfundsntonbuildingncontractorsnonnprojectsnguaranteednbynsuretynbonds
-retailersnmore nwillingntonacceptncommercialnrisksnwithnliabilityninsurance
-professionalsnmore nwillingntonprovide nservicesnwhenninsurednagainstnrisknof nmalpractice
-manufacturersnmore nwillingntonacceptnrisksnassociatednwithnshippingngoodsn(whenninsured)
-membersnof nsocietynmore nwillingntonuse nautomobiles
-peace nof nmind
-providesnemployment
-contributesntoneconomy
-investmentsnhelpnfinance ngovernments
-claimnpaymentsnboostnlocalneconomiesnandncreate njobs
Goalnofnreinsurance n-nanswer--givesnpeace nof nmindntoninsurers
-confidence ninstillednthatnfinancialnruinnwillnnotnoccurnisnanmajornunplannedneventnwere ntonoccur
Fournbasicnfunctionsnof nInsurance n-nanswer-Financingn-
n offers nan uniquenmethodn of nfinancingn toninsurance ncompanies, nfreesn upn capitaln thatn wouldnben otherwise n tiedn
up,nmeetnsolvencynregulations, nexpansionnof noperations
Stabilizationn-
n keepn insurer's n growthnandn development, nusedntonkeepnoperationalnresults nreasonablen withoutnfluctuatio
ns,ncannhelpnmaintainnconfidence nfromnstakeholders, nattractnnewncapital
Capacityn-
n require n ability n ton insure nbusinesses nbeyondntheirn resources, ntakenonnrisksnhighern thannthey nwould n normal
lynwrite,nmaynnotnwantntonbe nlimitedntonsmallnlines,ncaterntonneedsnofnbignproducers
Reinsurance nusedntonprotectnagainstncatastrophicnlossn-
n look n ton protectnresources nsuchnasntheirn capitaln andn surplus,theirn lossn rationandntheirn investmentn positio
n
,Fivenareasnofnchallengenfacingninsurancenindustryn-nanswer-
GlobalizationnRapidnadvancesninntechnology
Publicnimage nissues
Volatile ninvestmentnmarkets
n Increasinglynseverenweathe
rngrowingncompetition
mountingnshareholdernandnregulatorynscrutiny
n downloadingnandnoffloadingnbyngovernment
Long-tailncatastrophicnautoninjurynexposuresnaffectnreinsurersnandninsurersn-nanswer-- nsevere ninjuries
-long-tailntrendsnfornpriornaccidentnyears
-inadequate nreserving
-
LawnofnLarge nnumbers:n-nanswer-
mathematicalnpremise nwhichnstatesnthatnthe ndegreenof ncertaintyninnprobabilitiesnincreasesnasnthe nnumber
n of n events n increases n -
n insurance n companies n rely n onn lossn forecasts n builtn onn usingn datan fromn large n groups n of n similarn risks
5.nAdversenSelectionn-nanswer-
Processnbynwhichnpotentialnpolicyholdersnuse nprivatenknowledgenofntheirnownnhighnlevelnofnrisknwhennd
ecidingnwhethernornnotntonbuyninsurancen(highnrisknindividualsnwillnbuynlotsnofninsurancenandnpaynhighnra
tesnwhere nlownrisknclientsnmightnnotnbuynanyninsurance nbecause nthe nprice nisntoonhigh)
(Alsonoccursnwhennanbrokernplacesnitsnpoorernrisksnwithnone ninsurernandnitsnbetternrisksnwithnanothern-
n low n riskn clientn willn seekn bestnratesn where npoorernrisk n willn stay n withn existingn company nbecausen they n won't
n be n able n ton findn ratesn elsewhere)
7.nTwonconcernsnof nOntarionAutonexcessnreinsurersnthatnrelate ntonlong-tailnliabilities:n-nanswer--
n Increasingly n largern claimsn (increase n inn numbern of n claimsn exceedingn thresholders)
-Inherentnchallengesninnlong-
tailnpricingnbecause nit'sndifficultntonaccuratelynpredictnthenoutcomenof nclaimsnthatnhavennotnyetnoccurredna
ndnwillnremainnopennfornyears
-Late nreportingntoninsurers
-Capsnonnsoftntissue ninjurynbutnnotnonncatastrophicninjures
, -Adequate nclaimsnreservingnatnthe nprimaryncompanynlevel
-re-pricingninncertainnexcessnlayers
-impactnof nmedicalnandnhealthncare ninflationnonnclaims
9. Residualnmarketn-nanswer-
mechanismsnhavenbeennestablishednbynautomobile ninsurance nindustryntonprovidenanlastnresortninsuranc
e nfacilitynfornconsumers.nThisnensuresnthatninsurancencoverage nisnavailable nevenntonthose nwhonarenconsi
derednanhighnrisk.nFacilitynAssociation.
Advantagesnattributedntonthe ndirectnresponse nmethod:n-nanswer-• nProfessionalnadvice nwithnno
commissionncostsnornfeesnpaidntonindependentnbrokers
• Technology-enablesnsalesnandnservicesn(1-800ntelephone nservices,nInternet)
• Extendednhoursnofnaccessnfornconsumers
Sevennpotentialneffectsnofnforeignnownership:n-nanswer-
1.nDeployedncapital:nManynmore nchoicesnfornplacementnof ncapitalnwhenninternational
2. Divestingncertainnlines
3. Costnof nretrocessionncoversnandnreinsurance
4. Emergingnrisks
5. Settingnunderwritingnphilosophiesnandnprocedures
6. Technology
7. Investmentnmarkets
Three neffectsnofnMergersn-nanswer-• nReduce ncapacitynfromnwhatnisncurrentlynannalreadyntightnmarket
• Give nInsurance ncompaniesnanslightnsmallernreinsurance nuniverse nfromnwhichntongleanncapacity
• Give notherninsurersnthe nopportunityntongrow-albeitntonanfairlynsmallndegree
17. Three nrisksnthatninsurersnwillnface ninnmature nornmergingnmarket:n-nanswer-• nExposuresntonasbestos
• Large nnaturalncatastrophes
• Productsnliability
• Politicalnrisk
5nWaysnInsurance ncompaniesnspreadnriskn-nanswer--
Share nrisknwithnotherninsurance ncompaniesn(fornverynlarge nrisk,nseveralninsurersnsubscribentonpercentage n
ofnrisk)
-Reinsure nthe nrisk
-deductible
-spreadnrisknoverndiverse ngeographicalnregionn(softennrisknofnlocalizedndisasters)
-
formnrisknpoolsn(syndicatesnofninsurance nandnreinsurancencompanies,norganizedntonunderwrite nparticularn
risk)
Twonprinciplesnofninsurance n-nanswer-1.nPremiumsnofnthe nmanynare nusedntonpaynthe nlossesnof nthe nfew
(riskntransferredntoninsurer,ndeductible,ncompanynsharesnandnspreadsnrisk,ngeographicnspreadnof nrisk,nfor
mingnrisknpools)
Premiumnshallnbe ncommensurate nwithnthe nrisk
(Capitalnmeetsnprobabilitiesnofnloss,npremiumsnmustnbenadequatentonpaynfuturenclaims,nfierce ncompetitio
n,nadverse nselection,nlongnandnshortntailnlines,ntime ngapsninnpricing)
ShortntailnandnLongntailncomparedn-nanswer-
Tailnrefersntonthe namountnof ntime nbetweennthe nincidentnandnthe ndeterminationnofnclaim
-Shortntail-
linesnare nthosenwherentheninjurynornothernharmnbecomesnknownnquicklyn(relativelynshortnperiodnof ntime n
betweenneventnandnresolution)
-Longntail-linesnfeature nclaimsnseparatednfromnthe ncircumstancesnthatncausednitnbyn10,n15,n20nyrsnornmore
-tonprice nrisksntime ngapsnmustnbe nconsiderednfornlong-tailnlines
-tonpaynclaimsnfromnmanynyearsnago
-tonpaynfornclaimsninnthe nfuture nwithntoday'snpremium
Negative nconsumernperceptionsnofnindustrynandnhowntonimprove n-nanswer--
pricesngonup/downnasncapacityntightening
-leftncustomersnwithnpoornopinion
-medianportraysnnegative nimage n(politicatiansnpromise ntondonsomethingnaboutnrates)
-insurersnwantntoneducate ninsurance npeople naboutnhowninsurance nindustrynworks
-
cannprovide nmoreninformationnonnquestionsnlike n(goodnrisknvsnbad,nhownisnanrisknpriced,nwhynratesngonup,n
whynanprofitable nindustrynbenefitsneveryone0
,-feelnifnanclaimnnotnmade,npremiumnshouldnbe nreturned/reduced
-presentnservicesninnpostitive nlight
-insurance nprotectionnintangible
-
10nwaysninsurance naffectsnsocietynandneconomyn-nanswer--
banksnwillingntonissue nmortgagesnonnbuildingsnthatnare ninsured
-developersnwillingntonadvance nfundsntonbuildingncontractorsnonnprojectsnguaranteednbynsuretynbonds
-retailersnmore nwillingntonacceptncommercialnrisksnwithnliabilityninsurance
-professionalsnmore nwillingntonprovide nservicesnwhenninsurednagainstnrisknof nmalpractice
-manufacturersnmore nwillingntonacceptnrisksnassociatednwithnshippingngoodsn(whenninsured)
-membersnof nsocietynmore nwillingntonuse nautomobiles
-peace nof nmind
-providesnemployment
-contributesntoneconomy
-investmentsnhelpnfinance ngovernments
-claimnpaymentsnboostnlocalneconomiesnandncreate njobs
Goalnofnreinsurance n-nanswer--givesnpeace nof nmindntoninsurers
-confidence ninstillednthatnfinancialnruinnwillnnotnoccurnisnanmajornunplannedneventnwere ntonoccur
Fournbasicnfunctionsnof nInsurance n-nanswer-Financingn-
n offers nan uniquenmethodn of nfinancingn toninsurance ncompanies, nfreesn upn capitaln thatn wouldnben otherwise n tiedn
up,nmeetnsolvencynregulations, nexpansionnof noperations
Stabilizationn-
n keepn insurer's n growthnandn development, nusedntonkeepnoperationalnresults nreasonablen withoutnfluctuatio
ns,ncannhelpnmaintainnconfidence nfromnstakeholders, nattractnnewncapital
Capacityn-
n require n ability n ton insure nbusinesses nbeyondntheirn resources, ntakenonnrisksnhighern thannthey nwould n normal
lynwrite,nmaynnotnwantntonbe nlimitedntonsmallnlines,ncaterntonneedsnofnbignproducers
Reinsurance nusedntonprotectnagainstncatastrophicnlossn-
n look n ton protectnresources nsuchnasntheirn capitaln andn surplus,theirn lossn rationandntheirn investmentn positio
n
,Fivenareasnofnchallengenfacingninsurancenindustryn-nanswer-
GlobalizationnRapidnadvancesninntechnology
Publicnimage nissues
Volatile ninvestmentnmarkets
n Increasinglynseverenweathe
rngrowingncompetition
mountingnshareholdernandnregulatorynscrutiny
n downloadingnandnoffloadingnbyngovernment
Long-tailncatastrophicnautoninjurynexposuresnaffectnreinsurersnandninsurersn-nanswer-- nsevere ninjuries
-long-tailntrendsnfornpriornaccidentnyears
-inadequate nreserving
-
LawnofnLarge nnumbers:n-nanswer-
mathematicalnpremise nwhichnstatesnthatnthe ndegreenof ncertaintyninnprobabilitiesnincreasesnasnthe nnumber
n of n events n increases n -
n insurance n companies n rely n onn lossn forecasts n builtn onn usingn datan fromn large n groups n of n similarn risks
5.nAdversenSelectionn-nanswer-
Processnbynwhichnpotentialnpolicyholdersnuse nprivatenknowledgenofntheirnownnhighnlevelnofnrisknwhennd
ecidingnwhethernornnotntonbuyninsurancen(highnrisknindividualsnwillnbuynlotsnofninsurancenandnpaynhighnra
tesnwhere nlownrisknclientsnmightnnotnbuynanyninsurance nbecause nthe nprice nisntoonhigh)
(Alsonoccursnwhennanbrokernplacesnitsnpoorernrisksnwithnone ninsurernandnitsnbetternrisksnwithnanothern-
n low n riskn clientn willn seekn bestnratesn where npoorernrisk n willn stay n withn existingn company nbecausen they n won't
n be n able n ton findn ratesn elsewhere)
7.nTwonconcernsnof nOntarionAutonexcessnreinsurersnthatnrelate ntonlong-tailnliabilities:n-nanswer--
n Increasingly n largern claimsn (increase n inn numbern of n claimsn exceedingn thresholders)
-Inherentnchallengesninnlong-
tailnpricingnbecause nit'sndifficultntonaccuratelynpredictnthenoutcomenof nclaimsnthatnhavennotnyetnoccurredna
ndnwillnremainnopennfornyears
-Late nreportingntoninsurers
-Capsnonnsoftntissue ninjurynbutnnotnonncatastrophicninjures
, -Adequate nclaimsnreservingnatnthe nprimaryncompanynlevel
-re-pricingninncertainnexcessnlayers
-impactnof nmedicalnandnhealthncare ninflationnonnclaims
9. Residualnmarketn-nanswer-
mechanismsnhavenbeennestablishednbynautomobile ninsurance nindustryntonprovidenanlastnresortninsuranc
e nfacilitynfornconsumers.nThisnensuresnthatninsurancencoverage nisnavailable nevenntonthose nwhonarenconsi
derednanhighnrisk.nFacilitynAssociation.
Advantagesnattributedntonthe ndirectnresponse nmethod:n-nanswer-• nProfessionalnadvice nwithnno
commissionncostsnornfeesnpaidntonindependentnbrokers
• Technology-enablesnsalesnandnservicesn(1-800ntelephone nservices,nInternet)
• Extendednhoursnofnaccessnfornconsumers
Sevennpotentialneffectsnofnforeignnownership:n-nanswer-
1.nDeployedncapital:nManynmore nchoicesnfornplacementnof ncapitalnwhenninternational
2. Divestingncertainnlines
3. Costnof nretrocessionncoversnandnreinsurance
4. Emergingnrisks
5. Settingnunderwritingnphilosophiesnandnprocedures
6. Technology
7. Investmentnmarkets
Three neffectsnofnMergersn-nanswer-• nReduce ncapacitynfromnwhatnisncurrentlynannalreadyntightnmarket
• Give nInsurance ncompaniesnanslightnsmallernreinsurance nuniverse nfromnwhichntongleanncapacity
• Give notherninsurersnthe nopportunityntongrow-albeitntonanfairlynsmallndegree
17. Three nrisksnthatninsurersnwillnface ninnmature nornmergingnmarket:n-nanswer-• nExposuresntonasbestos
• Large nnaturalncatastrophes
• Productsnliability
• Politicalnrisk
