Institute of Actuaries of India
Subject SP7 – General Insurance Reserving
and Capital Modelling
November 2023 Examination
INDICATIVE SOLUTION
Introduction
The indicative solution has been written by the Examiners with the aim of helping candidates.
The solutions given are only indicative. It is realized that there could be other points as valid
answers and examiner have given credit for any alternative approach or interpretation which
they consider to be reasonable.
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Solution 1:
i) Parametric insurance refers to type of insurance contract that insures a policyholder
against the occurrence of a specific event by paying a set amount based on the
magnitude of the event, as opposed to the magnitude of the losses in a traditional
indemnity policy [2]
ii) Major advantages
• The key advantages of parametric insurance are fast payouts, high flexibility and the
option to provide coverage for losses that are difficult to model
• parametric insurance solutions are designed to to complement traditional insurance
programs by filling the protection gaps left by indemnity insurance like deductibles,
excluded perils, scarce capacity etc
• more certainty in term of Outgo for Insurer
• …this reduces the claims handling costs which can be passed on in the form of lower
premiums
• the lower uncertainty led to lower capital requirement during RBC regime
• This reduction in the cost of capital allow capital to be used for other purposes or
growth in other lines
• help in achieving diversification with relation to traditional insurance lines
• greater flexibility in the triggers used and the payouts based on the requirement of
the policyholder
• innovative product will improve market standing increasing brand reputation and
possibly attract more profitable business
• data requirements likely to be less onerous
• more suitable for new and emerging risks where the overall extent of risk severity and
frequency is not well understood given the high uncertainty around the potential
losses
• provide immediate liquidity to the insured post disaster
Major Disadvantages
• Lack of credible and reliable data leading to difficulty in pricing and reserving
• Payout may be more or less than actual loss suffered. It is not based on Indemnity
principle
• difficult for the insured to compare the policy with other traditional options
[6]
[8 Marks]
Solution 2:
i)
• Company is in 6th year; claims not fully run off- basic CL not suitable. Claims in first
year not completely developed
• Chain ladder using paid data may not be apt
• Differences in claim data between file used for chain ladder and that of case estimates
• Inflation lower than 5% in previous years from which data drawn for basic CL
• Change in business mix: evidence in question. Private car and other (possibly
commercial vehicles) give rise to higher amounts and frequency. Unadjusted Chain
ladder may not be directly applicable.
• Half-yearly reviews and improvements for case estimates reflect real picture,
especially social/ legal environment better than basic CL
• Large/ CAT claims in latest development year not fully reflected in paid claims data
• Company’s case procedure quicker in detecting new information and worsening
cases?
• Business growth cause of lower quality of business and higher average claim amount-
not reflected in basic CL
• Treatment of allocated loss different in basic CL.
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• Impact of reinsurance considered in basic CL different from case estimate reserving
[6]
ii)
a)
• Collect data for all the years since inception.
• Collate the data into homogeneous groups . The data should at least be split into
policy groups that have different excess levels, for example level of cover or age
bands.
• Adjust the data for inflation, IBNR, Changes in cover etc.
• Fit a density function to individual claim amounts. You may also fit a density function
to the probability frequency but this is less crucial and it may be modelled
deterministically instead.
• Check the goodness of fit and revise the parameters/ distribution function if
necessary.
• The expected claim experience can be determined using simulation techniques
allowing for chosen excess levels. This can be repeated for different excess levels.
[3]
b)
• There should be corresponding change in the premium rates to accompany the
change in the excess level. The expected impact on profitability should be examined.
• As the premium rates are changing the loading for expenses, profit and contingencies
should also be reviewed to ensure, for example, that the contribution to fixed
expenses is still adequate.
• The attitude of the policy holders towards claim may change. For example, if the
excess is increased then policyholder may not consider claim previously made to be
large enough to bother claiming. This would also lead to lower administration
expenses.
• Alternatively, policyholder may also try and inflate the claims so as not to lose out
financially.
• The effect the change in excess will have on new business volumes should be
considered. Will policy holders be disillusioned by any change.
• The excess of level of competitors/benchmarks should be examined.
• The change should be considered when estimating reserves
• Check that the change to administrative system and policy documents can be made.
• Reinsurance arrangement may need to be revised.
[7]
[16 Marks]
Solution 3:
i)
• Realising Fair value change account, if possible, leading to increase in investment income
• Requesting amortization from regulator of expenses
• Loss portfolio transfer or adverse development cover of loss making business
• Financial Reinsurance, if allowed
• Raising capital through Subordinated debt or any other form
• Re-pricing or stop writing loss making business
• Reducing business volumes as they can have a strain on solvency
• Requesting discounting of reserves
[4]
ii)
• Different Action will be taken by regulator depending upon if it is looking to keep company
Going Concern or run-off
• Regulator may request solvency on Economic Capital/RBC to see correct position
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• Regulator may look to identify the underlying reason for fall in solvency to take
appropriate steps
• May seek the detailed business plan with regulator for a next few years to see when will
solvency will reach back control level
• Plan should include measurable targets at each quarter to assess performance against
plan
• May ask to prepare solvency position monthly rather than quarterly
• Regulator could require that an external consultant to prepare a report on the company.
• Regulator may ask the company to increase rates for loss making business
• Better matching of Asset liability for a few initial years to ensure risk relating to asset
matching are reduces
• Regulator may ask promoters/shareholder to pump more capital
• However if company is not able to increase capital, more onerous requirements may be
placed such as ;
• Restrictions on the amount of business the company can underwrite
• Restrictions on the classes of business the company can underwrite
• Restrictions on offering high risk features in certain types of business
• Such restrictions ensures company has sufficient capital and expertise to underwrite
• Requirement to purchase additional reinsurance
• Restrictions on the amounts of dividends the company is permitted to pay
• Restriction on the types or amounts of certain assets to demonstrate solvency
• For example, requirement on transfer investments to liquid assets to reduce the risk of
failure arising from investment losses
• The use of prescribed bases to calculate premiums, asset values and liabilities to
demonstrate solvency.
• Additional reporting requirements
• Rigorous monitoring from regulator to company
• Additional audit requirements
• May look for change in top Management, if needed
• Look to sale of insurer to a well-capitalised parent, if infusion of capital is inevitable and
it id not available with Owners
• If failure considered inevitable, manage the orderly run-off of the insurer
• Close to new business entirely
[10]
[14 Marks]
Solution 4:
i) Assumptions:
• The loss ratio for 2015-2017 data is appropriate for 2019-2022
• Accident years 2018 and earlier years are fully run off.
• The development of the claims has been stable in monetary terms.
• Future inflation is weighted average of the past inflation.
Method:
Reserve under BF method= LR* EP* (1-1/UDF) where UDF is ultimate development factor
Estimating LR
Accident year Ultimate Claims Earned Premium LR
2015 12,672 25,500 50%
2016 12,379 28,970 43%
2017 14,678 34,650 42%
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The loss ratio for the year 2015 to 2017 suggests a loss ratio of 45% is appropriate. The ratio
is expected on the prudent side to estimate a prudential estimate of reserves. The LR for
2018 has been ignored as an aberration to be on the prudent side.
Note: Appropriate marks were given if students calculated simple/weighted averages for 3
years/2 years/4 years as well as long as they specified and explained the mathematical method
of computation for the same considering that there was some variability in the LRs and the
future premiums have been increasing and as long as they erred on the side of prudence with
respect to overall experience
Accident Earned
0 1 2 3 4 Ultimate
Year Premium
2015 8,789 9,645 10,066 11,892 12,672 12,672 25,500
2016 9,768 10,678 10,999 11,237 12,379 12,379 28,970
2017 9,980 10,567 12,489 13,300 14,678 14,678 34,650
2018 10,890 11,890 12,360 13,505 14,890 14,890 42,665
2019 11,999 12,764 13,876 15,890 40,905
2020 15,500 21,890 24,745 45,895
2021 18,768 19,765 51,895
2022 20,897 52,545
0-1 1 2 3 4 5 6
DFMs 1.134256774 1.0917039 1.10091989 1.09382385 1 1 1
cdf 1.491143187 1.3146434 1.20421243 1.09382385 1 1 1
% dev 67% 76% 83% 91% 100% 100% 100%
Estimating reserves
AY Ultimate claims (1-1/UDF) Reserve
2015 11,475 -
2016 13,037 -
2017 15,593 0% -
2018 19,199 0% -
2019 18,407 9% 1,579
2020 20,653 17% 3,502
2021 23,353 24% 5,589
2022 23,645 33% 7,788
The total reserve required is INR 18,459 crs.
[9]
ii)
• Legislation and prevailing accounting rules that allow or restrict discounting
techniques.
• Nature of business ..Long tailed or short tailed … investment income on long tail
reserves is significant.
• The asset type in which is invested in and the asset type that the company is permitted
to invest has a bearing on the discount rate to be applied.
• The extent to which the realistic picture of the financial condition of the insurer need
to be shown. There is a strong argument to use discounting when preparing published
accounts or account for solvency control for the purpose of rating.
• allowance for the assets not available for investment and because of the money held
with intermediaries and reinsures.
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• is discounting being viewed by investors as sign of weakness
• the extent discounting helps insurer solvency level and profitability by reserves
reduction.
• Margin for prudence ….it is prudent not to discount.
[4]
[13 Marks]
Solution 5:
i)
• Emergency Care due to sudden illness or injury
• Due to worsening medical condition, transport to home country, or to better hospital
in same country
• In case of death, repatriation of remains to home country or cost of local cremation/
burial
• PA death and disability cover, anytime during the trip outside country
• Baggage lost by Common Carrier
• Trip cancelled at beginning due to AOG, terrorism
• Legal liability to pay for third party Accidental
• Loss of Driving license, Passport & Visa
• Connecting Common Carrier is missed due to Common Carrier being late due to
weather, strike or equipment failure of common carrier,
• Automatic extension up to some number of days due to unavoidable/ unforeseen
circumstances
• For Hospitalization exceeding some number of days, family member visiting insured,
cost of economy airfare and accommodation cost
[5]
ii) Risk 1: Anti Selection if product is not properly priced
Measures :
• Competitor Benchmarking to compare premium rates
• Rating Factors which can be used:
• Travel to Country - ASEAN, ASIA, USA and Canada etc, Age of policyholder, duration of
travel … which will help in differentiating risks
• Regular monitoring will help in doing quick course correction. Experience can be quickly
available as very short duration policy
• Hire experience Underwriters for better selection of risk
• Purchase Appropriate reinsurance
Risk 2: New product so data may be not available for pricing
Measures :
• Industry data and research of foreign markets can be done to find various costs
• Flights/travel related data from travel website
Risk 3: Exhaustive coverages leading to higher premium and Lesser sale
Measures:
• Basic coverages can be compulsory and other can be provided as add-ons
• Online sale for better reach and reducing cost
• Introduction of deductibles
• Lower limit for single claim for some of high risk coverages
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Risk 4: Currency risk due to exchange rate movement
Measures:
• Change in rate chart with movement in exchange rates e.g. Increase in rates by 5% for
every 5% fall in currency
• Currency hedging can be explored
Risk 5 Operational Risk: Risk related to IT system and providing administrative and claim related
services
Measures:
• Study of IT system of Peers before development
• Thorough UAT and making sure all rating factors are captured
• New company so in start claim related services may be outsourced to TPA
• Need to tie up with Insurance related service providers in Oversees
[8]
[13 Marks]
Solution 6:
• Company can go for Run-off Reinsurance methods such as Loss Portfolio Transfer or
Adverse development covers
• Company needs to identify reasons for such an increase in reserve to decide for which
methods to choose;
• Is it due to any recent court judgements
• Is it due to some claims registered now which were outside claim system
• Is it due to recent one-off exercise of visiting all claims files
• All business is mainly short tell so most of the technical provisions will be of Motor TP.
Therefore, TP provision amount will be exorbitant requiring significant consideration in
choice of run-off method
• Most of the older years are fairly developed so not much movement in reserve is
expected
• Around 85-90% of the technical provisions are in latest 5/6 years so company need to
decide if it wants to Reinsure only recent years or complete Motor TP portfolio
LTP:
• Company needs to see if regulation allow for Loss Portfolio Transfer
• The company could use the LPT arrangement to transfer in view of loss making portfolio
• The company generally take LPT if it is not able to manage efficiently and resources can
be better deployed elsewhere
• However, company still continues to write TP so may not completely remove TP liability
from it’s book
• The company will need to inform policyholders and reinsurers of this transfer
• The company need to check if it needs any court approval which is required in many
foreign jurisdiction
• Claims handling functions could be removed or redeployed elsewhere
• Company/Reinsurer need to consider discounted value of Motor TP liability as right
now liabilities are not discounted
• Discounted value could be value depending on rate of current portfolio yield
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• There will still be significant Motor TP policies in its “premium receive in Advance” as
3/5 years policies are given to new vehicles
• Buy in of Reinsurer is required
• Significant release in capital can happen
• There can be Tax implications for Insurer
• GST on premium may nullify any benefit in Capital
ADC
• The company could purchase an ADC on a few accident years or it’s complete Motor TP
business
• The company has a choice of attachment point for the ADC depending on risk appetite
and cost
• The company could keep some share in the ADC to keep the cost down
• The company could decide to keep or pass on the claims handling function, depending
upon the arrangement with the reinsurer
• Company can benefit favourable reserve movements if it thinks reserve are prudent
• Investment income will be with company which can be significant
• No court approval required
• Keep an interest in the performance of the business and maintain data
• Claims would usually still be handled by Company B and hence there are the associated
expenses
[15 Marks]
Solution 7:
i)
• Capital will be needed to cover:
• Legal and regulatory costs- to hire legal and regulatory experts to navigate the
licensing and compliance processes, which may involve fees and ongoing compliance
costs
• Market Entry Costs: market research, establishing relationships with brokers, and
adapting to local regulations.
• Compliance and Risk Management Systems: includes software, training, and ongoing
monitoring costs.
• Professional Services: costs to engage consultants, auditors, and advisors to help set
up your company, ensure compliance, and manage risks.
• Insurance and Risk Management: to purchase insurance coverage to protect against
potential losses and liabilities. This can be a significant upfront cost.
• Depend on the business plan of the Company- specific capital requirements will
depend on regulatory guidelines and the risks you plan to underwrite.
• Office Space, technology, equipment and Infrastructure- cost will vary based on the
location and size of your company.
• Staffing: Hiring skilled professionals in the reinsurance industry, such as
underwriters, actuaries, claims adjusters, and administrative staff, is essential.
Salaries, benefits, and recruitment costs are part of this expense.
• Technology and Software: Reinsurance operations rely heavily on technology and
software for data analysis, risk modelling, and policy administration.
• Marketing and Business Development
• Reserving and Capital Adequacy: capital for potential claims and meet capital
adequacy requirements.
• Reinsurance Treaties: reinsurance premiums if plan to reinsure own risks
• Operating Expenses: Regular operating expenses, such as utilities, insurance, and
employee salaries, will also be incurred.
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[7]
ii)
• Estimate the inflows and outflows that will be incurred based on the specifics of the
reinsurance company and its business plan. It will be necessary to create model points
that represent the mix of employer’s liability and professional indemnity business the
Company intends to sell.
• Cashflow model will be needed which projects the cashflows into the future. Cashflows
will include premiums, claims, expenses, investment return, reinsurance premiums and
recoveries and tax.
• Model must allow for any required solvency margin.
• Cashflows should be discounted back at apt risk discount rate in order to determine the
reserves that are needed.
Basis should be chosen that will be fit for the purpose:
• If the company is calculating economic capital, a realistic basis might be apt
• If the company is calculating regulatory capital, then a prudent or cautious basis may
be more apt- in this case the basis may be prescribed.
It will be necessary to decide:
• Variables that will be modelled deterministically and the ones which will be modelled
stochastically
• Time horizon over which to model the cashflows- this should be the lifetime of the
business being modelled
• The degree of accuracy required and so the number of simulations required- a minimum
of 50,000 simulations would generally be considered apt.
• Correlations between different variables should also be allowed for
• Model should ensure consistency between various assumptions
• Allowance should be made according to the structure, terms and conditions of the
products- employer’s liability and professional indemnity
• Future tax position should also be considered
• Scenario and sensitivity testing should be carries out on different assumptions.
• Output from model will be the amount that needs to be held as reserves plus any
required solvency margin. This will be scaled up to reflect the volume of the business
the company expects to sell
• The initial capital required to set up the company will be added to give the total capital
required to set up the new reinsurance company.
[9]
iii) Let capital required for El =x
Capital for PI=3/2x
.3*x=12%*1000
x=400 crores
So the Capital Required for EL is 400 Crores
Capital for PI= 3/2*400=600 crores
So the capital Required for PI is 600 Crores
Total Capita = Capital for EL + Capital for PI
Total Capital= 600+400=1000 crores
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ROC= 30%* (1000)=300
Profit on PI= 300-120=180 crores
[5]
[21 Marks]
********************
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