Chapter 41 - Pricing And Insuring Risks

Question 1

What is risk classification?

Answer 1

• Risk classification is a tool for analysing a portfolio of prospective risks by their risk characteristics such that the resulting subgroups are homogeneous bodies of risks.
• It is the grouping of risks by similar characteristics.

Question 2

Why do we classify risks?

Answer 2

• To ensure pricing is equitable and fair
• To ensure the company stays competitive
• To avoid adverse selection

Question 3

Why would there be greater risk classification involved with a general insurer?

Answer 3

• There is more data available

- It is a more competitive market, so the company must protect itself against adverse selection.

Question 4

What happens after the risk classification stage? (3 marks)

Answer 4

The company can choose to

• Take on the risk and retain it
• Take on the risk and reinsure it or use Alternative Risk Transfer Methods
• Refuse the risk

If the risk is retained then the benefit design might change to eliminate unnecessary parts and only keep the most pertinent cover. This is also to ensure all risks and needs are met.

Question 5

What does an individual’s risk appetite depend on?

Answer 5

• Capital available
• Age
• Type of person

Question 6

What does an institution’s risk appetite depend on?

Answer 6

• Size
• Structure (mutual or proprietary)
• Culture
• Existence of parent company or other guarantees
• Board of director’s experience
• Providers of capital’s risk appetite
• Regulatory control
• Existing exposure
• Capital available

Question 7

What would make a risk insurable?

Answer 7

• Measurable, quantifiable and financial
• Insurable interest (own life, spouse, dependent, co-owner of assets, business partner)
• Claim size commensurate with the size of the financial loss if the risk event occurs
• Moral hazard must be avoided
• Large number of similar risks
• Limited liability on the insurer
• Independent of each other (spread)
• Probability of the event happening must be small
• Sufficient statistical data/info available so insurer can estimate frequency and severity
• Pooling of risks

Question 8

When will a market for risk exist?

Answer 8

• A market for risk exists if the price at which one party is willing to accept a risk is lower than the perceived cost of the risk to a second party.

Question 9

When will a market be risk efficient?

Answer 9

• A market is risk efficient if there is a good market for risk transfer.
• The market must be large enough -> economic factors will result in an efficient market.

Question 10

Explain how pooling of risk works.

Answer 10

• The law of large numbers state that if the sample size of observations (drawn from an IDD variable) increases, the average value will tend to the true expected value.
• So the more risks you take on, the more likely the outcome is close to the expected outcome.
• So there is more certainty in likely future payments.

Question 11

Give 6 examples of risk being traded as a commodity in a market for risk.

Answer 11

• Insurer to a bank
• Insurer to an auditor
• Insurer to reinsurer
• Members to the managers of an investment scheme
• Scheme sponsor to an insurance company
• Trustees of a scheme to advisors

Question 12

Mention rating factors that would be used in personal motor insurance.

Answer 12

• Age
• Sex
• Existing driving convictions
• Nr and type of previous accidents
• Post code
• Vehicle type
• Vehicle use
• Anticipated mileage

Question 13

List the rating factors used for critical illness products.

Answer 13

• Age
• Sex
• Height and weight
• Smoker status
• Units of alcohol consumer per week
• Occupation
• Medical history
• Family history
• Country of residence
• Level of SA

Question 14

List the rating factors used for employer’s liability contracts.

Answer 14

• Type of industry or occupation
• Nr of employees
• Average salary
• Sum assured
• Previous claims experience
• Location of the work force
• Materials handled or processes involved
• Extent of safety/first aid standards in place