Chapter 8 - External Environment

Question 1

Four different types of inflation that might affect insurance claims are

Answer 1

-price inflation, which will affect the replacement cost of goods

-earnings inflation, which will affect repair costs and loss of earnings claims

-medical inflation, which will affect medical expense claims

-court inflation, which will affect claims where the claim amount is decided by a court, eg on some liability claims.

Question 2

What will happen if you dont consider claims inflation properly?

Answer 2

-can lead to insurers undercharging charging premiums and also lead to under-reserving if reserving is done using methods that require an explicit assumption about inflation.

Question 3

Economic conditions (e.g. low growth, high unemployment) affect insurance how?

Answer 3

↑ Theft/arson/fraudulent claims.

↑ Demand for credit insurance (due to bankruptcies).

Inflation affects claim costs and expenses.

Underwriting cycle drives pricing volatility.

Investment and currency conditions also key.

Question 4

what does inflation have an impact on?

Answer 4

it will affect the amount of each claim (severity) apart from fixed benefit claims. Therefore, the expenses of the insurer will be affected.

Question 5

How is inflation affected in a household content insurance

Answer 5

maybe be retail price index or consumer price index - but may include items like food and housing costs. can use judgement to amend these indices.

Question 6

How is inflation affected in a buildings insurance

Answer 6

both wage and price inflation for cost of building materials. and wage for the labour costs. Labour = key driver; may exceed price inflation

may also have demand surge where there is a temporary increase in costs of labour due to a a cat event where there is a large number of claims at the same time.

Question 7

How is inflation affected in a medical insurance like private healthcare or bodily injury claims from motor insurance

Answer 7

medical expenses where medical inflation is significantly higher than price or wage inflation. This is because it has a combination of factors:
- more advanced medical treatment used so mor expensive
-better treatment means patients survive for longer
-doctors and consultants salaries can rise in access of average wage inflation.

Question 8

in order of higher first, price inflation, wage inflation and medical inflation

Answer 8

1)medical inflation
2)wage inflation
3)price inflation

Question 9

How is inflation affected in motor property damage

Answer 9

wage and price inlfation. Labour-intensive; may vary by vehicle type.

Question 10

How is fixed benefits affected by inflation?

Answer 10

immune to inflation so Payouts fixed; no inflation impact on claim amount (severity only).

Question 11

How is liability insurance affected by inflation?

Answer 11

more complex - as more components known as heads of damage:

1) compensation for income loss (wage inflation either structured settlements like annuities or changes to Ogden tables )

2)cost of medical and nursing care (medical expenses inflation)

3)awards for pain & suffering (set judgmentally and called social inflation/ superimposed inflation)

Question 12

Why generally expense inlfation is a cost loading is subject to inflation?

Answer 12

Expenses mainly salary-linked.

Inflation affects admin, commission, and claims-handling costs.

Wage inflation typically higher than price inflation.

Question 13

What is the UW cycel?

Answer 13

Cyclical pattern of insurance profits and premium rates (hard vs. soft markets).

Question 14

What are the stages of the UW cycle?

Answer 14

Hard market: high premiums/profits.

New entrants attracted by profit.

Rates fall due to competition.

Soft market: low premiums → losses.

Exits/insolvencies reduce capacity.

Rates rise due to limited supply.

Cycle repeats.

Question 15

Why not enter at the bottom/ and leave at top?

Answer 15

Hard to time market.

Start-up/shutdown costs high.

Need for market share continuity.

Question 16

The influences on the UW cycle

Answer 16

during hard market, premiums are high and high profits –> this means more retained profits and so more capital holding so can write more business
–> this leads to more competition and cheaper RI –> prices fall –> profits fall and soft market develops –> insolvencies and people leave which brings prices up again.

3 influences
1) capital availability and RI terms
2)big events like a cat event can lead to hardening market ( prices increase and stricter UW)
3)Regulatory intervention (e.g. Lloyd’s Decile 10 review).

Question 17

4 reasons why UW cycle exists.

Answer 17

Reasons cycle exists:

Low entry barriers.

Delay in writing bsusiness and knowing how profitable it is

Simplistic solvency capital (e.g. Solvency I).

Fear of losing market share.

Question 18

what are the factors influencing the signifcance of the investment conditions:

Answer 18

Size of free assets.

amount of business company writes e.g. annual premium income

size of its inforce business (size of reserves)

Claim delay length.

Contract term (investment less important for weekly travel insurance than 5 year warranty deal)

Premium payment method.

Question 19

Allowance for investment return on pricing?

Answer 19

Historically ignored (target underwriting profit).

Later, cashflow underwriting used: underprice, rely on investment returns → risky if returns fall.

Correct approach: include discounting of future claims/expenses using:

--free rate (e.g. gov’t bonds).

 --Avoid using risky actual returns.

Consistency with inflation assumptions critical.

Question 20

Why discount at risk-free rate, not actual return:?

Answer 20

Higher actual return includes risk → not guaranteed.

Risk-free ensures sufficient premium even if investments underperform.

Question 21

When pricing for investment return, also need to take account of profit loading!

Answer 21

Target return = excess over risk-free.

Long-tail lines: higher required return → counterbalances extra investment income.

Question 22

Currency movements depends on a range?

Answer 22

Where business is written vs where claims arise

multi currency operations» exposure to exchange rate risk e.g. marine/travel multiple currencies

business written through llyods in GBP, USD, CAD EUR

when pricing it is Better –> to convert to a single current exchange rate

Question 23

what is currency hedging?

Answer 23

Objective: match assets/liabilities by currency to offset FX risk.

Tools: forward currency contracts.

Not perfect due to unpredictable claim currencies or strategic decisions.

Question 24

insurance is also affected by other factors other than inflation? name 3

Answer 24

1)legal factor - courts awards for compensation claims in liability claims
2)political - impact of changes in legislation insurers
3)social - trends in society’s behavior and attitudes

If claim goes to court, court can determine this and can affect both frequency and severity of liability claims.

Question 25

Further explain the courts award factor - how negligence has arisen, how compensation size is decided, recent trends and impact on liability insurance.

Answer 25

claims made on basis of neglience. Tort law = civil wrongs where compensation is due (not criminal). The tort of negligence means a person must take reasonable care not to harm others (“neighbours”). Negligence applies even when a contract exists (e.g. professional negligence). Jurisdiction shopping - Claimants may try to file cases in countries or states with more generous legal systems how is compensation size determined - The goal is to restore the victim to the position they would have been in if no negligence occurred – this is the principle of indemnity 1. Property Damage or Loss -Easier to value (e.g. cost to repair or replace). Complications: -How to account for depreciation. -Whether to compensate for inconvenience (e.g. loss of luggage). 2. Bodily Injury – ‘Heads of Damage’ More complex since the victim can’t be “restored” physically. Courts use categories (heads of damage) such as: -Medical costs (past and future). -Loss of income/earning capacity. -Pain and suffering. -Loss of amenity (reduced quality of life).

Question 26

Further explain the political legislation factor - impact on claims experience, legislation impact on insurance directly, impact on changes on the litigation process,

Answer 26

indirectly - like enforecement on speed limit and rink dirving can reduce seveerity and frequency of claims directly - compulsory inbsurance like motor third party and EL litigation process - no win no fee

Question 27

Further explain the social trend factor - increasingly litigious society, societal attitudes

Answer 27

Affects claim frequency and moral hazard -Increased propensity to claim (people more likely to sue). -Fraudulent/exaggerated claims. -claim management companies encouraging claims. -changes in behaviour, e.g. reduced drunk driving or crime rates due to stricter laws.

Question 28

Other external environmental factors are climate change and environmental factors? what are in these sections?

Answer 28

Weather - seasonality and impact on global warming cat latent claims

Question 29

What is seasonality?

Answer 29

Seasonality -In most countries, weather follows a pattern — e.g.: Temperate countries: spring, summer, autumn, winter Tropical countries: wet season / dry season / monsoon The pattern and severity differ by region due to local geography, building standards, etc. Building codes are laws that dictate how strong or resilient structures must be — e.g.: In earthquake-prone areas like Japan or California, buildings must be able to withstand quakes. In areas with strong hurricanes, buildings must be wind-resistant. 👉 Better building standards = fewer insurance losses. Winter vs. Summer Risks -Winter brings more frequent claims: Storm damage Dangerous driving (ice, darkness) -Summer can still cause problems — e.g. subsidence (ground shrinking due to heat and dryness).

Question 30

What is subsidence and heave?

Answer 30

Subsidence: Ground shrinks due to heat/dryness → buildings crack or sink. -Heave: Ground swells due to too much moisture → pushes structures upward. -These are gradual, not sudden, and usually occur over months. 👉 Because of that, Catastrophe Excess of Loss (Cat XL) reinsurance may not cover them. Reinsurance “events” must occur within a defined short time (e.g. 72 hours). Subsidence develops slowly, so it falls outside that window.

Question 31

The location of the property also affected by weather differently

Answer 31

Even in the same area, risk can vary a lot: -One house might be on a dry, sheltered hill (low risk) -Another might be next to a river (high flood risk) To manage this, insurers now: -Collect more detailed location data (e.g. full postcode, not just partial) -Use detailed risk mapping and previous claim history 👉 This improves underwriting accuracy and pricing fairness.

Question 32

climate related risks can be seperated into 3 categories: physical risks, transition risks and liability risks

Answer 32

Physical = direct effct of extreme weather events so more hurricane and more property losses transition = shifting to low carbon economy e.g more sustainable manufacturing processes, replacement of fossil fuels liability risk - legal action for failing to adapt, mitigate or disclose climate risks e.g. company sued or not considering climate change in its business stragerty

Question 33

2 types of cats?

Answer 33

Natural -ice, snow,frost -storm, hurricane - US most highest losses due to high prop concentration, high insured values -earthquake - occasional but severe -fire -floods, typhoons manmade -aircrash -expolosion -terrorism

Question 34

Why is latent claims importsnt to insurers?

Answer 34

Losses can emerge decades later, long after premiums were earned - difficult to estimate ULT cost Creates pricing and reserving uncertainty. Difficult to determine which policy year (or reinsurer) should pay. May lead to mass tort litigation and large aggregate losses (large accumulations poss)

Question 35

latents claims impact on reserving, pricing, UW, Reinsurance, Capital Management

Answer 35

Reserving: -Need for IBNR (incurred but not reported) provisions. -High uncertainty due to long-tail nature. Pricing: -Historical data may not reflect emerging risks. Underwriting: -Review policy wording to limit unforeseen exposures. -Consider using “claims-made” policies rather than “occurrence-based.” Reinsurance: -Reinsurers may exclude or cap long-tail risks. Capital Management: -Latent risks increase solvency capital requirement (SCR) under Solvency II-type regimes.

Question 36

impact of technological advancement on insurance

Answer 36

increased computer power -can process more complex models -more accurate pricing models -Though risk of over reliance of the model outputs and higher IT and data costs Cheaper data storage -better predictive models -granular level pricing greater data aviailability -access to external data sources -improved UW insight -Though, new data privacy risks More sophisatied modelling - more accurate cat modelling digital distribution channels -can track/report claims by customer -more price transprancy -higher competition online claims handling -faster claim settlement -lower admin costs -improved customer satification telematics -encourages safer driving and real driving score driveless - less accietns -high repair costs -new cyber risks