Chapter 9: The External Environment

Question 1

3 Reasons why medical inflation can be significantly higher than price or wage inflation

Answer 1

• more advanced medical treatments are used, which are more expensive
• better treatment means patients survive for longer, but still require medical care
• in some cases, doctors and consultants salaries can rise in excess of average wage inflation

Question 2

3 Components of personal injury claims (“Heads of damage”)

Answer 2

• compensation for loss of income
• cost of medical and nursing care
• awards for pain and suffering

Question 3

Describe the underwriting cycle

Answer 3

• When insurance premiums are high and profitable, more insurers enter the market because they want a share of the profits
• This increases competition which proceeds to drive down premiums

Low, unprofitable premiums lead to insurers struggling to stay afloat
- some insurers become insolvent and leave the market, while others write less business
- this reduces competitive pressures and allows the remaining insurers to increase premiums until business is profitable again

… and the cycle continues …

Question 4

“Hard market”

Answer 4

A profitable market when premium rates are high

Question 5

“Soft” market

Answer 5

Unprofitable market with low premiums.

Question 6

3 Actual mechanisms that reduce the size of the market when it is unprofitable

Answer 6

• companies becoming insolvent
• companies withdrawing as a reaction to unprofitability because of unwillingness to accept continuing loss
• reinsurance being less readily available

Question 7

7 Factors that encourage the underwriting cycle’s progress

Answer 7

• the ease with which new entrants can join insurance markets
• the delay between writing business and knowing how profitable it is
• simplistic regulatory capital requirements that encourage insurers to write more business when premium rates are falling and less business when they are rising
• reduced insurance capacity (often following large-scale catastrophes)
• deliberate under-pricing by key players to drive out weaker competitors
• pricing strategy being determined by chasing market prices
• economies of scale.

Question 8

Court award inflation

Answer 8

In some territories, a decision made by a court can set a precedent for future court awards, ie in similar cases.
The effect is very similar to inflation.

Question 9

3 Differences between court inflation and price inflation

Answer 9

• court inflation historically, has been HIGHER than price inflation
• court inflation tends to remain level for a period, then increase in sharp JUMPS when new precedents are created
• court inflation is LESS PREDICTABLE than price inflation

Question 10

2 ways in which the increasing compensation for negligence has been observed:

Answer 10

• courts may be more willing to accept that there is liability for a victim’s suffering
• given that they decide there is liability, the courts may award larger amounts for similar losses

Question 11

4 Reasons for cases that might be successfully litigated, never to be brought

Answer 11

possibly because the victims
- are unaware of their rights
- do not know how to go about the process
- do not want to dwell on past miseries
- are not sufficiently motivated to go through the process

Question 12

The high cost of weather-related claims in the USA can be attributed to (3)

Answer 12

• the large number of properties in certain areas, particularly in cities along the eastern coast
• the high average value of those properties
• the high proportion of properties that are insured

Question 13

Reasons for a rising cost of major losses

Answer 13

• Largely due to economic development (in vulnerable areas)
• General trend towards insurance in developed economies

Question 14

3 Main types of man-made catastrophes

Answer 14

• Terrorist incidents
• industrial accidents
• conflagrations

Question 15

Conflagration

Answer 15

A large destructive fire, which can be difficult to control.

Question 16

Latent claims

Answer 16

Claims that derive from perils that were unforeseen when the policy concerned was signed.

Question 17

Problems with latent claims

Answer 17

• it is impossible to know where the potential claim is lurking
• problem of identifying when exactly the claim event occurred, especially if exposure was over many years(eg to harmful substance / conditions)

Question 18

4 Different claims affected by inflation (and how they are affected)

Answer 18

• household contents (mainly price inflation)
• buildings and motor damage repair costs (mainly wage inflation)
• medical expenses (medical cost inflation)
• liability for personal injury (court award inflation)

Question 19

Loss amplification / Demand surge

Answer 19

Where there is a temporary increase in the costs of labour or raw materials due to a large number of claims being made at the same time.

Question 20

3 Examples of court awards

Answer 20

Decisions on:
- the admission of certain claims and the amounts at which they will be settled
- relating to IMPRECISE POLICY WORDINGS that can lead to the admission of new types of claim that had not been allowed for in the costing.
- setting NEW LEVELS of award or compensation for existing categories of claim

Question 21

Jurisdiction shopping

Answer 21

Where the claimant will try to launch proceedings in the most claimant-friendly jurisdiction in order to maximise any potential award.

It is a particular issue in aviation insurance with changes to the Montreal Convention.

Question 22

Montreal Convention

Answer 22

An international treaty which sets out airlines’ liabilities for passengers (e.g. for death or injury) or their baggage.

Changes to this treaty are thought to have raised awareness of the fact that countries that have not signed up to the agreement may have arrangements that are more favorable to claimants, and these are the jurisdictions that people will tend to try and claim under.

Question 23

Societal attitudes

Answer 23

The way in which we think of, and behave towards, others in our community.

Question 24

3 notable examples of changes in societal attitudes

Answer 24

• drunk driving
• crime rates
• attitudes of people towards insurance
• organisations encouraging the placing of claims
• staged accidents