Insurance Operations, Regulation and Statutory Accounting

Finance 4356

Insurance Operations, Regulation and Statutory Accounting

Test Questions

Chapter 1

1. Identify the steps in the risk management process. (1.4 - 1.5)
2. Identify the four classifications that may be used to distinguish insurers from one another. (1.6)

1. Describe the internal constraints an insurer might face when trying to achieve its goals. (1.13 – 1.14)

1. Describe the operation of the following insurer functions: (1.26 – 1.28)
2. Marketing
3. Underwriting
4. Claims
5. Loss Control
6. Reinsurance
7. Investment

1. What are the usual sources of investable funds that insurers use to generate investment earnings? (1.28)

1. Insurance Company (IC) has the following year-end financial results: (1.18 – 1.21)

Written premiums$50,000,000

Earned premiums$45,000,000

Underwriting expenses$18,000,000

Incurred Losses$30,000,000

Lost Adjustment Expenses 6,000,000

Net Investment Ratio 15 percent

Calculate the following measures of financial performance for IC:

1. Loss ratio

1. Expense ratio

1. Trade basis

2. Financial basis

c. Combined ratio

1. Trade basis

2. Financial basis

d. Operating ratio

1. Trade basis

2. Financial basis

Chapter 2

1. Identify three recurring issues in insurance regulation. (2.3 - 2.4)

1. What role did each of the following play in establishing which level of government should regulate insurance? (2.4 – 2.11)
2. Paul v. Virginia
3. Sherman Antitrust Act
4. South-Eastern Underwriters Association decision
5. McCarran-Ferguson Act

1. What changes occurred at Insurance Services Office (ISO) that resulted from the settlement of the attorneys general lawsuit? (2.11 – 2.12)

1. Explain why each of the following is an important goal of insurance regulation. (2.13 – 2.15)
2. Protect Consumers
3. Maintain insurer solvency
4. Avoid destructive competition

1. Insurance regulation occurs primarily at the state level, but the issue of federal regulation is often raised. (2.19 – 2.20)
2. What arguments have been advanced in favor of federal regulation?
3. What arguments have been advanced in favor of continued regulation by the states?

1. What methods do state regulators use to monitor and regulate insurer solvency? (2.26 – 2.27)

1. What are the goals of insurance rate regulation? (2.30)

1. Briefly describe the advantages and disadvantages of each of the following insurance rating laws. (2.32 – 2.33)
2. Prior approval
3. File-and-use
4. Use-and-file
5. Flex rating
6. Open competition

1. State guaranty funds provide a safety net for policyholders when an insurer becomes insolvent. (2.27 – 2.28)
2. How do guaranty funds operate to pay the claims of insolvent insurers?
3. What are the limitations on guaranty funds as a solution to insurer insolvencies?

Chapter 3

1. Identify the principal characteristics that distinguish the three traditional insurance marketing systems from one another. (3.6 – 3.7)

1. Identify the five alternative distribution channels. (3.22 – 3.27)

1. Describe the key factors an insurer should evaluate during the distribution channel selection process? (3.27 – 3.28)

Chapter 4

1. Describe the purpose of underwriting and the effect of adverse selection on the insurance selection process. (4.4)

1. What are the steps in the underwriting decision-making process? (4.4)

1. What four major modifications can be made or recommended to make a submission more acceptable to an underwriter? (4.10)

1. Explain how each of the following constraints affects underwriting policy. (4.21 – 4.24)
2. Financial capacity
3. Regulation
4. Personnel and physical resources
5. Reinsurance

1. IIA Insurance Company recognizes that the combined ratio should not be the sole measure used to evaluate underwriting performance. Describe other, nonfinancial measures available to IIA. (4.34 – 4.36)

1. You are a personal insurance underwriter for Acme Insurance Company, an insurer using the independent agency system. One day, you receive a request for automobile insurance for a client of one of you newly appointed agents. The applicant is a twenty-four-year-old single male who was previously insured by a direct writer. The application indicates no accidents or traffic violations in the previous three-year period. You are concerned that perhaps the field underwriting was a little lax in this case, and you believe additional information should be obtained because the applicant is new business for your company. (4.5 – 4.10)
2. List the external and internal sources of underwriting information that you might use to assist you in your decision, and categorize each source as either an “internal source” or an “external source.”
3. What factors will determine how much and what kinds of information might be requested?
4. Briefly describe the kinds of information each source listed provides, and indicate whether the information should be categorized as objective or subjective.

Chapter 5

1. Compare the principal features of fire-resistive constructive with those of noncombustible construction. (5.4 – 5.5)

1. Why are high-rise buildings a concern to fire underwriters? (5.4)

1. Identify the five major detection systems used in private protection systems. (5.18 – 5.20)

1. Describe the process for determining the probable maximum loss for business income coverage. (5.39)

1. Describe how loss control representatives can assist underwriters in rehabilitating an account. (5.54)

1. Describe the three categories of insurer loss control activities. (5.59 – 5.66)

1. You are a multiple-lines underwriter, and a producer has submitted to you applications for property coverage on three automobile accessory stores. These stores’ inventories are substantially the same, and although they are located in different cities, their public and private protection and exposures are on par. However, the construction of the buildings in which the three stores are located is different. A’s store is in a fire-resistive building, B’s store is a noncombustible building, and C’s store is in a building of mill construction.
2. Based only on the preceding information, rank the three automobile accessory stores in order of desirability from a fire underwriting standpoint, and explain the characteristics of the three classes of construction that determined the rankings you assigned. (5.3 – 5.11)
3. Contrast public protection with private protection as used in property insurance underwriting. (5.16)

Chapter 6

1. What elements must be present for a court to find a party negligent? (6.4)

1. Identify relationships that may create vicarious liability. (6.5 – 6.6)

1. What are some of the loss exposures an underwriter would consider for products liability coverage applications? (6.13 – 6.14)

1. What are some of the common concerns when underwriting professional liability insurance? (6.16 – 6.17)

1. What are the essential elements of a good fleet safety program? (6.33)

1. Give four examples of specific on-premises hazards that could lead to workers’ compensation losses. (6.35 – 6.39)

1. You are underwriting a general liability submission covering a restaurant. Identify the five categories of loss exposure with which you must be concerned, and describe the hazards that may be involved in each area of exposure. (6.7 – 6.15)

Chapter 7

1. Identify the primary regulatory goals of ratemaking. (7.3)

1. List the five characteristics that rates should have to enable an insurer to be competitive and profitable. (7.4)

1. Describe the three components of an insurance rate. (7.5)

1. List the five basic ratemaking terms. (7.6)

1. Describe the three ratemaking methods. (7.13 – 7.16)

1. What are the disadvantages of the policy-year data collection method? (7.17 – 7.19)

1. What are the advantages of the calendar-year data collection method? (7.18 – 7.20)

1. How does the accident-year method avoid errors inherent in the calendar-year method? (7.20)

1. How are the effects of large losses on ratemaking controlled? (7.29)

1. XYZ Insurance Company has collected the following data:

Unearned premiums—December 31, 20X0$25,000,000

Written premiums for 20X0$45,000,000

Unearned premiums—December 31, 20X0$30,000,000

Loss reserves—December 31, 20X0$20,000,000

Loss paid during 20X1$40,000,000

Loss reserves—December 31, 20X1$30,000,000

1. Calculate earned premiums under the calendar-year ratemaking method. (7.18 – 7.20)
2. Calculate incurred losses under the calendar-year ratemaking method. (7.18 – 7.20)

1. Using the following loss development data, calculate loss development factors and developed losses. (7.22 – 7.24)

AccidentMonths of Development

Year12243648

1 7,100 9,585 10,208 10,514

2 7,800 10,140 10,647

3 8,200 11,480

4 8,500

Chapter 8

1. Describe the primary goals of the claim function. (8.3 – 8.4)

1. Describe the circumstances under which a policyholder might employ the services of a public adjuster. (8.14)

1. What are the four steps in the claim adjusting process? (8.17 – 8.18)

1. What are the four major categories into which policy exclusions can be placed? (8.19)

1. Describe the sources of policyholder liability. (8.21)

1. Describe the circumstances most appropriate for the use of the following reserving methods/ (8.32 – 8.33)
2. Judgment method
3. Average value method
4. Tabular method

1. Explain the penalties provided for under the provisions of the Unfair Claims Settlement Practices Act. (8.38 – 8.40)

1. Explain the contribution claim departments make to society and how profit goals may conflict with this altruistic goal. (8.4)

Chapter 9

1. Why do property insurance policies describe the value of the property insured in only a general way? (9.3 – 9.4)

1. Describe how coverage for indirect loss is triggered under property policies providing loss of income or extra expense coverage. (9.9)

1. Describe the policyholder’s duties after a loss. (9.21 – 9.24)

1. Describe the circumstances under which emergency repairs following a loss will be reimbursed by the insurer. (9.22)

1. Describe the pre- and post-loss activities that can assist insurers when catastrophes occur. (9.49 – 9.50)

1. Describe the factors that complicate the determination of depreciation. How can determination for fair market value solve problems with valuing property? (9.17-9.19)

Chapter 10

1. Describe the actions an adjuster should take when coverage under the policy is questionable. (10.5 – 10.6)

1. Explain why it is necessary for an adjuster to understand all the elements of tort liability. (10.10 – 10.11)

1. Describe the defenses that insurers may use when a claim involves charges of negligence against its policyholders. (10.13 – 10.14)

1. Describe how general damages are often valued by adjusters. (10.15)

1. Contrast the circumstances under which a claim for wrongful death or a survival action may be asserted. (10.18 – 10.19)

1. Under what circumstances does an insurer have a legal obligation to settle? (10.20 – 10.21)

1. Describe the standards of care that property owners owe to trespassers, licensees, and invitees. (10.36 – 10.37)

1. What are bases for liability under products coverage? (10.40)

1. Describe the standard of care to which professionals are held. (10.45 – 10.46)

1. Refined Insurance Company has been notified that an explosion and fire occurred at a large refinery operated by one of its insureds. The explosion and fire caused extensive injuries to the insured’s employees as well as to employees of nearby firms. Significant property damage occurred. Refined has relatively few staff adjusters in the immediate area. (8.15 – 8.16) (9.39 – 9.43) (9.49 – 9.50) (10.15 – 10.19) (10.42 – 10.44)
2. What steps should the insurer take to handle the claims resulting from this loss promptly and efficiently?
3. As a result of this loss, Refined will be faced with the settlement of many kinds of losses, including (1) business income, (2) bodily injury liability, and (3) workers’ compensation. Briefly describe the unique elements or problems associated with the settlement of each of these types of losses.

Chapter 11

1. Describe the principal functions of reinsurance. (11.6 – 11.10)

1. List and briefly explain the types of treaty reinsurance that are most effective in providing large-line capacity. (11.12 – 11.24)

1. List and briefly explain the types of reinsurance that are most effective in stabilizing the ceding company’s loss experience. (11.12 – 11.14)

1. Compare a per occurrence excess of loss treaty with an aggregate (or stop loss) excess of loss treaty. (11.22 – 11.24)

1. Describe how a primary insurer would design a catastrophe reinsurance program.

1. List the steps in setting the retention for a catastrophe treaty. (11.29)

1. What are the advantages of employing the services of a reinsurance intermediary? (11.39-11.41)

1. List three factors that affect the negotiation of the ceding commission. (11.44)

1. The Titanic Marine Insurance Company insured a ship for $1 million at an annual premium of $30,000. (11.13 – 11.15)
2. How much of the coverage and premium would it cede to its reinsurer under a quota share treaty with a 25 percent retention?
3. How much would it recover from its reinsurer on a covered loss of $30,000?

1. How much would the reinsurer be obligated to pay under a surplus share treaty for a covered loss of $100,000 on a building insured for $1 million? The treaty retention is $50,000, and the treaty limit is $2 million. (11.16 – 11.17)
2. Would your answer be different for a per risk or per policy excess of loss treaty with the same retention and limit? Explain. (11.19 – 11.21)

Chapter 12

1. Explain why investors have an interest in the financial statements of the companies in which they invest. (12.5)

1. Describe the information contained in a balance sheet. (12.8 – 12.11)

1. Explain why the designation of an insurance company’s net worth as “policyholders’ surplus” is an important distinction from non-insurance company balance sheets. (12.9)

1. What are loss reserves and how do they arise? (12.10)

1. Explain how reserving errors lead to misstatements of policyholders’ surplus. (12.10)

1. Describe the difference between incurred losses and paid losses for an insurer for a given year. (12.12)

1. Describe what is included in an insurer’s investment earnings. (12.13)

1. Describe the purpose of Schedule P of the Annual Statement. (12.23 – 12.25)

1. Describe the fundamental difference between SAP and GAAP rules. (12.30 – 12.32)

1. Identify the items that are considered nonadmitted assets under SAP. (12.31 – 12.32)

1. Listed below are several captions typically found in an insurer’s Annual Statement. Using Exhibit 12-9 in the text, indicate (1) whether the item is an asset or a liability and (2) the supporting documentation from which this information originates. (12.14 – 12.29)
2. Cash
3. Unearned premium
4. Reinsurance recoverables on loss and loss adjustment expense payments
5. Mortgage loans on real estate
6. Loss adjustment expenses

Chapter 13

1. Identify the three categories of ratios used to analyze property-casualty insurers. (13.3)

1. Describe how rapid growth can threaten an insurer’s solvency. (13.4)

1. Explain how the capacity ratio is calculated. (13.4)

1. Describe the profit measurements that are used for insurers. ( 13.5 – 13.8)

1. Describe the purpose of Best’s Capital Adequacy Ratio (BCAR), (13.16 – 13.17)

1. Identify the areas of insurer’s operations that are evaluated in Best’s qualitative tests. (3.17)

1. Excerpts from the Statement of income for ABC Insurance Company as of 12/31/XX are shown below. For purposes of this exercise, assume this statement is SAP based and that the recorded net written premiums for the year were $40,000,000. (13.4, 13.5 – 13.8)

Statement of Income ($000)

Premiums earned $35,000

Losses incurred 21,000

Loss expenses incurred 7,250

Underwriting expenses incurred 8,750

Total underwriting deductions $37,000

Net underwriting income (2,000)

Net investment income 4,000

Other income (expenses) 500

Pre-tax operating income $2,500

Realized capital gains 50

Income taxes incurred 25

Net income $2,425

Statement of Changes in Policyholder’s Surplus ($000)

Policyholder’s surplus, beginning of year$35,000

Net income 2,425

Net unrealized capital gains or losses 5,000

Change in nonadmitted assets 3,000

Dividends to shareholders 0

Change in surplus for the year$10,425

Policyholder’s surplus, end of year$45,425

8.

1) a. Calculate ABC’s capacity ratio.

b. Is this capacity ratio considered acceptable or unacceptable. Why?

2) a. Calculate the loss ratio.

b. Calculate the trade basis expense ratio.

c. Calculate the financial basis expense ratio.

d. Calculate combined ratio on trade and financial basis.

e. Determine operating ratio on trade basis.

Chapter 14

1. Describe the financial management issues that are unique to insurers. (14.3 – 14.5)

1. Identify the types of investments that can be considered as admitted assets on an insurer’s balance sheet. (14.5)

1. What is the goal of state regulation of insurer investments? (14.8)

1. List three investment limitations that regulators impose on insurers. (14.8)

1. Describe the factors that determine the amount and timing of expected investment cash outflows for property-casualty insurers. (14.8 – 14.9)

1. Explain why it is important for a bond portfolio manager to understand the characteristics of an insurer’s underwriting portfolio. (14.10 – 14.12)

1. Identify the three methods used to establish case reserves. (14.12)

1. Describe the two approaches to determining IBNR. (14.13)

1. What factors might affect the selection of values other than the mean value in calculating a loss development factor? (14.14 – 14.15)

1. Define the following terms as used within the RBC formula: (14.23 – 14.25)
2. Asset risk
3. Credit risk
4. Underwriting risk
5. One strategy bond managers use to control risk is cash matching. (14.9 – 14.10)
6. Briefly describe cash matching as it applies to managing a bond portfolio.
7. Explain why cash matching is a good way to eliminate interest rate risk.
8. Identify tow practical problems with using a cash matching approach to manage a bond portfolio.

Chapter 15

1. List the five forces that drive competition within an industry. (15.7)

1. Explain how a company would pursue a vertical integration strategy. (15.14)

1. Identify the three strategies at the business level. (15.16 – 15.17)

1. Describe the factors in the global environment that managers should examine when considering international expansion. (15.23 – 15.27)

1. What are the advantages of using admitted insurance to cover foreign exposures? (15.33 – 15.34)

1. The XYZ Insurance Company is facing several internal and external challenges in its business operation. Because of a competitive employment market, the insurer has struggled to maintain staffing levels and is having difficulty staffing its headquarters location. In addition to the headquarters location, XYZ has three regional offices throughout the Midwest and Northeast. Because of heavy competition in the types on insurance it writes, XYZ has lost considerable market share in most of its territories and has experienced steadily decreasing profits. What alternatives are available to XYZ’s management team as it formulates corporate-level strategy for the company? (15.13 – 15.16)