April 2009 Q1(iii)

[Shradha]

Hello,

In this question, it is being proposed that general insurance companies hold claims reserves equal to the 75th percentile of the range of possible future outcomes and question is about the concerns that the insurance industry may have with this proposal.

The answer includes two points below that I do not understand:
i. The assessment of diversification between classes of business is one of the more difficult areas. It is difficult to estimate correlations between lines of business based on observed experience. It is often necessary to use general reasoning to estimate correlations.
ii. Capital requirements should be revised to be consistent with the new reserving requirements, e.g. if companies are required to hold capital to the 99.5th percentile, then the regulations should reflect the fact the reserves are already at the 75th percentile. If current capital regulations are set at a very low level, some companies may not have enough capital to reserve to the 75th percentile.

How will risk margin affect the diversification calculation and the capital calculation at 99.5th percentile?

Thanks.

 

[Katherine Young]

How will risk margin affect the diversification calculation and the capital calculation at 99.5th percentile?

It's the other way round. The diversification will affect the risk margin.

If diversification is high, the aggregate claims distribution will be less volatile, hence the capital requirement will be lower.