Risk and Uncertainty in reserving and capital modelling

[Dar_Shan0209]

I was looking at the various process uncertainties in the core reading (Unit 6). Regarding "Increased use of profit share arrangements", the notes talk about the following:

Profit share arrangements may incentivise the broker to direct more business to the insurer. Adjustments need to be made to reflect this in a capital model, otherwise, the model might overstate the underwriting result.

Why do we refer to the capital model only?

My understanding would be an increase in profit share arrangements, which would mean that perhaps the direct commission paid element would change. Other effects could be an increased delay in reporting claims to the insurer. For sure given all this flows to the income statement, the underwriting result, insurance result and retained earnings would be affected. When looking at the capital model, we would be looking at how much risk capital we would need to hold - credit, market, operational and underwriting. It definitely makes sense that the underwriting and reserving risk would change. Perhaps credit risk as well (if we are having any premium receivables). So, bottom line risk capital would also increase in line with profit-sharing arrangements.

Are my thoughts okay?

 

[Ian Senator]

The sentence only mentions capital modelling here because the syllabus objective for this chapter/unit is specifically about how risk and uncertainty affects capital models (and reserves). Profit share arrangements can, of course, affect many other aspects of an insurer's business. I can't see why it would delay claims reporting though, to any great degree. A capital model incorporates numerous cashflows, so there is potential for many aspects of a capital model to be affected by the presence of profit share arrangements.