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Reserving risk in case of capital set up

M

Minh Ho

Very Active Member
On page 937 when discussing about insurance risk, the explanation of the book says:
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I agree on the underwriting risk (premium risk) that booking the capital too early even before the insurance starts.
But I don't understand the reserving risk if modelling required capital at 10 April 2018, which I believe the correct way to set up UPR?
Thanks
 
The key point here is that once the exposure period has started, the reserves required in respect of the earned exposures will form part of the reserve risk and not the underwriting risk.

We will make sure that this is made clearer in future versions of the Course Notes.
 
Darren Michaels said:
The key point here is that once the exposure period has started, the reserves required in respect of the earned exposures will form part of the reserve risk and not the underwriting risk.

We will make sure that this is made clearer in future versions of the Course Notes.
Click to expand...
what you mean is booking the reserve at 10 Apr is correct UPR way, but there are risk of reserving incorrectly (reserving risk).
While before the insurance kicks in, the risk is underwriting risk (underwrite it incorrectly).
Should I rephrase it this way below:
Required capital can be modelled at 1 Apr or 10 Apr.
If modelled at 1 Apr then there are 2 risks: Underwriting risk and Reserving risk (because policy will eventually kicks in)
If capital modelled at 10 Apr then there are 1 risk: Reserving risk.
 
I don't think the concept of 'correctly' or 'incorrectly' is useful when reserving. Reserving risk covers the fact that reserves are just estimates and the ultimate outcome may be something quite different, for business that is already written/earned.
When you build a model, you incorporate an allowance for various risks, in the way Darren has described. So on 1 April, the business has been 'bound', but the exposure has yet to start - hence it forms part of the u/w risk. After 10 April there will be both u/w and reserve risk, depending on whether you're talking about the business earned up to that date, or earned after that date. However, as the core reading says, all this depends on the precise rules being followed (more on that in Subject SA3).
 
Hi Ian,
Thanks for your response.
I am still confused about the date at when capital is modelled affect the risks of the insurer.
Based on the definition of risk: Risk is when the probabilities of the possible outcomes are known (such as when tossing a coin or throwing a dice); uncertainty is where the randomness of outcomes cannot be expressed in terms of specific probabilities. (based on ACCA definition -> since SP7 core reading doesn't have a clear definition).

The outcome of underwriting is the premium set for the business. For example, underwriter can decide the premium is 100 or 105 for the business being underwritten. Ultimate "correct" premium might be quite different.
The outcome of reserving is the reserve set for the business, for example 90 or 95 for the reserve of the business. Ultimate reserve can be quite different.

So on 1 April the business has been bound but exposure has yet to start, so there is underwriting risk and future reserve risk.
ON 10 April the exposure has started so there is reserve risk.

That's what I think about the risk.
Based on the logic you mentioned, the u/w risk persist even after 10 April, then the reserve risk still there at 1 April.
Please correct me if I am wrong
 
The date when the modelling is done, does affect which "type" of risk we are dealing with.

Assuming that we are using when the business is earned to differentiate between reserve and underwriting risk, then prior to the policy incepting it is all part of underwriting risk as none of the exposure will be earned yet.

Once the policy incepts and the exposure starts, we will have both reserve risk in relation to the earned exposure and underwriting risk in relation to the unearned exposure. [For example, for a policy running from 10 April 2018 to 9 April 2019, halfway through the policy year on 10 October 2018 say, if we assume that the risk is uniform over the policy period, half of the exposure would be earned and half unearned.]

Once the policy has expired (ie after 9 April 2019), all of the exposure would be earned so there would only be reserve risk and no more underwriting risk in relation to that specific policy.
 
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