CMP Questions - Chapter 9, 20 & 21

[LasTargaryen]

Hello I have a total of 3 questions from CMP that I just can't seem to understand even after many reads. Appreciate if anyone can help to clarify!

Chapter 9 - Underwriting Cycle
One of the reasons for existence of underwriting cycle is Economies of scale - economics of writing insurance business and fear of losing market share. But I can't seem to wrap my head around how it exacerbates or enforces the cycle. From what I understand, during a soft market, insurers would rather write businesses at a small loss (as long as variable cost is covered) than not write any businesses at all, the reason for this is to not lose market share/withdraw from the market. Isn't this going to slow down the process, because in order for market to turn, insurers need to leave at the lowest point of the cycle? Or maybe I misunderstood the meaning of 'enforcing the cycle'.


Chapter 20 & 21 - Losses-occurring basis reinsurance
I don't understand what any of the following sentences are saying:

Chapter 20.5.2: The extent to which occurrence-based programmes may overlap with exposure periods that would not otherwise be included in the model. It may therefore be necessary to include allowance for such exposure to ensure the application of the reinsurance on modelled exposures is accurate

Chapter 21.2.6:
Reinsurance of unexpired risk: if a firm has bought reinsurance on a losses-occurring basis rather than on a risks-attaching basis, we should either model the gross cost of risks unexpired at the end of the modelling period, or allow for possible additional costs in renewing cover, especially in a post-loss scenario. In other words, if reinsurance is purchased on a losses-occurring basis, then the insurer will not yet have purchased reinsurance to cover the (future) period that is being modelled.

I don't understand why loss-occurring basis reinsurance will still be unexpired after modelling period, but not the case for risk-attaching basis? I understand we should expect additional reinsurance cost after major loss, but I don't understand the part about 'unexpired'.

Chapter 21 - Diversification between underwriting risk and reserving risk
Finally, we should allow for diversification effects between underwriting risk and reserving risk. For long-tailed lines, any diversification effects between reserving risk for the more recent years and underwriting risk for the year ahead might be limited. For example, under-reserving of more recent years may lead to under-pricing of the year ahead and vice versa.

I get why under-reserving will lead to under-pricing, but I don't understand why it is more severe for longer-tailed classes, isn't this going to affect all type of insurance classes? My hypothesis is that for long-tailed business it might be harder to establish that we are under-reserved, so it takes time to realise it and charge the correct price next year?

Thank you so much!

 

[Katherine Young]

Chapter 9 - Underwriting Cycle
One of the reasons for existence of underwriting cycle is Economies of scale - economics of writing insurance business and fear of losing market share. But I can't seem to wrap my head around how it exacerbates or enforces the cycle. From what I understand, during a soft market, insurers would rather write businesses at a small loss (as long as variable cost is covered) than not write any businesses at all, the reason for this is to not lose market share/withdraw from the market. Isn't this going to slow down the process, because in order for market to turn, insurers need to leave at the lowest point of the cycle? Or maybe I misunderstood the meaning of 'enforcing the cycle'.

Let’s say there is an excess supply in the market, with the result that prices are beginning to fall. You might hope premiums would fall only just enough to ‘correct’ the imbalance. But instead premiums continue to fall below the theoretically correct price, because insurers would rather accept loss-making business than lose market share.

Chapter 20.5.2: The extent to which occurrence-based programmes may overlap with exposure periods that would not otherwise be included in the model. It may therefore be necessary to include allowance for such exposure to ensure the application of the reinsurance on modelled exposures is accurate

Let’s say you have a LOD reinsurance arrangement that incepts in December, and you’re running your capital model as-at year-end.

Well the reinsurance is already incepted, so you’d be forgiven for thinking you should include it in your model.

• However, some of the recoveries will be in respect of direct business that has not yet been written (ie policies that incept after the new year) and which should therefore not be included in the model.

• On the other hand, some of the recoveries will relate to direct business that was already on risk before the year end. You will want to include these recoveries in your model.

So you need to consider only those recoveries relating to direct claims that are included in the model.

Chapter 21.2.6:
Reinsurance of unexpired risk: if a firm has bought reinsurance on a losses-occurring basis rather than on a risks-attaching basis, we should either model the gross cost of risks unexpired at the end of the modelling period, or allow for possible additional costs in renewing cover, especially in a post-loss scenario. In other words, if reinsurance is purchased on a losses-occurring basis, then the insurer will not yet have purchased reinsurance to cover the (future) period that is being modelled.

I don't understand why loss-occurring basis reinsurance will still be unexpired after modelling period, but not the case for risk-attaching basis? I understand we should expect additional reinsurance cost after major loss, but I don't understand the part about 'unexpired'.

Assuming that the reinsurance incepts on 1st Jan, the LOD cover will not yet be in place at the year end, despite the insurer needing to model the period of unexpired risk.

If the reinsurance is RAD, then we don’t need to worry that next year’s cover has not yet been arranged, because it is the previous year’s reinsurance that will meet claims on unexpired risks.

Chapter 21 - Diversification between underwriting risk and reserving risk
Finally, we should allow for diversification effects between underwriting risk and reserving risk. For long-tailed lines, any diversification effects between reserving risk for the more recent years and underwriting risk for the year ahead might be limited. For example, under-reserving of more recent years may lead to under-pricing of the year ahead and vice versa.

I get why under-reserving will lead to under-pricing, but I don't understand why it is more severe for longer-tailed classes, isn't this going to affect all type of insurance classes? My hypothesis is that for long-tailed business it might be harder to establish that we are under-reserved, so it takes time to realise it and charge the correct price next year?

Quite right, well done. But more specifically, the point is not that it is harder to establish that you are under-reserved, it is that it takes so long to get any certainty about the ultimate loss ratio… and hence there will be a delay of several years before you realise that you need to correct your premium rates.