Part III Course 3B General Insurance
Study Notes
Contents
Part I: Summary of General Insurance Products .................................................................................... 5
Home and Contents ............................................................................................................................ 6
Fidelity................................................................................................................................................. 7
Comprehensive Motor Vehicle Insurance .......................................................................................... 8
Compulsory Third Party (CTP)/Motor Bodily Injury Insurance ........................................................... 9
Marine: Hull insurance-Passenger ships, fishing fleets, Pleasure craft ............................................ 10
Aviation ............................................................................................................................................. 11
Glass .................................................................................................................................................. 12
Public Liability ................................................................................................................................... 13
Product Liability ................................................................................................................................ 14
Workers Compensation .................................................................................................................... 15
Professional Indemnity/Medical Malpractice/Directors' and officers' insurance ............................ 16
Sickness and personal accident insurance ........................................................................................ 17
Travel Insurance ................................................................................................................................ 18
Builders Warranty ............................................................................................................................. 19
Extended Warranty Insurance .......................................................................................................... 20
Mortgage Indemnity Insurance/Mortgage Guarantee insurance/Lender's Mortgage Insurance.... 21
Consumer Credit Insurance (CCI) ...................................................................................................... 22
Commercial Fire/Commercial Property Insurance/Industrial Specific risk ....................................... 23
Consequential Loss/Business Interruption ....................................................................................... 24
Fleet .................................................................................................................................................. 25
Crop Insurance .................................................................................................................................. 26
Mortgage Protection Insurance (MPI) .............................................................................................. 27
Pet Insurance .................................................................................................................................... 28
Strata Insurance/Body corporate ..................................................................................................... 29
Cyber Risk Insurance ......................................................................................................................... 30
Part II: Study Notes by Course 3B General Insurance Syllabus Learning Objectives ........................... 31
Unit 1 General Insurance Pricing ...................................................................................................... 32
1
, L1.1 - Technical Premium Rate Components ................................................................................ 32
L1.2 - Practical Considerations to Pricing ...................................................................................... 39
L1.3 - Risk Classification ................................................................................................................ 44
L1.4 - Sound Rating ....................................................................................................................... 48
L1.5 - Short and Long Tail Business Recognition ........................................................................... 50
L1.6 - Pricing Techniques .............................................................................................................. 52
L1.7 - Evaluation of Pricing Techniques ........................................................................................ 56
L1.9 - Experience Rating ................................................................................................................ 59
L1.9 - Excesses and Deductibles .................................................................................................... 62
L1.9 - Treatment of Granular factors ............................................................................................ 65
L1.9 - Natural Hazards ................................................................................................................... 66
L1.10 - Long-tail pricing ................................................................................................................. 67
L1.11 - Non-risk considerations .................................................................................................... 69
L1.12 - Reinsurance Pricing ........................................................................................................... 73
Unit 2 Capital Management .............................................................................................................. 79
L2.1 - Internal Capital Adequacy Assessment Process - ICAAP ..................................................... 80
L2.2 - Prescribed Capital Requirements ........................................................................................ 86
L2.3 - Capital Efficiency ................................................................................................................. 97
L2.4 - Internal Model-based Method -IMB ................................................................................. 105
L2.5 - Catastrophe Modelling ...................................................................................................... 117
L2.6 - Injury Schemes and Funding Options................................................................................ 127
Unit 3 Financial Condition Reporting .............................................................................................. 128
L3.1 - FCR Requirements ............................................................................................................. 128
L3.2 - Key Sources of Risk ............................................................................................................ 132
L3.3 - Risk Management Framework .......................................................................................... 133
Part III: Pricing Models Summary Notes ............................................................................................ 134
One-Way (univariate) Analysis........................................................................................................ 135
Generalised Linear Models (GLM) .................................................................................................. 136
Credibility Theory ............................................................................................................................ 139
Spartial Smoothing (Distance-based and Adjacency-based) .......................................................... 141
Data Mining/Machine Learning ...................................................................................................... 142
Burning cost .................................................................................................................................... 143
Frequency-Severity Approach ......................................................................................................... 144
Original loss curves/Increased Limit Factor/First loss scale/Exposure Curves ............................... 145
2
,Part IV: 3B Course Notes Reflective Questions Solutions .................................................................. 146
Unit 1: General Insurance Pricing ................................................................................................... 147
Unit 2:Capital Management ............................................................................................................ 150
Unit 3: Financial Condition Reporting ............................................................................................. 152
Part V: Exam Cheat Sheet .................................................................................................................. 154
Exam Questions asking for broad understanding of a typical general insurer, their various
departments and stakeholders ....................................................................................................... 155
Exam Questions on "What Further Analysis?"................................................................................ 157
Exam Questions on Pricing Modelling ............................................................................................ 159
Exam Questions on GLM ................................................................................................................. 160
Exam Questions on Rating Considerations ..................................................................................... 161
Exam Questions on Dealing with Unprofitable Products ............................................................... 167
Exam Questions on Relativity/Rating Structure.............................................................................. 171
Exam Questions on Pricing a New Product ..................................................................................... 172
Exam Questions on New Scheme ................................................................................................... 174
Exam Questions on Reinsurance Considerations............................................................................ 177
Exam Questions on Investments .................................................................................................... 180
Exam Questions on Capital ............................................................................................................. 182
Exam Questions on Internal Capital Model .................................................................................... 183
Exam Questions on Rectifying Capital ............................................................................................ 188
Exam Questions on Risk Appetite Statement ................................................................................. 190
Exam Questions on FCR .................................................................................................................. 192
Exam Questions on Mergers and Acquisitions ............................................................................... 194
Exam Questions on Insurance Risk Charge ..................................................................................... 197
Exam Questions on Professional Issues for Appointed Actuary ..................................................... 198
Exam Questions on Role of Board................................................................................................... 199
Glossary of General Insurance Terms ................................................................................................. 200
3
,References
The author has consulted a variety of references during examination preparation. References to
source material is in the format [XXX###] where XXX stands for the text and ### is the page number.
Abbreviation Reference
HBH Actuarial Practice of General Insurance - 7th Ed
David Hart, Bob Buchanan, Bruce Howe
ST7 IFoA ST 7 notes - 2017
ST8 IFoA ST 8 notes - 2017
SA3 IFoA SA 3 notes - 2017
IAAust Actuaries Institute 3b Course Notes, 2016 v1
CAS Generalized Linear Models for Insurance Rating
Mark Goldburd, Anand Khare, Dan Tevet
GRIP General Insurance Premium Rating Issues Working Party, January 2007
Anderson et al.
Clarke The Basics of Reinsurance Pricing, 1996
Clark, D.R
Murphy Using Generalized Linear Models to Build Dynamic Pricing Systems for Personal Lines Insurance
Murphy, Brockman and Lee
GPS, CPG APRA GPS and CPG
Hitchcox The assessment of target capital for general insurance firms
Hitchcox et al
ICRC Insurance Concentration Risk Charge – natural perils
Waite, Gardner, Lin
ABI Industry good practice for catastrophe modelling
ABI
IntMod Note on the use of Internal Models for Risk and Capital Management Purposes by Insurers
IAA
GIPCCatModel Information Note: The Use of Catastrophe Model Results by Actuaries
Actuaries Institute
GF A Global Framework for Insurer Solvency Assessment
International Actuarial Association, Solvency Working Group
Disclaimer
The materials represent the author's study notes used as a Part III examination candidate and should
be understood as one such approach for examination preparation purposes. They provide an
example of the study process adopted by the author in passing the exam on the first go.
The materials are not, and not intended to be professional advice. These materials may not reflect
the most recent developments and judgement befalls on the reader to examine the suitability of the
materials for their own purposes, having full regard for any inaccuracies or omissions that may arise
in the materials. The author of the material expressly exclude themselves from any contractual,
tortuous or any other form of liability on whatever basis to any person, whether a participant in this
subject or not, for any loss or damage sustained or for any consequences which may be thought to
arise either directly or indirectly from reliance on statements made in these materials.
Any opinions expressed in these materials are from the point of view of a student preparing for an
examination and not necessarily those of any qualified professional, affiliated organisations or
members.
The materials are sold for the exclusive use of the purchaser and the author continues to reserve all
rights. No part may be reproduced, hired out, loaned, given out, resold, stored or transmitted in any
form or by any means without the written permission of the author.
4
, Part I:
Summary of General Insurance Products
Part I:
Summary of General Insurance Products 5
,Home and Contents
Home and Contents Accumulation: subsidence, fire, explosions, natural perils (earthquakes,
cyclones, hailstorms, bushfires, floods, droughts), civil disturbance, crime
Property/Personal Line/Short Tail but rates, unemployment rates
liability component is LT Common exclusions
Covers policyholder (and family members) for damage to property, loss or Damage caused by wear and tear, deliberate damage by the insured, damage
damage to personal property and personal liability insurance. by frost, wet rot or dry rot, losses caused by radioactive contamination, sonic
bangs and war, policy void in cases of under-insurance, theft/vandalism
Insured Perils damage if house is left empty for an extended period impact damage from
domestic pet, subsidence claims by coastal or river erosion, theft if house left
Home and Contents: Cover for fire (kitchen, electric appliance), explosion,
unlocked or windows opened, requires smoke alarm
lightening, storm, flood, earthquake, bush fire (natural perils), impact, riot
and civil commotion, water damage, malicious damage, burglary, breakage of
glass, subsidence (downward movement of the soil), sanitary fittings, burst Reserving Models
pipes, vandalism, impact (falling branches, cars, aircrafts), fusion of motors, ACS, ICD
collapse of television aerials, leakage of oil to insured
Personal liability: dog bite, your tree fall on someone's house, Insurance
Contract Act 1984 includes minimum of $2m personal liability. Basis for Compensation
Claims occurring
Renewal
Automatic - renew on the basis of information held by the insurer. Premium terms
To avoid underinsurance at time of high inflation, insured may have
Risk factors automatic indexation to sum insured.
Usually valued policies.
How likely to be burnt down, exposed to storm damage, flooded, suffer from
Premium liability: seasonality important
subsidence, attractive to burglars, ease of access of burglars.
Underwriting Criteria - Rating factors Underwriting/Distribution Channels
Based on answers to proposal form with unusually high levels of cover
Age of building, size (number of rooms), construction (house/flat), condition,
requiring surveys to be carried out.
security (locks/alarms), occupancy (normally unoccupied during the day,
Direct: Advertising, phone, banks, internet
holiday house, owner occupier or tenants), usage (business use, rent),
location (postcode - next to fire brigade?, natural hazards, burglary risk),
voluntary or compulsory use of excesses, safety/security measures (smoke Reinsurance Program
alarms, locks, neighbourhood watch), high risk contents, family composition, Quota share covering specific geographic areas to diversify,
smoker/non-smoker, type of heating, age of policyholder (old people claim
catastrophe treaties guard against catastrophic natural perils
less), high value portable items (jewellery, furs, antiques)
Measure of Exposure Investment
Sum insured years (sum of property multiplied by the period at risk), Short tail, liquidity => cash on deposit, short term bonds
number of bedrooms,
Legislation
Benefits Governed by Insurance Contracts Act 1984,
Building insurance: Amount required to fully reinstate the property (subject
to excess/deductible) rather than the market value of the property (cost of Customers
clearing, cost of re-erecting), ancillary costs (alternative accommodation
Individuals protect against largest assets (family home), lower income
while property uninhabitable)
householders cannot afford to replace their contents, seniors with no future
Contents: To provide a replacement item or monetary compensation using
earnings with accumulated assets in house, valuable assets in house, suburbs
the replacement value (cost of new item at the date of loss i.e reduced to
with high crime rates
allow for depreciation - indemnity) or 'new for old basis' (cost of an
equivalent new item is provided - replacement)
Where it is underinsured, principle of average may apply. Environment
Impacted by natural perils (accumulation) - H3 and H4 losses, supply and
Pattern over which risk emerges demand for price of goods and services, price inflation, recession, technology
(obsolete goods and new household items eg VCR), criminal activity,
Delays: Little Reporting delay, except for subsidence which make take time
catastrophes may result in supply problems to match increased demand
before a claim will need to be made. Settlement may be single payment, but
Seasonality: more subsidence claims in autumn/winter following a hot
larger claims (total loss) can take longer with intermediate payments for
summer
repairs or building projects
SI factors: labour costs, changes in building construction standards, higher
Claim Frequency: Generally high, and higher during recession
excess, claims management, demand surge
Claim severity: Reasonable estimate usually could be made. Usually small
number of larger, total loss and liability claims.
Part I:
Summary of General Insurance Products 6
,Fidelity
Fidelity Common exclusions/limitations
Property/Commercial Line/Short Tail Limit on the value of claims made on any one employee
(protects against accumulations)
Cover for misappropriation/loss of assets/goods or money by
Annual aggregate limit for all losses (protect against
employees.
accumulation)
Restrictions on particular industries
Insured Perils Limits on sum insured relative to turnover levels (avoids over
Fraud, theft, embezzlement, dishonest actions by employees insurance)
No cover for companies with poor risk management systems
Underwriting Criteria - Rating factors No cover for companies with poor history
Nature of business, size of the sums at risk, total value, type of No cover for 'known but unclaimed' events at the time of initial
company assets number of employees, turnover level, number of underwriting
locations of risk exposure, extent of internal controls/risk Sum insured/asset value substantiated by accounting documents.
management systems, industry company operates in. Excludes losses in the course of normal business operations (eg
poor investment performance)
Measure of Exposure
Sum insured year
Customers
Businesses concerned with dishonest employees
Companies with employees responsible for money, securities, stocks,
Benefits accounts or any other assets.
Loss of money or goods owned by the insured, reasonable fees
incurred in establishing the size of the loss paid to accountants and
auditors.
Environment
Economic conditions (recession), accumulation risk
Pattern over which risk emerges
Delays: Reporting delays caused by time to discover the
fraudulent behaviour of employees. Settlement delays in
establishing size of loss by auditors.
Part I:
Summary of General Insurance Products 7
,Comprehensive Motor Vehicle Insurance
Comprehensive Motor Vehicle Common exclusions
Excess, certain specified uses (business or racing), depreciation, wear and
Insurance tear, or damage to car tyres, element of illegality (no licence, alcohol, drugs),
earthquakes, war, riot or civil commotion, theft if car is left unlocked or
Property/Personal Line/Short Tail windows open, you destroy the car yourself, use personal car for Uber
Cover accidental loss or damage to the insured vehicle and liability to the (sharing economy)
property of others and excludes statutory liability for bodily injury)
Excess
Insured Perils Voluntary (keep premium low): low claim freq and low ACS.
Loss or damage to the property of third parties and insured vehicle, fire, theft, Imposed as conditional of acceptance (for young driver, inexperienced, with
windscreen, accidental damage, own vehicle collision, multi-vehicle collision. poor claim history): high claim freq, higher ACS
Risk factors Dealing with higher risks
Distance travelled (hard to verify), density of the traffic where the vehicle is Restricting cover, higher excess (more common for motorcycle insurance),
driven, ability of the driver, speed at which the vehicle is usually driven and limitations on drivers (by age), refusing to quote certain types of risk (Ferrari
its general level of performance, ease with which the vehicle can be drivers), over-pricing a quotation so policyholder seeks elsewhere.
damaged and the cost of repairing it, theft risk, weight of vehicle, fire risk,
when is car driven (rush hour, daytime, night time), how fast is car driven,
how expensive is the car to replace or repair, how susceptible to being stolen
Premium terms
Valued policies if have agreed value or unvalued polices if use market value.
Renewal
Automatic - renew on the basis of information held by the insurer.
Distribution Channels
Generally processed automatically on standard terms for brokers and sales
staff to follow.
Underwriting Criteria - Rating factors Direct/agents (motor dealer)
Make and type of vehicle, usage (private, business), claims experience, age of
driver, are where garaged (geographic zone), age of vehicle (new cars driven
more) and value, annual mileage, engine size, telematics (black box installed
Reinsurance Program
to monitor driving behaviour, speed, acceleration, braking), excesses, type of Facultative, surplus (some cars have higher sum insured - less homogenous),
cover, sex of main driver, age of driver, number of years of driving excess of loss (large single claim), catastrophe treaties (natural perils - hail,
experience, extent of any modification to the engine or body, location of earthquakes, floods)
policyholder (postcode), where driver has any driving convictions, past
experience (experience rating), manufacturer/brand, marital status, excess, Investment
NCB, year of manufacture
Short tail, liquidity => cash on deposit, short term bonds
Measure of Exposure Recoveries
Vehicle-year (number of vehicle per year), Agreed monetary premium,
Dependent on steel prices.
number of policies
Benefits Legislation
Governed by Insurance Contracts Act 1984
Cost of repairs, if write-off or stolen the benefit is the second-hand market
value at the time of the accident (if under market value) or at a
predetermined agreed value (if under agreed value) Customers
Loss or damage to personal items in the car Expensive vehicle, family car (without which transportation is limited)
Pattern over which risk emerges1 Environment
Delays: Reported and settled quickly Impacted by natural perils (snow and ice), supply and demand for price of
Claim Frequency: Generally high, and higher with the more covers goods and services, exchange rates, price of steel and oil/petrol, price
offered. inflation, safety features, legislative requirements (alcohol, seat beats)
Claim severity: Claim sizes generally around in the thousands, with few Seasonality: more claims in winter as conditions more hazardous
claims exceeding the cost of replacing a car, which would generally be SI: exchange rate on repair parts, changing features of cars (newer
the upper limit. technology eg sensor more costly to replace), shift in TPR with uninsured
Accumulation: Hail, storm damage, but generally no accumulation as third parties, hire cars agencies take long detour, cheaper cars manufactured
sold nationally. with more safety features, criminal activities of quoting inflated repair cost
1
For motorcycle, claim frequency is lower than car insurance but severity is
usually greater due to lower protection.
Part I:
Summary of General Insurance Products 8
,Compulsory Third Party (CTP)/Motor Bodily Injury Insurance
Compulsory Third Party (CTP)/Motor Claim severity: More skewed than comprehensive and no real
upper limit due to catastrophic injuries. Impacted by SI of legal
Bodily Injury Insurance precedent.
Accumulation: Generally no extreme accumulation as unlikely to
Liability/Personal Line/Long Tail have concentration of risk in one geographical area as sold
Cover for bodily injury to other people and in some circumstances nationally.
the driver.
Basis for Compensation
Purpose Claims occurring
It is to provide protection for personal injury to uninvolved Common law only (at fault): QLD, SA, WA, ACT
bystanders and is a social protection compulsory for register vehicles Limited No fault: NSW
to ensure an effective compensation regime for injured not a fault No-fault and Common Law: VIC, TAS
citizens. No fault and no Common Law: NT
Insured Perils Premium terms
Bodily injury and death of third parties caused by the insured vehicle. Done during registration.
Underwriting Criteria - Rating factors Underwriting/Distribution Channels
Same as for comprehensive, age of registered owner, year of vehicle Government: VIC (TAC), SA (MAC), TAS (MAIB), NT (TIO), ComCare
manufacture, driving record, sum insured, claim history, type of car, Private sector: NSW (MAA), QLD (MAIC), ACT
garaged, use, age of any other drivers. at fault accident over the last
2 years, number of demerit points, broad geographic area of the Reinsurance Program
policyholder, length of time after having full licence, private vs.
Excess of loss
business use, age of driver
Measure of Exposure Investment
Long tail => AWE indexed bonds
Agreed monetary premium
Benefits Legislation
Compulsory Third Party Act
No-fault prescribed by legislation: Weekly compensations for income,
Private sector regulated by APRA and must be approved by the
medical and hospital expenses, lump sum for specific injuries and
workers compensation authority; public seconds not subject to APRA.
permanent injuries, , rehabilitation expenses
At-fault: legal expenses and common law settlements reduced by
contributory negligence. Customers
60% of severe brain and spinal injuries come from motor vehicle Compulsory by legislation
accidents
Motorcycles: Involved in more accidents where rider is the only Environment
person injured but are less likely to cause injury to others (low rate
Compulsory seat belt laws, random breath testing, speed
at-fault but high no-fault)
cameras/fines/demerit points, vehicle design, road conditions,
advertising, attitude to drink driving/speeding/drugs, child restraints,
Pattern over which risk emerges legislation changes (SI)
Delays: Generally no reporting delays unless sufferer decides to Replacement ratio: higher will result in higher claim frequency,
wait as they expect their injury to be temporary, but turns out to longer average duration so higher average claim size
be more serious in a routine check up. Some settlement delay
where it takes time to establish the extent of the injury.
Claim Frequency:
Part I:
Summary of General Insurance Products 9
, Marine: Hull insurance-Passenger ships, fishing fleets, Pleasure craft
Marine: Hull insurance-Passenger Hull: Insured value of hull, turnover, passenger kilometres, passenger
voyages, in-service seats, in-service vessels/aircraft, tonnage of
ships, fishing fleets, Pleasure craft hull/ship, limits of liability
Cargo: Sum insured of cargo
Property/Liability/Commercial Line/Long
Tail/Short Tail Pattern over which risk emerges
Hull Insurance - Passenger ships, fishing fleets, pleasure craft: Delays: Reporting delays longer as not only reported when vessel
Cover for own damage and for third party liability for both property reaches a major port, but the full extent of the damage may only
damage and personal injury (bodily injury, death). be known until vessel is scheduled for its next refit. Settlements
Hull Insurance - Commercial vessels, barges: Covers the vessel, its delay may be long as some liabilities claims are large, involving
equipment, freight earnings and stores. large number of parties in many different parts of the world.
Cargo: Covers cargo moved by conventional means across land and Claim Frequency: Highly skewed and variable
sea (truck, ship or aircraft) on a voyage basis from the time the cargo Claim severity: Can vary from minor repairs to complete loss of
leaves the consignor until it reaches its destination vessel
Accumulation: Geographical concentration as storms and tidal
Insured Perils waves could affect many ships in one harbour (sell many polices
Loss of or damage to passengers' property (including luggage), bodily to a particular yacht club), ship spills hazardous material in
injury and death of passengers either while on board the vessel or populated coastal area can lead to many liability claims.
aircraft or when boarding or leaving the aircraft, bodily injury caused
and property damage by the vessel or aircraft, perils of the sea, fire, Common exclusions
explosions, jettison, piracy, sinking, fire, earthquake, volcanic Terrorism/piracy, war, illegal activities, unseaworthiness of vessels,
eruption, accidents in loading, discharging or shifting cargo or fuel, unfitness of containers, malicious acts (hijacking), outside
bursting of boilers, breakage of shafts, negligence of master, officers, geographical limits stated in policy, piloted by someone not specified
crew or pilots, repairers, deliberate sacrifice of property in a voyage in the policy, pre-existing damage, damage from contributory
to prevent total loss of both ship and cargo, damage to dock or negligence
harbour equipment, legal expenses
Basis for Compensation
Underwriting Criteria - Rating factors Claims occurring
Hull: Seaworthiness, loss history, age, size type of craft or vessel,
geographic region, use of craft or vessel (passenger/cargo,
leisure/business), commercial category (commercial, private,
Premium terms
military), scope of voyages, areas covered, number and experience of Usually valued policies with sum insured for property component.
crew, previous claim experience, scope of cover (total loss,
comprehensive cover), sum insured, maximum speed, cruising range Underwriting/Distribution Channels
(rivers, lakes, coastal waters, open sea), ownership, type of trade, Classes are large and underwritten on individual basis after detailed
past claim history, repair costs, engine capacity, age of owners, reports.
manufacturer, country of build, detention history, level of cover, Protection & Indemnity (P&I) clubs
Cargo: Voyage (origin, route, country of destination, reputation of
port), sum insured, type of cargo and how it is packed, scope and
cover, claims experience, vessel size/type, vessel age and condition, Customers
piloted/expertise in navigating a particular route and crews used, Shipowners or in the business of transportation
optional covers, deductibles sub-limits, level of cover, value of cargo
Liability: number of passengers and crew, type of work undertaken Environment
by the insured, limits of liability Exchange rates, legal jurisdiction, salvage and subrogation,
accumulation risk (ICRC) geographic concentration (storm/tidal wave),
Measure of Exposure spillage of hazardous material, economic conditions (moral hazard)
Part I:
Summary of General Insurance Products 10
