The Solvency of a General Insurance Company in Terms of Emerging Costs

Abstract

The authors challenge the traditional balance sheet concept of the solvency of a general insurance company and put forward an emerging costs concept, which enables the true nature of the assets and liabilities to be taken into account, including their essential variability. Simulation is suggested as a powerful tool for use in examining the financial strength of a company. A simulation model is then used to explore the resilience of a company's financial position to a variety of possible outcomes and to assess the probability that the assets will prove adequate to meet the liabilities with or without an assumption of continuing new business. This suggests the need for an appropriate asset margin assessed individually for each company. The implications for the management and supervision of general insurance companies are explored. The suggestion is made that the effectiveness of supervision based on the balance sheet and a crude solvency margin requirement is limited. More responsibility should be placed on an actuary or other suitably qualified professional individual to report on the overall financial strength of the company, both to management and to the supervisory authorities.

The Solvency of a General Insurance Company in Terms of Emerging Costs

“…This aggregate figure is assumed to vary according to a normal distribution with a standard deviation of the type: aX+bJX where X is the mean estimate of total claim payments in the year and a and b are suitably chosen constants. We understand that a similar formula is used by the Finnish supervisory authority for their statutory minimum solvency margin (see Appendix 5 for discussion of this formula which can be considered to be an approximation to the formula derived by BUCHANAN and TAYLOR, 1986). 4.2.6.…”