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P&C Underwriting Risks

Underwriting risk is the risk of loss or of adverse changes in the value of insurance liabilities, due to inadequate pricing and provisioning assumptions. The figure Illustration of P&C underwriting risk concepts depicts the P&C underwriting risk on a general level.

Illustration of P&C Underwriting Risk Concepts 

Premium Risk and Catastrophe Risk

Premium risk is the risk of loss or of adverse changes in the value of insurance liabilities, resulting from fluctuations in the timing, frequency and severity of insured events which have not occurred at the balance sheet date.

Catastrophe risk is the risk of loss or of adverse changes in the value of insurance liabilities, resulting from significant uncertainty of pricing and provisioning assumptions related to extreme or exceptional events.

Premium Risk and Catastrophe Risk Management and Control

The Underwriting Policy (UW Policy) is the principal document for underwriting and sets general principles, restrictions and directions for the organization of underwriting activities. The Board of Directors of If P&C approves the UW Policy at least once a year.

The UW Policy is supplemented with guidelines outlining in greater detail how to conduct underwriting within each business area. These guidelines cover such areas as tariff and rating models for pricing, guidelines in respect of standard conditions and manuscript wordings, as well as authorities and limits, such as sums insured and risks that are not acceptable to undertake. The Underwriting Committee (UWC) is responsible for monitoring compliance with the established underwriting principles.

The business areas manage the underwriting risk on a day-to-day basis. A crucial factor affecting the profitability and risk of P&C insurance operations is the ability to accurately estimate future claims and administrative costs and thereby correctly price insurance contracts. The pricing within the Private business area and smaller risks within the Commercial business area are set through tariffs. The underwriting of risks in the Industrial business area and more complex risks within Commercial is based to a greater extent on general principles and individual underwriting than on strict tariffs. In general, pricing is based on statistical analyses of historical claims data and assessments of the future development of claims frequency and claims inflation.

The insurance portfolio is well diversified, given the large number of customers and the fact that business is underwritten in different geographical areas and across several lines of businesses.

The degree of diversification is shown in the figure Breakdown of gross written premiums by business area, country and line of business, If P&C, 2012.

 

Breakdown of Gross Written Premiums by Business Area, Country and Line of Business
If P&C, 2012

The item Other (including group eliminations) is not shown in the breakdowns above but it is included in total gross written premiums.

Despite the diversified portfolio, risk concentrations and thereby severe claims may arise through, for example, exposures to natural catastrophes such as storms and floods. Of the geographical areas where If P&C operates, the most exposed to such events are Denmark, Norway and Sweden. Also single large claims can potentially have a significant impact on the result. The economic impact of natural disasters and single large claims is mitigated using reinsurance.

If P&C’s Reinsurance Policy stipulates guidelines for the purchase of reinsurance. The need and optimal choice of reinsurance is analyzed based on statistical models for single large claims, whereas If P&C cooperates with external advisors for the evaluation of the exposure to natural catastrophes and the probability of occurrence of catastrophe losses. The analysis relies on catastrophe models in which catastrophes are simulated based on historical meteorological data, supplemented by statistical models. Different reinsurance structures are evaluated based on (i) their expected costs versus their benefits, (ii) their impact on result volatility and (iii) their effect on capital requirement (economic, regulatory and rating capital requirement).

A Nordic wide reinsurance program has been in place in If P&C since 2003. In 2012, retention levels were between SEK 100 million (approximately EUR 11.5 million) and SEK 200 million (approximately EUR 23.0 million) per risk and SEK 200 million (approximately EUR 23.0 million) per event.

Sensitivity of underwriting result and hence underwriting risk is presented by changes in certain key figures in the table Sensitivity test of underwriting result, If P&C, 31 December 2012 and 31 December 2011.

Sensitivity Test of Underwriting Result
If P&C, 31 December 2012 and 31 December 2011
      Effect on pretax profit, EURm

Key figure

Current level (2012)

Change in
current level

2012

2011

Combined ratio, business area Private

88.1%

+/- 1 percentage point

+/- 25

+/- 23

Combined ratio, business area Commercial

89.0%

+/- 1 percentage point

+/- 13

+/- 13

Combined ratio, business area Industrial

95.8%

+/- 1 percentage point

+/- 4

+/- 4

Combined ratio, business area Baltics

87.1%

+/- 1 percentage point

+/- 1

+/- 1

Net premiums earned

4,363 +/- 1 per cent

+/- 44

+/- 41

Net claims incurred

3,146 +/- 1 per cent

+/- 31

+/- 31

Ceded written premiums

258 +/- 10 per cent

+/-26

+/- 21

Reserve Risk

Reserve risk is the risk of loss, or of adverse change in the value of insurance liabilities, resulting from fluctuations in the timing and amount of claim settlements for events which have occurred at or prior to the balance sheet date.

The technical provisions for unearned premiums is intended to cover anticipated claims costs and operating expenses during the remaining term of insurance contracts in force. Since claims are paid after they have occurred, it is also necessary to set provisions for claims outstanding. The technical provisions are the sum of provisions for unearned premiums and provisions for claims outstanding.

Technical provisions always include a certain degree of uncertainty since the provisions are based on estimates of the size and the frequency of future claim payments. The uncertainty of technical provisions is normally greater for new portfolios for which complete run-off statistics are not yet available, and for portfolios including claims that take a long time to settle. Workers’ Compensation (WC), Motor Third Party Liability (MTPL), Personal Accident and Liability insurance, are products with the latter characteristics.

Reserve Risk Management and Control

The Board of Directors of If P&C decides on the guidelines governing the calculation of technical provisions. If P&C’s Chief Actuary is responsible for developing and presenting guidelines on how the technical provisions are to be calculated and for assessing whether the level of the total provisions is sufficient. The Chief Actuary issues a quarterly report on the adequacy of technical provisions, which is submitted to the Board of Directors, CEO, CFO and IRCC of If P&C.

The Actuarial Committee is a preparatory and advisory board for If P&C’s Chief Actuary. The committee makes recommendations concerning guidelines for technical calculations. The committee also monitors technical provisions and provides advice to If P&C’s Chief Actuary regarding the adequacy of these provisions.

If P&C’s actuaries analyze the uncertainty of technical provisions. The actuaries continuously monitor the level of provisions to ensure that they comply with established guidelines. The actuaries also develop methods and systems to support these processes.

The actuarial estimates are based on historical claims data and existing exposures at the balance sheet date. Factors that are monitored include loss development trends, the level of unpaid claims, legislative amendments, case law and economic conditions. When setting provisions, the Chain Ladder and Bornhuetter-Fergusson methods are generally used, combined with projections of the number of claims and the average claim costs.

The anticipated inflation trend is taken into account when calculating all provisions and is of the utmost importance for claims settled over a long period of time, such as Motor Third Party Liability (MTPL) and Workers’ Compensation (WC). The anticipated inflation is based on external assessments of the inflation trend in various areas, such as the consumer price index and payroll index, combined with If P&C’s own estimation of cost increases for various types of claims costs. Inflation risk in the technical provisions is an important consideration underlying If P&C`s investment strategy.

For such insurance lines as MTPL and WC, legislation differs significantly between countries. Some of the Finnish, Swedish and Danish technical provisions for these lines include annuities that are sensitive to changes in mortality assumptions and discount rates. The proportion of technical provisions that are related to MTPL and WC is 69 per cent.

The book value of technical provisions and the duration broken down by line of business and major geographical area is shown in the table Technical provisions by line of business and major geographical area, If P&C, 31 December 2012.

 

Technical Provisions by Line of Business and Major Geographical Area
If P&C, 31 December 2012
  Sweden Norway Finland Denmark Total

 

EURm

Duration

EURm

Duration

EURm

Duration

EURm

Duration

EURm

Duration

Motor other and MTPL

2,694

7.7

875

2.3

853

11.3

130

1.6

4,553

7.2

Workers' compensation

-

-

412

5.9

1,044

12.0

251

7.1

1,707

10.0

Liability

303

4.0

165

2.7

128

2.4

79

2.4

674

3.1

Accident

226

4.6

363

2.3

124

2.6

75

1.2

788

2.8

Property

429

0.8

547

0.9

193

1.2

141

0.8

1,310

0.9

Marine, aviation, transport

 30

0.7

32

0.7

10

0.5

12

0.8

85

0.7

Total

3,682

6.4

2,394

2.5

2,352

9.9

688

3.6

9,116

6.2

The sensitivity of If P&C’s technical provisions to an increase in inflation, an increase in life expectancy and a decrease in the discount rate is presented in the table Sensitivities of technical provisions, If P&C, 2012.

Sensitivities of Technical Provisions
If P&C, 2012

Technical provision item

Risk factorChange in risk parameterCountryEffect EURm
Nominal reserves Inflation increase Increase by 1%-point Sweden 188.1
      Denmark 11.8
      Norway 67.1
      Finland 22.8
Annuities Decrease in mortality Life expectancy increase by 1 year Sweden 14.0
      Denmark 0.4
      Finland 33.5
Discounted reserves (annuities
and part of Finnish IBNR)
Decrease in discount rate Decrease by 1%-point Sweden 75.2
      Denmark 8.7
      Finland 198.5

If P&C’s technical provisions are further analyzed by claims years. The outputs of this analysis are illustrated both before and after reinsurance in the claims cost trend tables. These are disclosed in the Note 27 to the Financial Statements.