Sa3 Pu 14 PDF

SA3: CMP Upgrade 2013/14 Page 1
Subject SA3
CMP Upgrade 2013/14
CMP Upgrade
This CMP Upgrade lists all significant changes to the Core Reading and the ActEd
material since last year so that you can manually amend your 2013 study material to
make it suitable for study for the 2014 exams. It includes replacement pages and
additional pages where appropriate. Alternatively, you can buy a full replacement set of
up-to-date Course Notes at a significantly reduced price if you have previously bought
the full price Course Notes in this subject. Please see our 2014 Student Brochure for
more details.
This CMP Upgrade contains:
All changes to the Syllabus objectives and Core Reading.
Changes to the ActEd Course Notes, Series X Assignments and Question and
Answer Bank that will make them suitable for study for the 2014 exams.
The Actuarial Education Company IFE: 2014 Examinations

Page 2 SA3: CMP Upgrade 2013/14
1 Changes to the Syllabus objectives and Core Reading
1.1 Syllabus objectives
Syllabus objective (a) has been changed to:
Define the principal terms in use in general insurance.
Syllabus objective (n) has been changed to:
Produce coherent advice and recommendations for the overall financial management of a
general insurer.
Parts (i), (ii) and (iii) of objective (n) have not changed.
1.2 Core Reading
Chapter 2
Page 11
The fourth paragraph from the bottom of the page now reads:
Each loss above a fixed amount is pooled amongst the members in accordance
with an agreed formula depending on claim history. The group also operates a
captive to share some risks above the pooling arrangement. Any risk in excess
of the pooling arrangement is reinsured in the market. Some clubs also buy their
own market reinsurance below the pool attachment point.
Page 14
A new discussion of Payment Protection Insurance has been added to Section 5.1.
Remove pages 13 to 16 and replace with new pages 13-14, 14a-14b and 15-16 provided
at the end of this Upgrade.
IFE: 2014 Examinations The Actuarial Education Company

Page 18
In the first paragraph of Section 7.1, the first sentence should now read as follows:
In most insurance companies, the activities are vertically integrated: the

company owns or leases the properties needed to carry out insurance; employs
or contracts underwriters, claims staff, accountants and all other staff involved;
obtains the necessary licences; and is regulated by the Financial Conduct
Authority (FCA) and by the Prudential Regulation Authority (PRA) in the UK.
Page 20
In the fourth paragraph, change FSA to PRA.
Page 23
Add a new sentence of Core Reading after the fifth paragraph on this page, to read:
At closure, any profits are distributed amongst the Names.
Page 28
In the fifth paragraph, change FSA to PRA.
Page 30
Change the six occurrences of FSA on this page to PRA.
In the seventh paragraph, change 1 January 2014 to some future date.
Page 32
Change the three occurrences of FSA on this page to PRA.
Page 33
Change the four occurrences of FSA on this page to PRA.
Page 36
Change the two occurrences of FSA on this page to PRA.

Page 38
Change the first sentence on the page so that it now reads:
Since 2006, Lloyds has been subject to the ICAS regime (originally under the
FSA and now under the PRA) and each syndicate has been required to produce an
ICA.
Change the two occurrences of FSA in the third paragraph to PRA.
In the last paragraph on this page, change On 1 January 2014, to When Solvency
II takes effect,
Page 39
Change the four occurrences of FSA in the section on ICA review to PRA.
Page 40
In the first paragraph of Core Reading in Section 10.2, the last sentence should now
read:
FAL are set bottom-up as ICA times 135% less a credit for member
diversification.
Chapter 3
Page 1
In the fist paragraph of Core Reading, change April 2012 to April 2013.
In the second paragraph, change year-end 2011 to year-end 2012.
Pages 8-12
There have been a number of changes and additions to Section 3. Remove pages 7-12
from your Course Notes and use replacement pages 7-12, 12a and 12b provided at the
end of this Upgrade.
Page 16
In the last paragraph on the page, change Finance Bill 2012 to Finance Act 2012.

Page 18
At the end of the first paragraph of Core Reading in Section 7.1, change 30 April
2012 to 30 April 2013.
Chapter 4
Pages 1-20
There have been significant changes made to Sections 0, 1, 2, 3, 4 and 5. Remove

pages 1-20 from your Course Notes and use replacement pages 1-20, 20a and 20b
provided at the end of this Upgrade.
Page 24
In the paragraph immediately preceding the table, delete the words based on the QIS5
specification,.
Page 26
In the second sentence of the first paragraph on this page, delete the words based on
the QIS5 specification,.
In the last paragraph, change (May 2012) to (April 2013).
Page 27
In the sentence immediately preceding the bullet points in the discussion of the risk
margin, delete the words based on the QIS5 specification,.
Page 29
In the first paragraph of the discussion of contract boundaries, delete the words based
on the QIS5 specification,.
Pages 31-38
There have been numerous changes to these pages, including the updating of values in
the tables of MCR factors and standard deviations, and changes to the SCR risk
structure diagram. Remove pages 31-38 from your Course Notes and replace with new
pages 31-38 provided at the end of this Upgrade.

Page 42
In the last paragraph, change the FSA to the PRA.
Page 43
The Core Reading at the end of the page should be extended to read as follows:
Having already developed models for the similar ICA calculation described
earlier in this chapter, it is anticipated that insurance companies within the UK,
particularly larger ones with economies of scale, may be more likely to use the
internal model option than insurers in continental Europe.
It should be noted that there are subtle differences between ICAS and Solvency
II. The latter is more stretching as once a model is approved it can be used to
set SCR. The ICA meanwhile is a number that may come from a model but may
not.
The PRA sent a letter to firms in the internal model approval process on
29 January 2013 setting out the PRAs intention to allow firms to use their
Solvency II work to meet the current regulatory requirements under the
Individual Capital Adequacy Standards (ICAS).
Page 48
In the last paragraph, change The FSA to The PRA.
Page 52
A new sentence of Core Reading has been added, which should be inserted at the
bottom of this page:
EIOPA has also published draft detailed quantitative reporting templates (QRTs)
for reporting on an annual and quarterly basis of quantitative financial
information under Solvency II.
Page 54
Significant changes have been made to Section 5.13. Remove pages 53-54 from your
Course Notes and replace with new pages 53, 54, 54a and 54b provided at the end of
this Upgrade.

Pages 55-56
Significant changes have been made to Sections 5.14 and 6. Remove pages 55-56 from
your Course Notes and replace with new pages 55-56 provided at the end of this
Upgrade.
Pages 59-61
Significant changes have been made to the Chapter Summary. Remove pages 59-62
from your Course Notes and replace with new pages 59-62, 62a and 62b provided at the
end of this Upgrade.
Chapter 5
There have been significant changes made throughout this Chapter. Remove all pages
in the chapter and insert the replacement chapter provided at the end of this Upgrade.
Chapter 6
Page 7
A new paragraph of Core Reading has been added. The following paragraph should be
inserted at the end of Section 1.3
Binders may operate in this context. These are contractual agreements setting
out the scope of delegated authority, allowing cover holders to enter into
contracts of insurance and to issue insurance documents on behalf of Lloyds
managing agents or other London Market participants.
Page 8
An extra sentence has been added to the fifth paragraph on this page. This whole
paragraph should now read:
Most large risks are coinsured due to their size it is not practical for one
insurer to take 100%. In coinsurance each insurer takes a proportional share of
the risk. The percentage of whole risk is the percentage of the 100% value of the
layer/insured value.

Page 15
Extra Core Reading has been added. The following wording should be inserted at the
end of Section 3:
What claims have been experienced?
This is perhaps the most fundamental question in client understanding as a

prelude to pricing large commercial risks.
Page 16
At the end of the discussion on underwriter licensing, add the following:
Similar limits and processes will apply to the purchase of facultative

reinsurance.
Page 19
The first bullet point in Section 5.1 has been expanded and should now read as follows:
retroactive employers liability or public/products liability covers (these

relate to policies where the insured is covered for negligent acts, errors or
omissions that are reported during the policy term but where the acts
predate the policies inception)
Page 20
Two new sentences have been added to the fourth paragraph of Section 6. The whole
paragraph now reads as follows:
For new business propositions, it is likely that the data will be particularly
scanty. Renewals should in theory have more data available. However it should
be borne in mind that even if the business is new to the insurer, it is likely to
have previously been insured. If this past data is not available, the terms offered
may reflect this.
Page 24
A third bullet point has been added to the discussion of premium payment:
A minimum premium paid up-front but adjusted after the end of the
coverage period to allow for actual exposure.

Page 25
A new paragraph of Core Reading has been added. Insert the following paragraph
immediately after Question 6.8:
There may also be multi-year risks, eg construction, where the sum insured
varies by period and where premiums may be shown in the original year
proportionally. These may be re-rated subsequently based on the actual
exposure (re-signing).
Page 26
The two paragraphs of Core Reading in the discussion of commission have been
replaced with the following single paragraph:
For large policies, the insurer may pay a fee instead of commission. In any
case, we should understand all premium deductions. There may also be profit
commission agreements with the broker. The broker may also rebate
commission to the original insured.
A new summary paragraph has been added right at the end of Section 7.1, as follows:
Summary
These examples should make it clear that there are many areas to consider. A
brief consideration of every area may often be better than an in depth
consideration of only one or two areas.
Page 28
An extra bullet point has been added. Insert the following bullet point at the top of the
existing list:
how much data to use and the relevance of old years

Chapter 8
Page 10
The bullet points at the beginning of Section 2.1 have changed. Replace the existing
text with the following:
Catastrophe models will typically consider separately the following types of

storms:
Tropical cyclones (including tropical storms, hurricanes and typhoons)
Extra-tropical cyclones, such as the windstorms typically seen in Europe
Tornadoes
Chapter 11
Page 5
Delete the whole of the penultimate paragraph of Core Reading on this page.
Page 6
A new sentence has been added to the final paragraph in Section 2.1. This whole
We have to make many assumptions in this modelling process. We will discuss

these in the following sections. While we discuss the key components of
general financial models, it should be noted that these are becoming more
sophisticated and more specific in modelling all the risks that insurers face,
particularly for those companies seeking to meet the Solvency II requirements
for an internal model.
Page 8
A new sentence has been added to the final paragraph in Section 2.7. This whole
The projected premium income and attaching loss ratios should be consistent
with the stage in the underwriting cycle for the line of business in question. This
is likely to require discussion with management to understand the extent to
which they intend to follow the underwriting cycle for each line of business (eg a
strategic decision to maintain profitability in a softening market should normally
be accompanied by assumptions about the loss of volume as competitiveness
reduces).

Page 12
A new sentence has been added to the penultimate paragraph in Section 3. This whole
We could run the model using different values for the variables to assess the
sensitivity of the results to these. Note that judgement from a suitably
experienced person may be required to help assess / select some of the
parameters, as data may either be scarce or not capture features that we may
expect to occur.
Page 19
A new paragraph of Core Reading has been added. The following wording should be
inserted at the end of Section 6.6:
A more recent development has been the preparations made by insurance

companies to comply with the upcoming Solvency II regulations, some of who
have significantly invested in their financial modelling processes.
Chapter 14
Page 16
In the discussion of Cost savings and capital releases, change FSA returns to PRA
returns.
Pages 17-18
In the discussion of Parties involved, change all incidences of FSA returns to PRA
returns.
Page 18
In the discussion of Court hearings, change the FSA to the PRA. Similarly, in the
discussion of Policyholder notification, change The FSA to The PRA.
Pages 23-24
In Section 6.3, change all six incidences of FSA to PRA.

Page 27
In the last paragraph, change FSA to PRA.
Chapter 18
Pages 1-14
There have been many additions to the Core Reading and ActEd text at the start of this
Chapter. Remove pages 1-14 and insert replacement pages 1-14f, provided at the end of
this Upgrade.
Glossary
Page 1
The final phrase has been deleted. This was:
an example being the Claims Reserving Manual published by the Faculty and
Institute of Actuaries.
Page 7
The definition of a bordereau has been updated to read:
A detailed list of premiums, claims and other important statistics provided by

ceding insurers to reinsurers (or by coverholders to insurers in direct
insurance), so that payments due under a reinsurance treaty (or delegated
authority schemes in direct insurance) can be calculated.
Page 10
The definition of a claim cohort has been updated to read:
A group of claims with a common period of origin. The period is usually a

month, a quarter or a year. The origin varies but is usually defined by the
incident date of a claim, the date of reporting of a claim, the date of payment of a
claim, or the date when the period of cover to which a claim attaches
commenced.

Page 14
The definition of deferred acquisition costs has been updated. The first sentence now
reads:
Acquisition costs relating to unexpired periods of contracts in force at the

balance sheet date.
Page 18
In the definition of experience rating, the end of the first paragraph now reads:
... a collar or corridor.
Page 19
The definitions of Financial Services and Markets Act 2000 (FSMA)* and Financial
Services Authority (FSA)* have been deleted.
Page 20
A new definition of fronting has been included. This reads:
Fronting
Fronting occurs when an insurer, acting as a mere conduit, underwrites a risk

and cedes all (or nearly all) of the risk to another insurer which is technically
acting as a reinsurer. The ceding or fronting insurer will typically receive a fee
for its involvement to cover its expenses and profit.
In insurance the term fronting may also be used to describe the process
whereby an individual effects a policy for him/herself but tries to save money by
putting the policy in someone elses name.
Page 39
In the definition of required solvency margin*, FSA has been changed to PRA.

Page 46
The definition of Value at Risk has been changed to:
Value at Risk (VaR)
In financial mathematics and financial risk management, Value at Risk (VaR) is a

widely used measure of the risk of loss. For a given probability and time
horizon, VaR is defined as a threshold value such that the probability that the
loss on the portfolio over the given time horizon exceeds this value is the given
probability level.
Pages 48 52
The following items have been added to the list of abbreviations:
ATAFs Age to age factors

ATUFs Age to ultimate factors
BAU Business as usual
FCA Financial Conduct Authority
ORSA Own Risk and Solvency Assessment
PRA Prudential Regulation Authority
SCR Solvency Capital Requirement
TAS Technical Actuarial Standard
The following items have been deleted from the list of abbreviations:
FSA Financial Services Authority

GRIP General insurance premium Rating Issues working Party
GRIT General insurance Reserving Issues Taskforce

2 Changes to the ActEd Course Notes
Chapter 3
Page 3
In the last paragraph on the page, change the reference to FSA returns to PRA
returns.
Pages 8-12
As stated above, there have been a number of changes and additions to Section 3.
Remove pages 7-12 from your Course Notes and use replacement pages 7-12, 12a and
12b provided at the end of this Upgrade.
Chapter 4
Pages 1-20
As stated above, there have been significant changes made to Sections 0, 1, 2, 3, 4

and 5. Remove pages 1-20 from your Course Notes and use replacement pages 1-20,
20a and 20b provided at the end of this Upgrade.
Page 43
Change each of the nine incidences of FSA to PRA.
Pages 55-56
As stated above, changes have been made to Section 6. Remove pages 55-56 from your
Course Notes and replace with new pages 55-56 provided at the end of this Upgrade.
Page 63
In Solution 4.1, change each of the seven incidences of FSA to PRA.
Chapter 5
As stated above, there have been significant changes made throughout this Chapter.
Remove all pages in the chapter and insert the replacement chapter provided at the end
of this Upgrade.

Chapter 6
Page 28
As stated above, an extra Core Reading bullet point has been added. Insert the
following paragraph immediately after the new bullet point:
We want a long enough period of data to provide a sufficient volume of data

for credibility and accuracy. However, the further back we go into the past, the
greater the danger that the experience is less relevant for the future.
Page 33
Add a new bullet point to the end of the second set of points on this page, as follows:
what claims have been experienced.
Chapter 7
Page 7
A new sentence has been added to the sentence that immediately precedes the section
on incorporating capital costs into premiums. This should now read as follows:
If you are interesting in digging deeper into this theory, Donald Mangos paper
referenced above gives a lengthy numerical example to illustrate the above ideas. This
paper is thought-provoking but some of its assumptions are questionable, eg the
assumption that it is appropriate to use the same opportunity cost rate when calculating
the capital call cost as when calculating the capacity occupation cost.
Page 10
The discussion of coherence of risk measures has been increased. The following text
should be inserted after the second paragraph on the page:
If you decide to read further around this subject, you may find that practitioners have
differing views on the desirable qualities of a risk measure, including different
definitions of some of the measures mentioned in the Core Reading, and (for example)
different conclusions about whether a particular measure is coherent or not.

For exam purposes, its important not to be too dogmatic about the rights or wrongs of
any particular conclusion. Rather, use this chapter to improve your general awareness
of the topic of capital allocation and risk measurement. It is also worth bearing in mind
that, at the time of writing (Summer 2013), the material in this chapter has never been
examined directly in the Subject SA3 exam.
If you are interested in exploring these concepts in more detail, you may like to look at
the following papers:
Denault, M. (2001) Coherent allocation of risk capital
http://www.risk.net/digital_assets/4969/v4n1a1.pdf
Kaye, P. (2005) A guide to risk measurement, capital allocation and related

decision support issues
http://www.casact.net/pubs/dpp/dpp05/05dpp1.pdf
Myers, S. & Read, J. (2001) Capital allocation for insurance companies

https://www.casact.org/pubs/forum/03fforum/03ff459.pdf
Venter, G. (2004) A survey of capital allocation methods with commentary

http://www.actuaries.org/ASTIN/Colloquia/Berlin/Venter2.pdf.
Chapter 9
Page 5
The FSA Returns have now become the PRA Returns. Therefore the third paragraph of
Section 1.2 should be amended to read:
The statutory returns are also known as PRA Returns, and Insurance Annual Returns.
They were formerly known as FSA Returns (most recently) and also as DTI Returns,
when they were made in terms of the Insurance Companies Act and Regulations, prior
to 2002.
Page 26
The four incidences of FSA Returns within this table should be changed to PRA
Returns.

Page 27
In Solution 9.12, the two incidences of FSA Returns should be changed to PRA
Returns.
Chapter 10
Page 38
The reference given for more details of the working party findings is no longer valid.
Replace the link with the following:
www.actuaries.org.uk/research-and-resources/documents/f10-update-uk-
asbestos-working-party.
Chapter 11
Page 5
Delete the last paragraph on this page.
Page 22
Add a new sentence at the end of the summary box as follows:
The upcoming Solvency II regulations have meant that many insurers have
significantly increased their levels of financial modelling.
Chapter 15
Page 5
Change the second bullet point in Section 2.3 so that it reads:
Use your knowledge of the Core Reading and any professional guidance.
Page 11
Change the title at the top of the page to read:
Professional guidance and Core Reading

Chapter 18
Pages 1-14
As stated above, there have been many additions to the Core Reading and ActEd text at
the start of this Chapter. Remove pages 1-14 and insert replacement pages 1-14f,
provided at the end of this Upgrade.
Page 16
In the discussion of the 2006 paper Treating customers fairly, change the FSA to the
PRA.
Page 24
The wording has changed in the sixth paragraph of Section 3.4. This should now read
as follows:
The PRAs website, now found under www.bankofengland.co.uk, contains numerous

Consultation Papers (CPs). Some of these are very relevant to Subject SA3, for
instance those covering solvency issues. Check regularly with the site to see the latest
papers.

3 Changes to the Q&A Bank
Part 1
In Solution 1.4 part (iii), in the fourth bullet point from the end, replace FSA
Handbook with PRA Handbook.
Part 2
In Solution 2.3 part (i), replace Actuarial Profession Standards with Actuarial
Practice Standards in the point immediately following the bullet points.
In Solution 2.3 part (ii), the third point should now read:
To signal to those outside the Institute and Faculty of Actuaries (IFoA) the standards
to which members operate. []
Part 3
In Solution 3.1 part(i)(a), the paragraph following the formula has been changed. This
now reads:
For example, if portfolio X has a value of 100m and an otherwise identical portfolio Y
has a value of 50m, the risk associated with portfolio X can not be greater than the risk
associated with portfolio Y.
In Solution 3.1 part(i)(b), the paragraph following the formula has been changed. This
now reads:
For example, if this constant were related to currency exchange rates, where the risk
measure is independent of the currency in which the risk is measured, then doubling the
exposure would correctly double the capital required, without allowing for any extra
diversification.
Part 6
In the discussion of Shareholders funds in Solution 6.4, change the reference to the
FSA in the sixth point to the PRA.
In the bullet points at the end of Solution 6.6 part (iv), change RMM in the second
bullet point to MCR.

In the Introduction section of Solution 6.7, change the second paragraph so that it reads:
The reserves have been calculated in accordance with generally accepted actuarial
principles and in accordance with professional guidance from the Institute and Faculty
of Actuaries.
In the discussion of Investment income in Solution 6.7, change the penultimate point on
page 36 so that it reads not discounting rather than discounting.

4 Changes to the X Assignments

This section provides details of material changes that have been made to the
2013 X Assignments, so that you can continue to use these for the 2014 exams.
However, if you are having your attempts marked by ActEd, you will need to use the
2014 version of the assignments.
A comment has been added to each solution detailing which part of the course it covers.
Assignment X1
Solution X1.1
In part (i), change the reference to the FSA on the second page to the PRA.
Solution X1.4
In part (v), the sixth point is now worth [1] mark.
Assignment X2
Solution X2.2
In the first point of part (i), change UK Actuarial Profession to Institute and Faculty
of Actuaries (IFoA)
Assignment X3
Solution X3.2
In part (ii), insert a new point after the fourth point, as follows:
We are assuming here that it is appropriate to use the same opportunity cost rate when
calculating the capital call cost as when calculating the capacity occupation cost. []
Change [Total 6] to [Maximum 6] for part (ii).
Solution X3.3
In the discussion of Guidance, change the three incidences of profession to IFoA.

In the discussion of Legislation, change FSA to PRA.

Assignment X4
Solution X4.2
In the section on Capital and solvency in part (ii), change both incidences of FSA to
PRA.
Change FSA to PRA in the last point of part (iii).

5 Other tuition services

In addition to this CMP Upgrade you might find the following services helpful with
your study.
5.1 Study material
We offer the following study material in Subject SA3:

ASET (ActEd Solutions with Exam Technique) and Mini-ASET
Mock Exam A and the Additional Mock Pack
Practice Module booklets. (These are a good alternative to the Flashcards that
are available in other subjects.)
For further details on ActEds study materials, please refer to the 2014 Student
Brochure, which is available from the ActEd website at www.ActEd.co.uk.
5.2 Tutorials
We offer the following tutorials in Subject SA3:

a set of Regular Tutorials (lasting three full days)
a Block Tutorial (lasting three full days)
For further details on ActEds tutorials, please refer to our latest Tuition Bulletin, which
is available from the ActEd website at www.ActEd.co.uk.
5.3 Marking
You can have your attempts at any of our assignments or mock exams marked by
ActEd. When marking your scripts, we aim to provide specific advice to improve your
chances of success in the exam and to return your scripts as quickly as possible.
For further details on ActEds marking services, please refer to the 2014 Student
Brochure, which is available from the ActEd website at www.ActEd.co.uk.

6 Feedback on the study material

ActEd is always pleased to get feedback from students about any aspect of our study
programmes. Please let us know if you have any specific comments (eg about certain
sections of the notes or particular questions) or general suggestions about how we can
improve the study material. We will incorporate as many of your suggestions as we can
when we update the course material each year.
If you have any comments on this course please send them by email to SA3@bpp.com
or by fax to 01235 550085.

All study material produced by ActEd is copyright and is sold
for the exclusive use of the purchaser. The copyright is owned
by Institute and Faculty Education Limited, a subsidiary of
the Institute and Faculty of Actuaries.
Unless prior authority is granted by ActEd, you may not hire

out, lend, give out, sell, store or transmit electronically or
photocopy any part of the study material.
You must take care of your study material to ensure that it is

not used or copied by anybody else.
Legal action will be taken if these terms are infringed. In

addition, we may seek to take disciplinary action through the
profession or through your employer.
These conditions remain in force after you have finished using

the course.

SA3-02: The UK general insurance market Page 13
4 The London Market

The London Market forms an important part of the world insurance and
reinsurance markets. It is centred around Lloyds and includes most of the
business written by Lloyds syndicates (some personal lines business written by
Lloyds syndicates cannot strictly be termed London Market business).
Insurers active in the London Market include:

Lloyds syndicates
a large number of UK subsidiaries or branches of overseas insurance
companies
a large number of UK subsidiaries or branches of overseas reinsurance
companies
the home foreign or reinsurance departments of UK composite
companies, or reinsurance subsidiaries of such companies (home foreign
business consists of business written in London, where the risk
originates overseas)
small professional reinsurance companies set up by (or acquired by) large
broking firms for the specific purpose of transacting London market
business
captive companies owned by UK or overseas industrial or commercial
companies
P&I Clubs and other mutuals
pools, or companies owned by a group of insurance or reinsurance
companies.

Page 14 SA3-02: The UK general insurance market
5 Acquisition of business
The main methods of acquiring business are discussed in this section. However, new
methods sometimes appear, as insurers strive to boost their market share. You should
keep an eye on the financial press to see what companies are doing to attract customers.
5.1 Non-London Market business
Insurers obtain their business through:

intermediaries such as brokers, banks and building societies
staff directly employed by the insurance provider
internet, telesales, post and off-the-page.
Intermediaries
Normally intermediaries are only paid by a commission for each policy that they sell.
For example, private motor insurance is often sold through high street insurance
brokers. A prospective policyholder will contact a brokers office and the broker will
be rewarded by commission payments from the insurance company with whom the
business is placed.
With classes such as domestic buildings insurance, mortgage guarantee insurance and
travel insurance, insurance brokers may not be the most natural intermediary. With
buildings insurance and mortgage guarantee insurance, much of the business is sold
through the building society or bank that supplied the mortgage for the house purchase.
In the case of travel insurance, the travel agent will often sell the insurance.
Payment Protection Insurance
Payment Protection Insurance is an example of an insurance product that is often sold

through banks and other providers of loans.
A product that in recent years has come to haunt many insurers selling
financial / credit covers in the personal lines market is payment protection
insurance (PPI). PPI has become the most complained about financial product
ever in the UK.

SA3-02: The UK general insurance market Page 14a
PPI, also known as creditor insurance, credit protection insurance, or loan

repayment insurance, is an insurance product that enables consumers to insure
repayment of loans if the borrower dies, becomes ill or disabled, loses a job, or
faces other circumstances that may prevent them from earning income to
service the debt. PPI is widely sold by banks and other credit providers as an
add-on to the loan or overdraft product.
Although the policy is purchased by the consumer / borrower, the benefit paid in
the event of a claim goes to the company that extended credit to the consumer.
PPI usually covers minimum loan (or overdraft) payments for a finite period
(typically 12 months).
It may sound like a useful product (and indeed it can be), but PPI has caused a great
deal of controversy in recent years.
In all types of insurance some claims are accepted and some are rejected.
However, in the case of PPI, the number of rejected claims is high compared to
other types of insurance.
A primary reason for this is that, as with many forms of general insurance, the
insurance is not underwritten at the sales stage; it is sometimes taken out by
customers without careful consideration as to whether it is right for their
circumstances, and without careful attention to the policy eligibility conditions,
eg care needs to be taken if a person is or became unemployed, as payments in
lieu of notice (for example) may render a claim ineligible despite the insured
person being genuinely unemployed.
Policies that were designed to cover people in full-time employment were often sold to
unemployed or self-employed people who wouldnt be eligible to make a claim. Other
policies were sold to customers who were older than the age limit specified. Careful
consideration at the sales stage could have avoided these policies being taken out in the
first place.
As is the case for most forms of insurance, individuals who seek out and purchase a
policy without advice have little recourse if and when a policy does not benefit
them. However, most PPI policies are not sought out by consumers. In some
cases, consumers claim to be unaware that they even have the insurance.
Surveys show that 40% of policyholders claim to be unaware that they had a
policy.
If a customer has been sold a policy that isnt suitable, this is called mis-selling.

Page 14b SA3-02: The UK general insurance market
PPI was mis-sold and complaints about it were mishandled on an industrial scale
for well over a decade with this mis-selling being carried out not only by the
banks or providers, but also by third party brokers. The sale of such policies
was typically encouraged by large commissions, as the insurance would
commonly make the bank / provider more money than the interest on the original
loan, such that many mainstream personal loan providers made little or no profit
on the loans themselves; all or almost all profit was derived from PPI
commission and profit share.
Certain companies developed sales scripts which guided salespeople to say

only that the loan was protected without mentioning the nature or cost of the
insurance. When challenged by the customer, they sometimes incorrectly stated
that this insurance improved the borrower's chances of getting the loan or that it
was mandatory. A consumer in financial difficulty is unlikely to further question
the policy and risk the loan being refused.
Where a policy has been mis-sold, the customer should be able to cancel the policy and
get a refund of premiums paid. They will normally need to actively make a claim in
order to do this, and so claims management companies have been very busy in recent
years trying to persuade / help people to make a claim, in return for a substantial
percentage of the amount refunded.
In response to the mis-selling scandal, new regulations have been introduced to prevent
it (or something similar) from happening again.
On 6 April 2011, the Competition Commission released their investigation order

designed to prevent mis-selling in the future. Key rules in the order, designed to
enable the customer to shop around and make an informed decision, include:
provision of adequate information when selling payment protection and
providing a personal quote
obligation to provide an annual review
prohibition of selling payment protection at the same time the credit
agreement is entered into.
Most rules came into force in October 2011, with some following in April 2012.

SA3-02: The UK general insurance market Page 15
Staff directly employed by the insurer
The insurer may employ a number of staff to sell motor insurance directly to the public.
These employees will have a customer base that has been built up over many years.
The same salesman will visit their customers on a regular basis with the hope that they
will renew their policy (eg their motor policy) each year and that they will also take out
new types of insurance. Nowadays, the number of insurers offering this door
collection service is negligible, as most customers now prefer to deal via payment
methods such as direct debit and credit card.
Insurance company employees may be paid by salary, performance-related bonus or a

combination of the two.
Internet etc
Many insurers have a distribution division or subsidiary that devotes itself to

direct sales. Here the distribution division or subsidiary invites proposers,
through advertising, to make proposals by telephone or the internet, or through
cold selling by post, telephone or the internet. As there are no intermediaries,
the insurer pays no commission and reduces the costs of acquiring business.
At least this is the intention: it is not always the case, however, that direct
marketing costs are less than commission.
Following the success of Direct Line since the 1980s, there are now adverts for a
number of new insurers with names like Tom-Dick-and-Harry Direct. This applies in
the UK and in a number of countries overseas, eg South Africa. The aim of these new
companies is to reduce costs by cutting out the need for regional sales branches and
commission payments to intermediaries, although advertising costs can be high. In the
UK in particular, internet sales now make up the majority of all general insurance sales
for some classes of business.
Aggregators are another more recent development these are websites that submit a
prospective policyholders details to many other sites, collect quotes (hopefully on a
like-for-like basis) and compare them side-by-side. It is debateable whether or not they
can be classed as brokers, depending on how they make their money (through
commissions or otherwise).
Contact is made with the public through advertising in the media (eg TV, newspapers),
by direct mail or by phone. The main classes affected by the growth of direct sales in
recent years have been private motor and domestic property.

Page 16 SA3-02: The UK general insurance market
5.2 London Market business
Many risks that are insured in the London Market are too large to be insured
entirely by one insurer. Instead, they are co-insured. A particular co-insurers
percentage share of a risk is known as its line.
The Lloyds Act states that Lloyds business must be introduced through a
Lloyds broker. However, it does provide for exceptions to be decided upon by
the Council of Lloyds. To date exceptions have been given for:
personal lines business
term life business (which is life assurance, not general insurance).
There are service companies that have been approved to introduce personal
lines business into Lloyds.
Some syndicates selling personal lines now deal directly with the public via direct
telephone sales, as outlined above.
Underwriting agencies
A very large source of London Market business for insurers is underwriting

agencies (also known as managing general agents). These companies
underwrite business on behalf of insurers. The insurer agrees a contract (also
known as a binding authority) with the agency. The contract will specify that for
an agreed period the agency can place the insurer on risk for certain classes of
business under agreed policy wordings.
There have been some problems in the past with this type of arrangement. For
example, many agencies are paid a percentage of premiums as commission.
This causes a potential conflict of interest for the agency because it has an
incentive to increase the volume of business written without sufficient regard for
the profitability of the business. It is important that the interests of the agency
and the insurer are aligned and that the insurer has good access to exposure
data.
Many of these agencies were formed by brokers. For them it is an efficient way
of doing London Market business. The agency might also be formed by a
company established for that reason. In some cases, a company may establish a
specialist agency to underwrite risks on behalf of an insurer. For example, an
agency might specialise in offering cover to caravan owners. Some agencies
have been formed with specialist risk management functions in-house to write
specialist business on behalf of an insurer, for example, environmental pollution.
This type of arrangement remains a major source of business for many London
Market companies.

SA3-03: Taxation Page 7
If these transitional rules continue to apply to a company, this results in an

annual adjustment in the tax computation.
2.4 Other income
Miscellaneous sources of income such as investment underwriting and

stock-lending fees are generally taxed as they are earned and recognised in the
companys financial statements.
Investment underwriting is when a lender undertakes to buy unsold stock at a certain

price. Stock lending fees are paid to bodies which will lend out stock without an
actual transfer of ownership. Both examples may generate income.
Question 3.1
Summarise the taxation of investment income for a proprietary general insurance

company.

Page 8 SA3-03: Taxation
3 The underwriting result and provisions
3.1 UK generally accepted accounting principles (GAAP)
A general insurer will calculate its underwriting result by reference to UK

generally accepted accounting principles (UK GAAP, as amplified for specific
insurance accounting issues by the Statement of Recommended Practice on
accounting for insurance business issued by the Association of British Insurers
(last updated in December 2005), a body recognised for this purpose by the
Accounting Standards Board (now the Accounting Council of the Financial
Reporting Council)).
The Statement of Recommended Practice (SORP) will be covered further in Chapter 9.
The main feature of the UK GAAP principles is what is known as deferral and
matching of assets and liabilities, ie consistent methods of valuation that can, to an
extent, be some way from reality. For example, the deferral of acquisition costs is
currently acceptable, but arguably not exactly realistic.
This has caused some concern amongst regulators, in that UK GAAP principles could
be seen as unfair, and so moves have taken place to rectify the situation, as follows.
3.2 International accounting standards (IAS)
Compliance with International Accounting Standards (IAS) is required for all

listed companies within the EU from year-end 2005. Unlisted companies
(including subsidiaries of listed companies) may stay on UK GAAP. However,
for accounting periods beginning on or after 1 January 2015 current UK GAAP
will be replaced by three new Financial Reporting Standards, FRS 100, 101 and
102 (new UK GAAP). Early adoption is permitted.
The standards that the IAS prescribe are called the International Financial Reporting
Standards (IFRS).
The new Financial Reporting Standards are as follows:

FRS 100: Application of financial reporting requirements.
This sets out overall financial reporting requirements applicable in the UK and
Republic of Ireland.
FRS 101: Reduced disclosure framework.

Entities that are not required to use IFRS but wish to use its recognition and
measurement requirements can choose to apply FRS 101 in their individual
financial statements, and so benefit from reduced disclosures.

FRS 102: The financial reporting standard applicable in the UK and Republic of
Ireland.
This is the new UK GAAP. It was issued on 14 March 2013 and will apply to
unlisted entities for accounting periods commencing on or after 1 January 2015,
bringing about a simplified and modernised reporting regime for those entities
compared to the current UK GAAP.
These new revisions to financial reporting standards have been made by the Financial
Reporting Council (FRC). The FRCs overriding objective in setting these accounting
standards is to enable users of accounts to receive high-quality understandable financial
reporting proportionate to the size and complexity of the entity and users information
needs. A key aim is to have consistency with international accounting standards, using
a method that is cost-effective to apply.
UK accounting standards require the annual basis of accounting to be used

unless delays in the receipt of information on premiums and claims renders it
inappropriate, in which case the funded basis of accounting should be used.
This is likely to be the case only in exceptional circumstances.
Under UK GAAP the underwriting result is calculated net of outwards

reinsurance transactions.
Question 3.2
Give examples of situations where an annual basis of accounting would be

inappropriate.
3.3 Allowable technical reserves
An insurance company may well want to defer its tax payments by setting up reserves
that are as large as possible. HM Revenue and Customs (HMRC) will not be very keen
on insurance companies deferring tax by setting up unnecessarily large reserves.
Therefore one key question that the tax inspectors will ask is whether they believe the
reserves being set up are appropriate.
A general insurers insurance technical provisions are in principle deductible for

tax purposes provided they have been calculated under UK or International
GAAP. For accounting periods ending before 31 December 2009 Her Majestys
Revenue and Customs could enquire into whether they were correctly calculated
for accounting purposes.

For accounting periods of insurers ending on or after 31 December 2009, new

legislation potentially limits the tax deduction to the appropriate amount.
Insurers will make their corporation tax returns on the basis of the figures in
their financial statements, but HM Revenue and Customs may enquire into these.
If HM Revenue and Customs does enquire into the appropriateness of the
technical provisions, then the appropriate amount depends on whether or not
the company has an actuarial opinion supporting the figure in the financial
statements. If the figure is properly supported by an actuarial opinion and the
insurance company confirms this with its tax return the figure in the financial
statements will stand for tax purposes. If not, the appropriate amount will be
the undiscounted best estimate, if that is less, and the excess will be disallowed
for tax purposes. Any disallowance will reverse in the next year, subject to any
further disallowance at the end of that year.
The written actuarial opinion must be in accordance with actuarial standards and
confirm that, on the basis of the information at the time the financial statements
are adopted, the amount is not excessive. The opinion need not be given by
an actuary, though it must conform to actuarial standards.
The legislation brings HMRC additional powers, including the power to

commission an independent report into the provisions. In practice HMRC use
this power sparingly, and they generally seek to resolve enquiries on the basis of
information provided without invoking the formal power.
Equalisation provisions are not, strictly speaking, technical provisions.

Transfers to equalisation provisions are dealt with under different rules. Under
current law, the amount as shown in the PRA return (or if the company or
permanent establishment does not prepare an PRA return, the amount that
would be shown in its PRA return had it prepared one) is deductible, unless the
company elects otherwise. Transfers from the equalisation provision as shown
(or would have been shown) in the PRA return are taxable unless no tax
deduction was claimed when it was set up. However, note that the tax rules on
equalisation provisions are expected to change when Solvency II comes into
force (see below).
Reported claims provisions
These should be supported by case estimates or statistical projections.
Question 3.3
Where could HMRC find evidence that the insurer is over-reserving?

Provision for unearned premiums (UPR)
These provisions must be calculated in the most accurate manner available to

the insurer. It also follows that acquisition costs relating to unearned premiums
should be deferred through the establishment of a deferred-cost asset.
Question 3.4
Give three examples of circumstances that could lead to possible disagreements

between the insurer and HMRC over the size of the UPR.
Additional provision for unexpired risks (URR or AURR)
This is acceptable, provided it can be established on a statistical basis that the

provision for unearned premiums net of related acquisition costs is inadequate
to meet the losses on unearned premiums.
Note that the Core Reading has used both URR and AURR. Remember that the term
can be used in either way, so always define it.
Question 3.5
Which accounting concept might the insurer use to justify setting up an AURR?
Which one might HMRC use to disallow AURR?
Incurred but not reported claims provision (IBNR)
Provisions for IBNR are acceptable subject to justification of the existence and
extent of such claims. This will be most difficult in classes subject to great claim
variation and in particular those where latent claims may exist.
Question 3.6
How might you convince HMRC that your method of allowing for latent claims is
reasonable?

Claims handling expense provision
A provision for internal and external claims handling expenses is allowable to

the extent that the expenses relate directly to claims for which claims provisions
have been accepted by HMRC.
HMRC have been known to examine claims handling expense provisions to test
whether the provision is calculated with sufficient accuracy as to enable the
provision to be considered specific and therefore tax deductible.
Reinsurers share of technical provisions
The insurance technical provisions claimed for tax purposes are net of amounts
recoverable from reinsurers. For tax purposes it is necessary to assume that all
amounts due will be recovered. A deduction is allowed for specific provisions
for amounts estimated to be irrecoverable from reinsurers but a general
provision is not allowed.
In other words, only if you have doubts over a specific reinsurers ability to pay specific
recoveries, can the provision set aside for this be deducted for tax purposes.
Equalisation provisions
These were mentioned earlier.
In the UK, insurers are required to establish an equalisation reserve/provision

over and above their claims provisions in respect of certain classes of business
(regarded as being potentially volatile). Statutory rules govern the calculation of
transfers to the reserve (which are tax deductible, unless the company elects
otherwise) and transfers from the reserve (on which tax is payable, unless the
company elected not to claim a tax deduction when it was set up).
Question 3.7
Have an educated guess at which classes these are.
The maximum amount that may be transferred into the reserve in a given year is
expressed as a percentage of written premium. The rules for transferring money out of
the reserves are related to a claim ratio. Once the ratio in a particular year exceeds a
prescribed amount, then the reserve is reduced. There is a maximum amount for the
size of the reserve that the insurer can hold. This maximum is also expressed as a
percentage of written premium.
For all classes other than those specified (ie for less volatile classes) HMRC will not
allow the reserves against tax.

SA3-03: Taxation Page 12a
Broadly speaking, equalisation reserves are therefore treated as normal reserves and are
tax-deductible. In the next chapter we shall see that, for published accounts, insurers
often have the choice of basis (either UK GAAP or IFRS). Equalisation reserves are
not shown under the IFRS basis, but are under the UK GAAP basis however, as an
insurers tax computation usually follows the PRA Return, it will allow for the
equalisation reserves shown there.
Under Solvency II, the regulatory requirement to set up equalisation provisions

will no longer exist. Finance Act 2012 introduced legislation that will remove any
entitlement to a tax deduction for equalisation provisions, which the government
intends to bring into force when Solvency II comes into force. The charge to tax
on the release of provisions held at that time will be spread over a six-year
period, with the insurer having an option to pay the full amount remaining at any
stage in the six-year period.
Provisions not allowable against tax
Provisions for future catastrophe losses are not allowable except under the
equalisation reserve rules (see above).
A catastrophe reserve might be thought of as a specific example of a claims equalisation

reserve. However, the money is released from a catastrophe reserve only when a
specified event occurs.

Page 12b SA3-03: Taxation
This page has been left blank so that you can slot the replacement
pages into your Course Notes.

SA3-04: Legislation Page 1
Chapter 4
Legislation
Syllabus objectives
(c) Describe the principal regulatory and supervisory requirements that affect
general insurers (including Lloyds) established in the UK, under:
Current insurance regulations
Prospective Solvency II regulations.
0 Introduction
Why should insurance business suffer more legislation than, say, washing machine
manufacturers? One of the reasons is that there is more scope for the purchaser to lose
out financially. With insurance you have to trust the insurer to pay valid claims as and
when they arise in the future.
The uncertainty underlying insurance business means that it is not just a question of
trusting the honesty of the insurer. The insurer may be very well-meaning but if their
business is not soundly managed they may well have collapsed by the time you make a
claim. There is clearly a danger of policyholders suffering at the hands of unscrupulous
or incompetent operators.

Page 2 SA3-04: Legislation
UK legislation aims to protect policyholders from this by implementing controls over:

the classes that an insurer can sell
the people who run the company
the level of financial strength
information that is published about the company.
As it is difficult to totally prevent each individual insurance company from collapsing,

there are schemes to ensure that policyholders do not lose out if this were to happen.
The regulation, supervision and taxation of UK insurers are rapidly evolving

areas. This chapter was updated in April 2013, and is a fair reflection of the
position at that time. The student is advised, however, to keep abreast of
developments by reading the financial and insurance press.
Some monetary amounts set out in this unit are subject to annual indexation.
For the avoidance of doubt, all such amounts are correct at the date of drafting
and relate to returns at year-end 2012. Candidates should familiarise themselves
with any updated values.
There is insufficient space in this course to cover the taxation (covered in the
previous chapter), legislation, regulation and supervision of insurance entities in
the UK in detail. This chapter aims to provide an overview of the most important
areas affecting general insurers.
Section 1 of this chapter covers current general insurance supervision in the UK and the
role of the Prudential Regulation Authority (PRA).
Section 2 gives details about the PRA Handbook.
Section 3 covers how the solvency of insurers and Lloyds is monitored.
Section 4 covers the Regulatory Returns made to the PRA.
Finally, Section 5 covers the prospective Solvency II regulations.

1 Supervision of general insurance in the UK

The legislation governing general (and life) insurance regulation and supervision
in the UK is the Financial Services and Markets Act 2000 (FSMA 2000) and a
series of EU Directives, the most important of which currently are Insurance
Directives and the Reinsurance Directive1. These directives are implemented in
UK law by FSMA 2000.
The Financial Services Act 20122, which came into effect on 1 April 2013,
amended FSMA 20003 to create two UK regulators of insurance (and other
financial services); the Prudential Regulation Authority of the Bank of England
(PRA) and the Financial Conduct Authority (FCA).
The current Insurance Directives and Reinsurance Directive are to be replaced

by Directive 2009/138/EC on the taking-up and pursuit of the business of
Insurance and Reinsurance (Solvency II). Solvency II will bring about major
changes to insurance supervision across Europe. At the time of writing this
course material the European Parliament had not yet decided the date when
Solvency II comes into effect.
Various target implementation dates for Solvency II have been missed. The feeling, at
the time of writing (June 2013) is that full implementation wont happen before 2016
and it is quite possible that this date may slip further.
1.1 The regulatory framework under FSMA
The FCAs objectives
The FCA has a strategic objective of ensuring that financial markets function
well and three operational objectives of:
(a) securing an appropriate degree of protection for consumers,
(b) protecting and enhancing the integrity of the UK financial system and
(c) promoting effective competition in the interests of consumers in financial
services.
1
For general insurers, the relevant European Directives are the first, second and
third non-life directives (73/239/EEC, 88/357/EEC and 92/49/EEC) as updated by
the non-life Solvency I Directive (2002/13/EC) and the Reinsurance Directive
2005/69/EC).
2
http://www.legislation.gov.uk/ukpga/2012/21/enacted.
3
When FSMA 2000 initially came into effect in December 2001, it created the
Financial Services Authority. The Financial Services Act 2012 replaced the FSA
with the PRA and FCA.

Essentially, the FCA wants consumers to be able to use financial services with
confidence and have products that meet their needs, from firms and individuals they can
trust. It achieves this by regulating firms and financial advisers so that firms put the
interests of their customers and the integrity of the market at the core of what they do.
More information is available on the website, www.fca.org.uk.
The PRAs objectives
The PRA is responsible for the prudential regulation and supervision of banks, building
societies, credit unions, insurers and major investment firms; in total, the PRA regulates
around 1,700 financial firms, of which around 500 are insurers.
The PRAs role is defined in terms of two statutory objectives.
The PRA has a general objective of promoting safety and soundness of persons
who carry out PRA regulated activities (which include effecting and carrying out
a contract of insurance).
In addition to this general objective, the PRA has a second statutory objective specific
to its regulation of insurers:
An insurance objective of contributing to securing an appropriate degree of

protection for those who are or may become policyholders.
Note that it is not the PRAs role to ensure that no insurer fails. Rather, it seeks to
ensure that any insurer that does fail does so in a way that allows for an appropriate
degree of protection for policyholders and avoids significant disruption to the supply of
critical financial services (ie it fails in an orderly manner).
More information is available on the website, www.bankofengland.co.uk/pra.

Handbooks
The rules and guidance of the FCA and PRA are contained in their respective
handbooks4. It is primarily through these Handbooks that the UK implements the
EU Insurance and Reinsurance Directives. The supervisory approach of the PRA
is contained in its supervisory approach document5. The supervisory approach
of the FCA can be found on its website6.
The remainder of this chapter is concerned with supervision of general

insurance by the PRA only. PRA rules and supervision is of far greater
relevance to actuarial general insurance work than FCA supervision, although
pricing actuaries may be affected by FCA decisions on products and profitability.
The PRAs approach to general insurance supervision
At a high level, the PRAs approach is to:

satisfy itself that insurers meet and are likely to continue to meet the
PRAs Threshold Conditions
These Threshold Conditions set out the minimum requirements that insurers
must meet in order to be permitted to carry on the regulated activities in which
they engage. They are designed to promote safety and soundness of the firms,
and appropriate protection of policyholders. They are listed on the next page.
assess risk to identify any risks to the PRAs objectives

mitigate risks identified
satisfy itself that, should an insurer fail, it could fail in a way that would
not harm the UK financial system. (The PRA refers to this as
resolvability)
4
The FCA Handbook can be found at http://fshandbook.info/FS/html/FCA and the
PRA Handbook can be found at http://fshandbook.info/FS/html/PRA. They can
also be found at the respective FCA and PRA websites http://www.fca.org.uk/
and http://www.bankofengland.co.uk/pra/Pages/about/default.aspx
5
http://www.bankofengland.co.uk/publications/Documents/praapproach/insuranc
eappr1304.pdf (www.bankofengland.co.uk / PRA / supervision)
6
http://www.fca.org.uk/about/what/regulating/how-we-supervise-firms (from the
FCA home page go to about us / what we do/ regulating / how we supervise
firms)

The PRAs approach to resolvability is to satisfy itself that an insurer can

exit the market with minimal disruption to the supply of critical financial
services, including continuity for policyholders cover against insured
risks. The PRAs approach to resolvability takes into account the role of
the Financial Services Compensation Scheme (FSCS) to provide
compensation to policyholders for claims against insurers that are
declared to be in default, or seek to ensure continuity of cover.
To be more confident that all insurers are resolvable, it may be necessary to

strengthen the arrangements by which insurers leave the market. These methods
will be covered in Chapter 14.
use its powers to force insurers to take prescribed actions, where

necessary, to safeguard safety and soundness or policyholder protection.
Threshold conditions
In broad terms the PRAs Threshold Conditions are8 that insurers:

have appropriate financial resources
have appropriate resources to measure, monitor and manage risk
These can be thought of as non-financial resources.
be fit and proper, and appropriately staffed
conduct their business prudently

be capable of being supervised by the PRA.
The conditions also require that the insurers head office and management are in the
UK, if it is incorporated in the UK.
8
Full details of the Threshold Conditions can be found in Box 1 at page 12 of the
PRAs supervisory approach document.

2 The PRA Handbook

The PRAs requirements are contained in a single handbook of rules with
guidance which is available online on the PRA website9. Firms may use the
tailored handbook facility to identify the parts of the Handbook that apply to
them, eg general insurers, general insurance brokers and intermediaries.
Under the FSMA, the PRA is required to consult on changes to its rules (unless
delay would be prejudicial) and to issue feedback. Consultation Papers (CPs)
detail the proposed new requirements, including a commentary on the changes
and specific questions on areas where the PRA would like comments. The PRA
issues feedback statements on the responses received and details of additional
areas for consultation. Once the requirements are finalised they are issued as
Policy Statements (PSs) or Handbook Notices and revisions to Handbook text
are published in the form of legal instruments.
All the CPs and PSs can be found on the PRAs website. You might want to have a
quick read through some of the more important ones relating to general insurance
(particularly those mentioned in this chapter) but dont get too bogged down in the
detail. Rather, use them as an indication of the areas of interest that the PRA is
currently concerned with.
The current structure of the Handbook is eight blocks:

Glossary: The meaning of defined terms shown italicised in the Handbook
High level standards: Standards applying to all firms and approved
persons
Prudential standards: Includes the General Prudential Sourcebook
(GENPRU), the Insurance Prudential Sourcebook for insurers (INSPRU)
and the Interim Prudential Sourcebook for Insurers (IPRU-INS) in which
reporting requirements for insurers are contained
Business standards: Conduct of business
Regulatory processes: Supervision
Redress: Compensation
Specialist sourcebooks: Building societies and credit unions
Regulatory guides: Building societies.
9
http://fshandbook.info/FS/html/PRA or from www.bankofengland.co.uk click on
Prudential Regulation Authority and the PRA Handbook can be found under
External links

2.1 Prudential standards
Of the PRA Handbook blocks, prudential standards are the principal regulatory
requirements of interest to actuaries.
This block includes details of the Prudential Sourcebooks GENPRU and INSPRU.
These contain a number of standards that the PRA expects firms to meet.
Many of the areas addressed by the Sourcebooks look very similar to those that were in
the old legislation prior to introduction of the FSMA.
Prudential supervision is aimed at consumer protection, maintaining confidence

in the financial system and to protecting and enhancing it. The objective of
prudential regulation is to ensure that insurers can and will meet their liabilities
to policyholders as they fall due. This involves assessing the overall position of
a company rather than individual sales or transactions.
Many of the requirements relating to prudential regulation are based on EU

Directives, so that the standards of prudential regulation in the UK are subject to
the same minimum requirement as those in other EEA member states.
The structure of the Handbook sets out the prudential requirements common to all
regulated firms in a general prudential sourcebook with separate sourcebooks for
sector-specific matters. The General Prudential Sourcebook (GENPRU) is
applicable generally to banks, building societies, investment firms and insurers,
and includes some insurance-specific requirements. The Insurance Prudential
Sourcebook (INSPRU) is applicable just to insurers (including Lloyds). The
Interim Prudential Sourcebook for Insurers (IPRU-INS) contains primarily financial
reporting requirements, including financial reporting requirements in respect of
Lloyds.
Prudential requirements for insurers
GENPRU and INSPRU are structured as follows:
The General Prudential Sourcebook (GENPRU)

Application and general requirements (including adequacy of financial
resources and valuation)
Capital (ie capital requirements and capital resources available to meet
those requirements)
Cross-sector groups (ie firms that are members of financial
conglomerates)

The Insurance Prudential Sourcebook (INSPRU)

Capital resources and technical provisions for insurance business
Credit risk
Market risk
Liquidity risk management
Operational risk management
Group risk for insurance groups
Individual capital assessment
Lloyds of London
2.2 Financial adequacy requirements
The prudential rules specify the financial adequacy requirements applicable to

firms.
Individual capital assessments (ICA)
In addition to complying with prescribed financial requirements, insurers are

required to assess and manage the risks to which they are or might be exposed
and make their own assessment of their capital needs (referred to as an
individual capital assessment). The ICA is not reported through the Annual
Return but information is provided privately to the PRA on request.
INSPRU 7 includes rules and guidance on factors that firms should follow in
performing their ICA, including factors to consider when assessing the various
types of risk (eg credit risk, market risk, liquidity risk, operational risk) together
with guidance on taking account of the results of stress and scenario testing.
The PRA has introduced a number of sub-principles, and associated guidance,

to articulate minimum standards for firms in undertaking their ICAs. The
Association of British Insurers (ABI) has also published guidance on ICAs to
assist firms in their assessments.
The firms assessment of its capital needs and of its risks are subject to PRA
review and the PRA will issue Individual Capital Guidance (ICG) to firms setting
out the level of capital that it believes should be maintained. ICG takes into
consideration capital resources consistent with a 99.5% confidence level over a
one year timeframe that the value of assets will exceed the value of liabilities (or,
if appropriate, an equivalent lower confidence level over a longer timeframe).

The ICG will often be equal to the ICA, but it could be more if the PRA believes the
ICA is insufficient.
ICAs are a relatively recent but important development, using much actuarial resource.
Enhanced capital requirement (ECR)
In addition to the ICA process described above, there is another capital requirement
calculation. This has been in place for a relatively short period of time and arose from
perceived deficiencies in the pre-existing minimum capital requirements. The basic
idea behind the ECR is to encourage insurers to hold more capital.
The ECR goes some way towards a risk-based capital approach, and so could be
thought of as another of the interim steps between now and implementation of
Solvency II, which is discussed in Section 5.
Non-life insurers are required to carry out an Enhanced Capital Requirement

(ECR) calculation (as per INSPRU 1.1.72A to 1.1.79, and INSPRU 2.2) and to
report the results to the PRA. The ECR is a private reporting requirement. It is
used as the basis of discussions between firms and the PRA when considering
the basis for setting the level of individual capital guidance (ICG) that a firm
should hold, eg the ICG may be expressed as a percentage of ECR.
2.3 Lloyds
The PRA has full responsibility for the regulation of the Society of Lloyds, and
the Society has a risk management role.
The Society, managing agents, members agents and Lloyds advisers have to
comply with the general rules of PRA regulated firms, including those for
authorisation and approval.
The prudential requirements for Lloyds have been developed on the same lines
as for the companies market, wherever possible and are contained in GENPRU
and INSPRU where special sections set out the application to Lloyds. Reporting
requirements for Lloyds are contained in IPRU-INS and the PRA website.

Overview of Lloyds prudential requirements
The key requirements are:
The Society of Lloyds

To maintain appropriate controls over the funds that it holds and
manages centrally including managing risk within appropriate
limits.
To assess the capital needs for each member, taking into account
the capital needs of syndicates assessed by managing agents.
Managing agents
To maintain appropriate controls over syndicates including
managing risks such as credit risk and market risk within limits
that are substantially the same as those defined for companies.
To assess the capital needed to support each syndicate that they
manage, to help to ensure that financial resources are adequate at
all times.

3 Monitoring the solvency of insurers

How the PRA imposes solvency requirements on insurers was introduced in Section 1.
This section gives the details behind the calculations.
3.1 Financial resource requirements
PRA-regulated firms are required to maintain adequate financial resources. In

particular:
a firm must at all times maintain overall financial resources,

including capital resources and liquidity resources, which are
adequate, both as to amount and quality, to ensure that there is no
significant risk that its liabilities cannot be met as they fall due.
(GENPRU 1.2.26R) (the overall financial adequacy rule).
The PRA requires firms to assess the adequacy of their financial resources for
themselves and to be able to demonstrate to the regulator that they hold enough
capital. The overall Pillar 2 rule (GENPRU 1.2.30R) sets out the requirement for
firms to have in place sound, effective and complete processes, strategies and
systems to identify and manage the major sources of risk and to assess and
maintain on an ongoing basis the amounts, types and distribution of financial
resources that it considers adequate to cover:
the risk in the overall financial adequacy rule
the nature and the level of the risks to which it is, or might be, exposed;
and
the risk that a firm might not be able to meet its capital resource
requirement (CRR).
GENPRU and INSPRU contain rules and guidance on the application of the
overall Pillar 2 rule, including rules in respect of stress and scenario tests
(general stress testing rule GENPRU 1.2.42R) and principles and guidance
specific to insurers on Individual Capital Assessments.
In addition, general insurers must comply with capital resource requirements

(CRR) based on EU Directives. It is these Pillar 1 solvency requirements that are
reported in the Annual Return, rather than the Pillar 2 assessments of capital
adequacy referred to above.
The Annual Return is discussed in Section 4.

The PRA refers to admissible assets less liabilities (subject to certain

adjustments) as capital resources.
Notice that the glossary defines free reserves to be the excess of assets over technical
reserves and current liabilities, although some practitioners take it to mean the excess of
assets (either admissible or otherwise) over the liabilities including the capital resource
requirement.
Whichever terminology you use in the exam, be sure to define what you mean by it.
3.2 Capital resources requirement (CRR)
Insurers are required to maintain capital resources equal to or in excess of their CRR, at
all times.
The CRR for general insurers is equal to the minimum capital requirement (MCR)
required by the Non-Life Directives (also known as the Required Minimum
Margin (RMM)).
The next section describes how the MCR is calculated. The MCR also used to be
known as the Statutory Minimum Solvency Margin (SMSM). You will come across all
these terms in this course, in past papers, and throughout the general insurance industry.
The calculations are expressed in terms of euro, but for the purposes of calculating the
minimum solvency requirements the exchange rate to be used is laid down in
legislation. This is to avoid having to continually allow for changing currency
exchange rates. If you are looking through very old exam papers, you may see
questions referring to the old basis of calculation, which used ecus. The method was
essentially the same, although the numerical figures were slightly different.
The solvency rules in GENPRU (in particular GENPRU 2.1.17 and 2.1.34, and
INSPRU 1.1.44 to 1.1.52) apply to all except a limited number of insurers.
For composite insurers (other than pure reinsurers) the rules apply separately in
respect of both its long-term (life) insurance business and its general insurance
business. Therefore, a firm carrying on both general insurance business and
long-term insurance business will need to allocate its capital resources between
its general insurance business and long-term insurance business so that the
capital resources allocated to its general insurance business are equal to or in
excess of its CRR for its general insurance business and the capital resources
allocated to its long-term insurance business are equal to or in excess of its CRR
for its long-term insurance business.

Whereas long-term insurance assets cannot be used towards meeting a firm's

CRR for its general insurance business, surplus general insurance assets may
be used towards meeting the CRR for its long-term insurance business. INSPRU
sets out the detailed requirements for the separation of long-term and general
insurance business.
3.3 Minimum capital requirement (MCR)
The MCR for insurers reflects the requirements of the Solvency I EU directives.
The MCR calculation requirements are also set out in the PRA Handbook in
GENPRU 2.1.34 and INSPRU 1.1.44.
The MCR (or Required Minimum Margin) is the greater of:
the General Insurance Capital Requirement (GICR)

(which is the greatest of:
the Premiums amount
the Claims amount and
the Brought forward amount)
and
the Base Capital Resources Requirement (BCRR), ie Minimum Guarantee
Fund (MGF).
The premiums amount is equal to between 16% and 18% of gross premiums, adjusted
for the effect of reinsurance.
The claims amount is equal to between 23% and 26% of average gross claims (usually
over the last three years), adjusted for the effect of reinsurance.
The brought forward amount is the same as the GICR that applied during the prior
financial year, except where claims outstanding have fallen during that financial year.
If they have fallen, the brought forward amount is itself reduced by the same percentage
fall.
3.4 Base Capital Resources Requirement (BCRR)
The base capital resources requirement (referred to in EU directives as the

Minimum Guarantee Fund (MGF)) is an absolute amount set at an EU level
dependent on classes of business underwritten. The amounts are subject to an
automatic indexation procedure in line with consumer price inflation.

3.5 Capital resources
Capital resources are divided into tiers, reflecting the differences in the extent to
which the capital instruments concerned meet the purpose and conform to the
loss absorbency and permanence characteristics of capital. Higher quality
capital is known as tier one capital and capital instruments falling into core tier
one capital can be included in a firms regulatory capital without limit.
Tier one capital (eg most equities) includes assets that:

are able to absorb losses
are permanent
rank for repayment upon winding up after all other debts and liabilities
have no fixed costs.
Other forms of capital are either subject to limits or, in the case of some
specialist types of capital items, may only be included in capital resources with
the express consent of the PRA by waiver.
Tier two capital (eg most subordinated debt) does not meet the requirements above and
is therefore restricted when considering regulatory capital available.
The calculation of capital resources for an insurer is set out in the PRA
Handbook in GENPRU Annex 1.
3.6 Valuation
The valuation rules (GENPRU 1.3) set out how a firm should recognise and value
assets, liabilities, equity and income statement items. In general, where no
specific valuation rules are set out in GENPRU or INSPRU, recognition and
valuation of assets and liabilities should be in accordance with whichever of the
items listed in GENPRU 1.3.4 are appropriate.
The list includes:

1985 Companies Act Sch9A
2006 Companies Act
Schedule 3 to the Large and Medium-sized Companies and Groups
(Accounts and Reports) Regulations 2008 (SI 2008/410)
International Accounting Standards within the meaning of EC Regulation
No. 1606/2002, and
standards and practice issued by the Accounting Standards Board.
Only certain assets may be included in capital resources.

Admissibility rules only allow certain assets, or certain amounts of assets, to count for
the purposes of demonstrating statutory solvency. Other assets may be held, but they
cannot be included in the asset valuation for statutory purposes. The result of this is that
insurers will tend to:
invest in good quality assets
spread investments across a wide range of assets.
3.7 Discounting
For published solvency purposes, any discounting of claims provisions by direct

insurers is added back when compiling the PRA returns. This also applies to pure
reinsurers from the end of 2006 unless they were in run off at that date. Hence solvency
is assessed on undiscounted claims provisions. However, there are exceptions:
General insurers can only discount outstanding claims for the purpose of
calculating capital resources in respect of Class 1 (Accident) or Class 2
(Sickness) or to reflect the discounting of annuities, even if discounting is more
widely used in their financial statements. In the case of classes 1 or 2 the
average time from the accounting date to settlement date must be four years or
more. There are restrictions on the discount rate used (see INSPRU 1.1.14).
Pure reinsurers that have been in run-off since before 31 December 2006,
however, can discount more widely.

4 The Regulatory Insurance Return

All general insurers have to submit annual returns to the PRA. This is how statutory
solvency calculations, which we covered in Section 3, are publicised.
All insurers (with some limited exceptions) must prepare annually a revenue
account, balance sheet and profit and loss account in the format prescribed by
IPRU-INS.
The Return comprises a large number of forms, containing very detailed financial
information about the insurer. This information is available to the public since
any person has a right to request a copy from the insurer. This availability
means that competitors, journalists, brokers and many others have access to an
insurers detailed financial information.
However, the amount of detail contained in the Return is far short of that needed to
make any real in-depth analysis of a companys profitability. It is more useful as an
indication of a companys ability to meet statutory solvency levels, and hence is most
useful to establish the level of protection available to policyholders.
The PRA uses the Insurance Annual Return prepared by insurance companies as
a key source of information to monitor the financial resources of an insurer and,
for general insurance business, to assess retrospectively the adequacy of the
insurer's claims provisions. The PRA's primary concern in relation to the Return
is the solvency of an insurer, ie with its ability to meet future claims payments to
policyholders.
The Insurance Annual Return consists of six main sections, each consisting of a series
of forms and other information. The main forms that a general insurer must complete
are:
balance sheet and profit and loss account
revenue account and additional information
additional information on business ceded
directors certificate and auditors report
further statements on such items as major reinsurers, major cedants, derivatives,
controllers, financial reinsurance and financing arrangements.

5 Solvency II
This section focuses on the Solvency II requirements for non-life insurance and
reinsurance undertakings. There are separate (but broadly equivalent)
requirements for life and health insurance business.
All information included in this chapter is current as at the time of writing (April
2013). However, since Solvency II remains under development during 2013, it is
likely that some of the details will have been amended or replaced by the time of
the examination. In particular, it is likely that some of the details included in this
chapter will be amended or replaced following the publication of level 2
implementing measures and level 3 guidelines, probably during the late 2013 or
early 2014.
Although the examination questions will be based on the details as included in

this chapter, students are encouraged to be aware of and monitor the ongoing
developments, and answers that reflect such developments will be given
equivalent credit.
5.1 Background to development of Solvency II
Current UK regulation is based on the EU Solvency I Directives. Although the

latest of those Directives was implemented in 2002, the overall EU solvency
approach has its origins in the 1970s and has consequently become outdated,
with financial markets having developed substantially in recent years.
For example, Solvency I only requires explicit solvency capital to be held against
insurance risks. There is no specific requirement to hold capital against market,
credit or operational risks.
In the UK, as described earlier in this chapter, further regulations have been
developed that seek to address these shortcomings. Some other EU Member
States have introduced their own additional rules at national level, leading to
there being a wide range of different regulatory requirements across the EU.
This effectively undermines the single market and could hinder insurance
groups.
It therefore became clear to the European Commission that a more fundamental

review of the regulation of insurance companies was required and this project
became Solvency II.
Key objectives were to increase the level of harmonisation of solvency

regulation across Europe, to introduce capital requirements that are more
sensitive to the levels of risk being undertaken, and to provide appropriate
incentives for good risk management.

5.2 Introduction to Solvency II
Solvency II will reform the solvency requirements for life and non-life insurance
undertakings, thus improving policyholder security. Solvency II will supersede
the current Insurance Directives and the Reinsurance Directive.
There have been significant delays to the implementation of Solvency II, which
are described in more detail later in this section. At the time of preparation of
this material, it appears that some elements of Solvency II will be implemented
with effect from 1 January 2014 with the remaining elements being implemented
at a later date, possibly 1 January 2016. These dates have not yet been finally
agreed; the Prudential Regulation Authority (PRA) website will provide the latest
information on timing.
Solvency II is a risk-based approach to prudential requirements which will bring

harmonisation at EEA level.
The Solvency II Directive will apply to all insurance and reinsurance companies
with gross premium income exceeding 5 million or gross technical provisions
in excess of 25 million; member states have the option to impose lower limits.
Lamfalussy process
The new Solvency II framework has been created in accordance with the
Lamfalussy four-level process:
Level 1: developing an EU legislative instrument that sets out the key

framework principles, including implementation powers (completed in
2009)
At Level 1, the European Commission proposes framework legislation to be

voted on by the European Council and the European Parliament.
Level 2: developing more detailed implementing measures
At Level 2, the legislation is supplemented by more detailed implementation

measures, prepared by the Commission on the basis of advice provided by
representatives of national supervisory authorities.
Level 3: developing supervisory guidance and common standards, and

conducting peer reviews and consistency comparisons
At Level 3, national supervisory authorities work together to provide advice to

the Commission. This stage also aims to foster supervisory convergence.

Level 4: enforcement across the Member States.
Finally, at Level 4, the Commission ensures that Member States comply with
applicable legislation, pursuing enforcement action where required.
The Lamfalussy process has also been used to implement regulatory changes in the
banking industry.
Development of the quantitative requirements has been supported through a

number of Quantitative Impact Studies (QIS) that insurance companies have
been asked to complete, and through liaison with national supervisory bodies.
A Quantitative Impact Study (QIS) is a field test of how a particular set of rules will
impact a firm or industry.
For Solvency II, QISs have taken place at the end of each of year since 2004 except for
2008. Each QIS exercise has been more comprehensive than the last, both in terms of
the number of participants taking part, and the scope tested.
EIOPA (the European Insurance and Occupational Pensions Authority, one of the
EUs three main financial supervisory bodies and which was previously known
as CEIOPS) has provided technical advice and support to the European
Commission for the development of the implementing measures under Level 2,
and is responsible for producing the Level 3 additional guidance.
EIOPA has published a technical specification dated 18 October 2012 as a

working document for the Solvency II valuation and Solvency Capital
Requirements calculations.
This document is over 300 pages long. You can find it at:
http://tinyurl.com/cdsm6lf.
Revisions to this document can be expected.
Students may like to refer to recent changes to the Lamfalussy regime as a result
of the de Larosiere report.

SA3-04: Legislation Page 20a
These changes result from the establishment of three European Supervisory Authorities
(ESAs) to oversee the regulation of financial services across Europe (from January
2011). The ESAs are:
the European Securities and Markets Agency (ESMA)
the European Banking Agency (EBA)
the European Insurance and Occupational Pensions Authority (EIOPA).
These replace the Level 3 Committees:

Committee of European Banking Supervisors (CEBS)
Committee of European Securities Regulators (CESR)
Committee of European Insurance and Occupational Pensions Supervsiors
(CEIOPS).
In terms of the Lamfalussy process, national supervisory authorities will now act
through the new ESAs rather than Level 3 Committees as before. In contrast to the
Level 3 Committees, the ESAs have internal resources of their own. They have an
enhanced role at the third level of the process involving, amongst other things, creating
draft technical standards (to be adopted by the Commission as EU Law) and taking
decisions binding on national supervisors and, to a lesser extent, firms.
The legislative process continues to be split into different levels, and legislation
continues to be divided between high-level framework provisions and implementing
measures. Open consultation procedures and transparency are also central to the new
approach.
The de Larosiere report can be found at:
http://ec.europa.eu/internal_market/finances/docs/de_larosiere_report_en.pdf
5.3 Advantages of Solvency II over Solvency I
Solvency I solvency regulation focuses primarily on underwriting risk whereas

Solvency II has an integrated and holistic approach to risk.
The overall aims of the Solvency II project are to:

protect policyholders and beneficiaries
set solvency standards to match risk and encourage proper risk control
and be in line with IAIS requirements
The IAIS is discussed in Subject ST7.

Page 20b SA3-04: Legislation
harmonise standards across the EU to avoid the need for Member States
to set higher standards (to improve the international competitiveness of
insurance)
bring valuation of assets and liabilities onto a fair value basis, if
possible consistent with IASB (International Accounting Standards Board)
valuation
set a higher capital requirement than currently applicable to permit timely
intervention by the supervisor
have regard to Basel II for banks, with the same 3 Pillar approach
although the definitions of the three Pillars are not identical
not be too onerous to operate for smaller companies.

The MCR factors, based on the EIOPA specification dated 18 October 2012, are
set out in the following table for each line of business.
Line of business MCR factor premium MCR factor reserve

risk (%) risk (%)
Motor vehicle liability 9.4 8.5

Motor other 7.5 7.5
Marine aviation and transport 14.0 10.3
Fire and other damage 7.5 9.4
Third party liability 13.1 10.3
Credit and suretyship 11.3 17.7
Legal expenses 6.6 11.3
Assistance 8.5 18.6
Miscellaneous financial loss 12.2 18.6
NPL property 15.9 18.6
NPL casualty 15.9 18.6
NPL marine aviation and casualty 15.9 18.6
Notes: The above factors apply to direct, facultative reinsurance and

proportional reinsurance business, with the exception of the non-proportional
reinsurance (NPL) lines of business.
The resulting MCRs are summed across lines of business to obtain the overall
MCR. The MCR must lie between 25% and 45% of the SCR.
Solvency Capital Requirement (SCR)
The Solvency Capital Requirement is calculated by combining a number of

separate risk charges, allowing for diversification credits by means of correlation
matrices or other methodologies.
The SCR is calibrated to the Value-at-Risk of the basic own funds of an

insurance or reinsurance undertaking subject to a confidence level of
approximately 99.5% over a one-year time horizon.
The SCR for each individual risk is then determined as the difference between
the net asset value (for practical purposes this can be taken as assets less best
estimate liabilities) in the unstressed balance sheet and the net asset value in the
stressed balance sheet. These individual risk capital amounts are then
combined across the risks within the module, using a specified correlation
matrix and matrix multiplication.
Solvency II provides a range of methods to calculate the SCR which allows

undertakings to choose a method that is proportionate to the nature, scale and
complexity of the risks of the undertaking.

The SCR may be calculated using:

a standard formula with simplifications
a standard formula
a standard formula with undertaking-specific parameters. If the standard
formula is used, non-life underwriting risk factors may, subject to prior
supervisory approval, be replaced with undertaking-specific parameters
("USPs") which are calculating using an undertaking's own claims
experience
the combination of the standard formula for some risk factors and a
partial internal model for the remaining risk factors
a full internal model. The use of an insurer's (full or partial) internal model
is subject to prior supervisory approval.
This approval process is called IMAP and is covered in Section 5.7.

Structure of standard formula risk charges
The proposed structure of the SCR risk charges in the standard formula is
shown in the following diagram.
SCR
Adj BSCR Operational
Non-Life Market Health Default Life Intangible
Premium Currency SLT Non SLT Lapse Mortality

Reserve
Spread Mortality Premium

Reserve Expenses Longevity
Lapse
Interest rate Longevity Lapse Disability CAT

CAT
Property Expenses Revision
CAT
Equity Disability
Included in the adjustment for the loss absorbing capacity of

Concentration Revision TP under the modular approach
Counter-cyclical premium 3
SCR standard formula
The SCR, based on the standard formula, comprises the following risk charges:
Operational risk
An adjustment, which may include, for example, the loss absorbing
capacity of deferred taxes. This could comprise a reduction in any base
balance sheet deferred tax liability, as this would no longer be fully
payable in a stressed scenario.
The loss absorbing capacity of deferred taxes refers to the fact that deferred
tax liabilities would decrease (or deferred tax assets increase) in the event of a
shock.

Market risk (comprising interest rate risk, equity risk, property risk, spread
risk, currency risk, concentration risk and counter-cyclical premium risk)
Non-life underwriting risk (comprising premium and reserve risk,
catastrophe risk and lapse risk)
Life underwriting risk (comprising mortality risk, longevity risk,
disability/morbidity risk, expenses risk, revision risk, catastrophe risk and
lapse risk)
Health risk (comprising SLT health risk, non-SLT health risk and
catastrophe risk)
SLT stands for similar to life techniques.
Counterparty default risk

Intangible asset risk.
The various risk charges are combined together using the following formulae
and correlation coefficients:
SCR = BSCR + Adj + SCRop.
In the formula above, SCRop denotes the operational risk charge (from the first bullet
point) and Adj denotes the adjustment referred to in the second bullet point.
The basic SCR (BSCR) is calculated using the following formula:
BSCR = Corri , j SCRi SCR j + SCRIntangible

i, j
where SCRintangible denotes the intangible asset risk and the correlation coefficients
Corri,j are taken from the following coefficient matrix:
Market Default Life Health Non Life

Market 1
Default 0.25 1
Life 0.25 0.25 1
Health 0.25 0.25 0.25 1
Non Life 0.25 0.5 0 0 1

The ones on the diagonal simply convey the fact that each risk type is fully correlated
with itself. From the table, we can see that non-life underwriting risk is assumed to be
entirely uncorrelated with both life underwriting risk and health risk, as indicated by the
zeros in the bottom row.
The other figures in the table indicate partial correlations. For example, the entry in the
second row of the first column indicates a correlation coefficient of 0.25 between
counterparty default risk and market risk.
Note that there is no allowance for any diversification benefit between operational risk
and any of the other risks. Therefore all the correlation factors involving operational
risk are assumed to be 1 and are omitted from the table.
Key values of factors in the SCR standard formula
The following key values of factors in the SCR standard formula are based
(except where stated to the contrary) on the EIOPA specification dated 18
October 2012, and are subject to potential future change. The following
description is simplified in some respects.
Operational risk
Operational risk is the risk of losses occurring due to inadequate or failed internal
processes, people and systems, or due to external events.
The operational risk charge is equal to the greater of 3% of gross earned

premiums during the previous 12 months and 3% of gross technical provisions,
with the result being subjected to a maximum of 30% of the basic SCR. It is
assumed that there is no diversification credit between operational risk and
other components of risk.
Non-life underwriting risk
The standard deviations used to calculate the premium and reserve risk factors
in the standard formula are set out in the following table. The standard formula
calculates 99.5% VaR factors from these standard deviations by multiplying the
standard deviations by three.

Line of business Standard deviation Standard deviation

premium risk reserve risk (%)
(%)
Motor vehicle liability 10.0 9.0
Motor other 8.0 8.0
Marine aviation and transport 15.0 11.0
Fire and other damage 8.0 10.0
Third party liability 14.0 11.0
Credit and suretyship 12.0 19.0
Legal expenses 7.0 12.0
Assistance 9.0 20.0
Miscellaneous 13.0 20.0
NPL property 17.0 20.0
NPL casualty 17.0 20.0
NPL marine aviation and casualty 17.0 20.0
Notes: The above factors apply to direct and proportional reinsurance business
with the exception of the lines of business labelled NPL, which relate to non-
proportional reinsurance business.
The 99.5% VaR factors in respect of premium risk are applied to the maximum of:
the estimate of net earned premium for each line of business during the
forthcoming year
net earned premiums for each line of business during the previous year.
The premium risk factors have been derived from claims development data
which is gross of reinsurance. For this reason, undertakings are permitted to
multiply the premium risk factors for each line of business by the following
factors, which are intended to represent the excess-of-loss reinsurance which is
in place for each line of business:
80% for motor vehicle liability, fire and other damage, and third party
liability business
100% for all other lines of business.
The 99.5% VaR factors in respect of reserve risk are applied to the best estimate
for claims outstanding for each line of business, after deducting the amount
recoverable from reinsurance and special purpose vehicles.
There is scope, using a specified formula, for the premium risk and reserve risk
factors to be reduced by up to 25% to allow for geographical diversification.

Allowance is also made for:

a correlation coefficient of 0.5 between premium risk and reserve risk
factors
diversification by line of business.
Non-life catastrophe risk
The non-life catastrophe risk charge is determined using a complex series of

formulae, and comprises:
a natural catastrophe risk sub-module, sub-divided between windstorm,
earthquake, flood, hail and subsidence risk
a sub-module for catastrophe risk of non-proportional property
reinsurance
a man-made catastrophe risk sub-module, sub-divided between motor,
fire, marine, aviation, liability and credit & suretyship
a sub-module for other non-life catastrophe risk.
Market risk
Market risk relates to risks arising from changes in investment market values, or other
quantities correlated with investment markets, eg interest rates.
The equity risk charge is equal to 39% of the market value of equities for Type 1
equities (equities listed in regulated markets in countries which are members of
the EEA or the OECD) and 49% for Type 2 equities. A symmetrical adjustment
has been introduced to avoid pro-cyclical effects in other words, in general
terms the equity stress will be smaller following a decline in equity markets and
will be higher following a period of strong performance of equity markets. For
the EIOPA specification dated 18 October 2012, this resulted in an adjustment of
-7%, reducing the Type 1 equity and Type 2 equity stresses from 39% and 49% to
32% and 42% respectively.
The interest rate risk charge is determined by stressing the yield curve by
specified percentages, varying by the term to maturity. This will affect both the
value of certain classes of assets (for example fixed coupon bonds) and the
value of liabilities (which are discounted to allow for the time value of money).
The property risk charge is equal to 25% of the market value of properties.
The currency risk charge is calculated by assuming a 25% change in currency

exchange rates in respect of net currency exposures.

The spread risk charge is determined through the use of a formula. For
corporate bonds, the loss on the assets is given by a function of the duration of
the assets and the credit rating of the underlying bonds, with lower requirements
for public sector and mortgage-covered bonds.
The concentration risk charge applies to holdings in excess of a specified

threshold, and is based on exposure, rating and total assets held.
Counterparty default risk
The calculation of the counterparty default risk charge differentiates between:

Type 1 exposures which consist of a small number of counterparties
which are usually rated (for example reinsurers or derivative
counterparties). The risk charges for type 1 exposures are based on a
loss distribution derived from loss given defaults and default probabilities
Type 2 exposures where there is likely to be a diversified mix of
counterparties which are not rated. The risk charges for type 2 exposures
are based on an immediate shock, assuming losses of 90% of receivables
which have been due for more than three months and 15% on other
receivables.
5.7 Internal model approval
In Section 5.4, we said that there was an option to use an internal model.
If the SCR is calculated using a (full or partial) internal model, the company must
obtain prior supervisory approval.
In the UK, companies wishing to obtain internal model approval on day 1 of

Solvency II have entered the PRA's Internal Model Approval Process ("IMAP").
The use of an internal model might be appropriate if the risk profile of the
business differs materially from that underlying the standard formula, and/or if
the company already uses such a model for risk management or other decision-
making purposes (eg pricing, investment strategy). The supervisor can require
an insurance company to develop an internal model if it considers that the
standard formula is not appropriate to the risk profile of the company.
Under some circumstances, the use of an internal model can potentially lead to
less onerous overall capital requirements than if the standard formula was used.

5.11 Application of Solvency II to insurance groups
The intention is that Solvency II will enable insurance groups to be supervised

more efficiently through a group supervisor in the home country, co-operating
with other relevant national supervisors. This ensures that group-wide risks are
not overlooked and should enable groups to operate more effectively, whilst
continuing to provide policyholder protection.
Each insurance group must cover its overall group SCR (which will allow for
diversification benefits across the group, and is subject to a minimum of the sum
of the MCRs of each subsidiary) and each insurance subsidiary needs to cover
its own SCR.
Group supervision would normally be carried out at the top level company within
the European Economic Area (EEA). Additional rules apply to subsidiaries and
parents located in a third country, ie non-EEA. These broadly impose
Solvency II requirements or, in the case of a non-EEA parent, the establishment
of an EU holding company.
If the third country regulatory regime is considered to be broadly compliant with

Solvency II, then it is said to have third country equivalence and the group can
be regulated as if located in the EEA, replacing Solvency II rules with those of
the third country regulatory regime where appropriate.
Transitional arrangements are available to those non-EEA countries interested in

pursuing the third country equivalence route, which are likely to include
Bermuda, Switzerland and Japan.
5.12 Impact on business culture and strategy
It is important to obtain buy-in to Solvency II across the business, from Board

level down. This is the case for all insurance companies and not just those
opting to use an internal model although as noted above, being able to
demonstrate full integration of Solvency II into the business is a key part of the
internal model approval process.
Solvency II is not just a reporting framework, but a risk management framework

with implications for capital allocation, risk mitigation activities and performance
management.
The Solvency II regime may also have an impact on the optimal product mix for
the company, and on product design.
It is also likely to impact the optimal asset mix for the company, since some
asset classes may become relatively more or less attractive as a result of their
lower or higher capital requirements.

The availability, or otherwise, of risk diversification benefits may also affect

corporate structures and generate merger and acquisition activity.
Management information is also likely to change to align the new metrics with
the business and strategic decision-making process.
External disclosures will change, and in general are likely to increase, so the
impact on the market also needs to be considered.
5.13 Recent developments and current issues
Recent developments and current issues as at April 2013 are as follows.
There have been significant delays in the implementation of Solvency II due to

the need to resolve disagreements in respect of a number of issues including the
counter-cyclical premium, matching adjustment and transitional measures from
Solvency I to Solvency II.
Recall that the counter-cyclical premium is one of the components of market risk in the
standard formula SCR calculation.
At the time of preparation of this material, it appears that some elements of

Solvency II will be implemented with effect from 1 January 2014 with the
remaining elements being implemented at a later date, possibly 1 January 2016.
These dates have not yet been finally agreed; the Prudential Regulation
Authority (PRA) website will provide the latest information on timing.
EIOPA is currently undertaking a Long Term Guarantees impact assessment

which is designed to address some of the principal areas of disagreement. The
results of this impact assessment are likely to be available in the summer of
2013.
The vote of the European Parliament on the Final Version of the Omnibus II
Directive, which has been substantially delayed, has now been rescheduled to
October 2013. The plenary vote will lead to a final version of Omnibus II,
enabling EIOPA to issue level 2 implementing measures and draft level 3
guidelines, probably in late 2013 or early 2014.
The level 2 and level 3 materials are not currently in the public domain and
cannot therefore be discussed in these tuition notes.
The significant delay in the publication of level 2 and level 3 material is causing
difficulties for companies in their preparations for Solvency II implementation.

EIOPA has published a technical specification dated 18 October 2012 as a

working document for the Solvency II valuation and Solvency Capital
Requirements calculations.
As noted in Section 5.2, you can find this document at:
http://tinyurl.com/cdsm6lf.
EIOPA published draft interim measures on their website on 27 March 2013 for
consultation in respect of:
systems of governance (including the actuarial function)
a forward looking assessment of the undertakings own risks (based on
ORSA principles)
submission of information to National Competent Authorities (NCAs
these are the national regulators)
pre-application for internal models.
In March 2013, EIOPA launched a public consultation on guidelines covering the four
areas above. The purpose of these guidelines is to support national supervisors and
undertakings in their preparations for the Solvency II requirements.


5.14 Further reading
Students may find the following links to be useful sources of further information:
Solvency II Directive
http://register.consilium.europa.eu/pdf/en/09/st03/st03643-re01.en09.pdf
EIOPA draft interim measures
https://eiopa.europa.eu/consultations/consultation-papers/index.html
Groupe Consultatif Solvency II
http://www.gcactuaries.org/solvency.html
Prudential Regulation Authority Solvency II
http://www.bankofengland.co.uk/pra/Pages/solvency2/default.aspx
Insurance Europe Solvency II
http://www.insuranceeurope.eu/key-issues/solvency-ii
Lloyds of London Solvency II
http://www.lloyds.com/The-Market/Operating-at-Lloyds/Solvency-II

6 Glossary items
Having studied this chapter you should now read the following Glossary items:
Base Capital Resources Requirement (BCRR)

Financial Services Compensation Scheme (FSCS)
General Insurance Capital Requirement (GICR)
Guarantee Fund
Minimum Capital Requirement (MCR)
Motor Insurers Bureau (MIB)
Required Solvency Margin.

Chapter 4 Summary
The Financial Conduct Authority (FCA) is responsible for ensuring that financial
markets function well and that consumers are protected.
The Prudential Regulation Authority (PRA) is responsible for regulation and

supervision of financial firms including general insurers and Lloyds. Its requirements
are detailed in the PRA Handbook, which contains:
Glossary
High Level Standards, which apply to all firms and approved persons
Prudential Standards, to include Prudential sourcebooks
Business Standards, including conduct of business
Regulatory processes, including supervision
Redress, including compensation schemes
Specialist sourcebooks, including building societies and credit unions
Regulatory guides.
GENPRU, INSPRU and IPRU-INS contain the relevant requirements for general
insurers.
Under the requirements of the Solvency I EU Directives, at each year-end insurers must
demonstrate that their assets exceed their liabilities by more than a minimum margin.
This is shown in the Annual Return.
The GICR is the higher of three amounts:

the premiums amount
the claims amount
brought forward amount.
The above calculations are reduced by the ratio of net to gross claims incurred over the
last three years, up to a maximum reduction of 50%.
The MCR is the higher of the GICR and the MGF (BCRR).
Insurers are also required to assess and manage the risks to which they might be
exposed and assess their own capital needs via an ICA assessment, which is
supplemented by ICG. There is an additional soft test of solvency called the ECR.

Prospective Solvency II regulations
The new Solvency II regime:

will reform the solvency margin requirements, thus improving policyholder
security
is a risk-based approach to prudential requirements which will bring
harmonisation at EEA level
has been created in accordance with the Lamfalussy four-level process
will supersede the current Insurance Directives and the Reinsurance Directive
will apply to all insurance and reinsurance companies with gross premium
income exceeding 5m or gross technical provisions in excess of 25m.
The overall aims of the Solvency II project are to:

protect policyholders and beneficiaries
overcome the perceived inadequacies of Solvency I
set solvency standards to match risk and encourage proper risk control
harmonise standards across the EU to avoid the need for Member States to set
higher standards (to improve the international competitiveness of insurance)
bring valuation of assets and liabilities onto a fair value basis, if possible
consistent with IASB valuation
set a higher capital requirement than currently applicable to permit timely
intervention by the supervisor
have regard to Basel II for banks, with the same 3 Pillar approach although
the definitions of the three Pillars are not identical
not be too onerous to operate for smaller companies.
Solvency II is based on three pillars:

Pillar 1: quantitative requirements including risk-based capital requirements (the
Solvency Capital Requirement (SCR) and Minimum Capital Requirement
(MCR))
Pillar 2: qualitative requirements focusing on governance, risk management and
required functions and including the supervisory review process.
Pillar 3: reporting and disclosure requirements including a public Solvency and
Financial Condition Report (SFCR) and a private Regulatory Supervisory Report
(RSR).

In the Solvency II balance sheet:

Assets should be valued at the amount for which they could be exchanged
between knowledgeable willing parties in an arm's length transaction.
Technical provisions should represent the amount that the insurance company
would have to pay in order to transfer its obligations immediately to another
insurance company. They comprise premium provisions and claims provisions
and are equal to the sum of a best estimate and a risk margin.
The assets in excess of technical provisions and subordinated liabilities are
called the own funds. These are split into basic and ancillary own funds,
which are then tiered based on specific criteria.
MCR and SCR
Note that the MCR under Pillar 1 of Solvency II is not the same as the MCR under
current regulations.
The MCR is calculated using a factor-based approach for each line of business and is
intended to be calibrated to a VaR confidence level of 85% over a one-year time
horizon. Additionally, the MCR must lie between 25% and 45% of the SCR.
The SCR is calculated by combining a number of separate risk charges and allowing for
diversification credits. It is calibrated at a confidence level of 99.5% over a one-year
time horizon.
The SCR may be calculated using:

a standard formula with simplifications
a standard formula
a standard formula with undertaking-specific parameters (USPs)
a combination of the standard formula for some risk factors and a partial internal
model for the remaining risk factors
a full internal model.

The SCR based on the standard formula comprises the following risk charges:
operational risk
an adjustment, eg for the loss absorbing capacity of deferred taxes
market risk
non-life underwriting risk
life underwriting risk
health risk
counterparty default risk
intangible asset risk.
If the SCR is calculated using a (full or partial) internal model, the company must
obtain prior supervisory approval. To do so, it must pass the following tests:
use test
statistical quality standards
calibration standards
profit and loss attribution
validation standards
documentation standards.
Under Pillar 2, companies need to have in place an effective system of governance.

They should have written policies in respect of each of the following functions:
risk management
internal control
internal audit
actuarial function
outsourcing (if applicable).
Each insurer will also be required to carry out an Own Risk and Solvency Assessment
(ORSA) in which it will identify all the risks to which it is subject and the related risk
management processes and controls.

Under Pillar 3, each of the SFCR and RSR documents should include at least sufficient
information to assess:
the system of governance applied by the undertakings
the business they are pursuing
the valuation principles applied for solvency purposes
the risks faced
the risk management systems
capital structure, needs and management.

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SA3-05: Professional guidance Page 1
Chapter 5
Professional guidance
Syllabus objective
(e) Describe the requirements of the professional guidance relevant to actuaries

practising in or advising United Kingdom general insurance companies and
Lloyds syndicates.
0 Introduction
When carrying out work for a UK general insurance company all members must
comply with all relevant requirements under the Financial Services and Markets
Act (FSMA) together with any professional standards or guidance relevant to the
work being done and the professional body to which they belong.
Standards required of members of the Institute and Faculty of Actuaries (IFoA)

are detailed in the Actuaries Code, the Technical Actuarial Standards and the
Actuarial Profession Standards.
The Actuaries Code and the Actuarial Standards are relatively new.
Following the Morris Review of the actuarial profession in 2005, HM Treasury asked
the Financial Reporting Council (FRC) to take on responsibility for oversight of the UK
actuarial profession and the independent setting of actuarial technical standards. The
FRC is a UK independent regulator responsible for promoting confidence in corporate
reporting and governance. It also acts for the accounting profession as well as the
actuarial profession.
Professional standards that are deemed to be technical in nature are produced

and maintained by an independent body, the Financial Reporting Council (FRC).
These principles-based Technical Actuarial Standards (TASs) are mandatory for
all members of the IFoA when undertaking work that is within the scope of that
TAS (broadly speaking, UK business).

Page 2 SA3-05: Professional guidance
The IFoA will continue to set ethical standards via the Actuarial Profession Standards
(APSs). The Standards Approval Process sets out the process to be followed in order
that APSs and IANs (covered below) can be published and binding on members of the
IFoA. This process is overseen by the Standards Review Committee.
The IFoA retains the responsibility for regulation of members and in particular
requires members, to whom the Standards apply, to observe them.
The TASs of relevance to SA3 are:

TAS D Data
TAS R Reporting
TAS M Modelling
Insurance TAS
Transformations TAS.
These are described in Section 1 below.
You might want to consult the FRC website at www.frc.org.uk for further information
on these.
The Actuary magazine is an additional source of articles, if you wish to keep up-to-date
with the latest developments.
The Professional Standards Directory on the IFoAs website enables members to

access the current FRC Standards and the current version of the Standards
issued by the IFoA, ie the Actuaries Code (see Section 2 below) and the
Actuarial Profession Standards.
The Actuaries Code came into force on 1 October 2009, and replaced what was known
as the Professional Conduct Standards (PCS) from that date.
The Regulation area of the IFoAs website also includes Information and
Assistance Notes (IANs) and other non-mandatory resource material which are
intended to provide helpful information on particular matters. Unlike the TASs,
IANs are not mandatory and, therefore, members do not have to follow them,
being free to obtain and follow alternative advice from other sources. However,
because they are part of professional guidance, members may have to
demonstrate that they have considered them, if relevant. The IFoA has to ensure
that the content of an IAN does not conflict with any of the FRC standards.
At the time of writing, there are no IANs that are directly related to general insurance
business.

As at April 2013, the other non-mandatory resource material covered:

Constitutional Framework
Regulatory Framework
The Standards Decision Tree
Whistleblowing: A guide for actuaries
Whistleblowing: A guide for employers of actuaries
Memoranda of Understanding: Working with our co-regulators
The Risks of Derivative Exposures.
These could be used by any actuary, including those working in the general insurance
field.
The principles outlined in this Core Reading reflect the up-to-date versions as at
30 April 2013. You are not required to have knowledge of changes made after
this date for the purpose of Subject SA3. However, if your answer to an exam
question reflects knowledge of such changes, your answer will, in principle, be
acceptable.

1 Technical Actuarial Standards

SA3 students are expected to be familiar with the underlying principles of the
relevant TASs, but will not be examined on the detail.
The TASs are split into two categories:

Generic TASs, which apply to more than one actuarial discipline
Specific TASs, which apply to actuaries working in one particular area.
1.1 Generic TASs
TAS R, TAS D and TAS M are Generic TASs, which means that they apply to any
work which is commonly (or exclusively) performed by actuaries and which falls
within the scope of one or more of the Specific TASs (see below).
The topics covered by these TASs are:

TAS R: Reporting Actuarial Information
TAS D: Data
TAS M: Modelling.
The purpose of TAS R is to ensure that the reporting of actuarial work enables
users to judge the relevance and implications of the reports contents, and that
the information is presented in a clear and comprehensible manner. It differs
markedly from previous guidance in its emphasis on the information
communicated in the lead up to decisions rather than on formal reports.
The purpose of TAS D is to ensure that data is subject to sufficient scrutiny and
checking so that users can rely on the resulting actuarial information, and that
appropriate actions are taken where data is inaccurate or incomplete.
The purpose of TAS M is to ensure that actuarial models sufficiently represent

the issues on which decisions will be based, and are fit for purpose both as
theoretical concepts and as practical tools. Further, TAS M requires that models
be properly documented and that significant limitations and their implications be
reported.
You should now read TAS R, TAS D and TAS M, since their contents may help you to
answer exam questions covering related topics.

1.2 Specific TASs
As well as these Generic TASs, the FRC has published a set of Specific TASs
applying to work in particular areas. Of most relevance to this Subject is the
Insurance TAS, but actuaries should also be aware of other Specific TASs such
as that for transformations.
At the time of writing, the other specific TASs that have been published are the
Pensions TAS and the Funeral Plans TAS, neither of which are relevant for general
insurance. You should check the FRC website regularly for updates.
The purpose of the Insurance TAS is to ensure that management and governing
bodies of insurers can understand and rely on the information supplied by their
actuaries, and understand its limitations. It also requires that information
provided to policyholders is relevant, comprehensible and sufficient for their
needs.
The key principles include requirements to check data, to use appropriate

assumptions derived from relevant information, and to explain uncertainty
around any figures. There are principles relating specifically to discount rates
and claim rates.
It can be noted that the Insurance TAS is principles-based and is intended to be

durable, containing few references to legislation and regulations. It therefore
differs markedly from the technical Guidance Notes.
The Transformations TAS gives more detail on principles that should be applied
in actuarial work relating to business reorganisations which affect policyholders
including Part VII transfers and schemes of arrangement.
Part VII transfers and schemes of arrangement will be covered further in Chapter 14.
The IFoA also appreciates input from its members with regards to possible changes to
the guidance. Just because you have yet to qualify does not mean that your input would
not be appreciated.

2 The Actuaries Code

The Actuaries Code sets out five core principles which all members are
expected to observe in their professional lives, in both the spirit and the letter.
The content of the Actuaries Code is outside the scope of Subject SA3 but
should be known by all members (students and actuaries) of the Institute and
Faculty of Actuaries or Institute of Actuaries.
For your own career, and background reading for Subject SA3, you should read the
Actuaries Code now its only three pages! You can find it here:
www.actuaries.org.uk/research-and-resources/documents/actuaries-code-october-
2009
You should at least remember the five basic principles covered in the Code, ie:
Integrity
Competence and care
Impartiality
Compliance
Open communication.

3 Actuarial Practice Standards

APS G2 Actuarial reporting for Lloyds syndicates writing US
business
APS G2 (formerly GN33) applies to the preparation, by an actuary appointed by a

Lloyds managing agent, of opinions required by the IID of the NAIC or by the
NYID for Lloyds syndicates writing relevant USA insurance or reinsurance
business.
APS G2 can be found at:
http://www.actuaries.org.uk/research-and-resources/documents/aps-g2-actuarial-
reporting-lloyds-syndicates-writing-us-business
Read through APS G2 and the Advisory Note on Lloyds US Opinions, which
supplements it.
Question 5.1
In order to be able to provide an SAO, what does a member need to be satisfied of?
It is the intention of the IFoA to produce a number of APSs to replace the former
Guidance Notes. A new APS G1 which covers overarching ethical obligations
has been proposed but may now be replaced by a cross-practice APS on ethical
behaviour. Further APSs are anticipated.

4 Advisory Notes
The Institute and Faculty of Actuaries also issue Advisory Notes on particular issues
from time to time. They do not carry the same weight as the TASs, but offer advice
which an actuary should consider when forming or communicating an opinion on the
issue in question. A recent Advisory Note covers provisions for large losses.
Previous Advisory Notes have covered provisions for reinsurance bad debt and
unallocated loss adjustment expenses.

Chapter 5 Summary
Actuaries should always consider professional standards and guidance.
Actuaries Code
This includes brief sections on:

integrity
competence and care
impartiality
compliance
open communication.
Technical Actuarial Standards
TASD Data (Generic)

TASR Reporting (Generic)
TASM Modelling (Generic)
Insurance TAS (Specific)
Transformations TAS (Specific)
Actuarial Practice Standards
APS G2 Actuarial reporting for Lloyds syndicates writing US business.

This page has been left blank so that you can keep the chapter
summaries together for revision purposes.

Chapter 5 Solutions
Solution 5.1
The member needs to be satisfied that the technical provisions held by the syndicate are
at least as large as those calculated by applying generally accepted actuarial methods
and using assumptions that he/she considers reasonable in the context of the Lloyds
Valuation of Liabilities Rules or the basis agreed with regulators.
The technical provisions calculated by the member for the purpose of forming the
opinion must be at least as large as those implied by a best estimate basis without
precautionary margins.

All study material produced by ActEd is copyright and is sold
for the exclusive use of the purchaser. The copyright is owned
by Institute and Faculty Education Limited, a subsidiary of
the Institute and Faculty of Actuaries.
Unless prior authority is granted by ActEd, you may not hire

out, lend, give out, sell, store or transmit electronically or
photocopy any part of the study material.
You must take care of your study material to ensure that it is

not used or copied by anybody else.
Legal action will be taken if these terms are infringed. In

addition, we may seek to take disciplinary action through the
profession or through your employer.
These conditions remain in force after you have finished using

the course.

SA3-18: Further reading Page 1
Chapter 18
Further reading
0 Introduction
The following is a list of suggested reading for Subject SA3. Students will find it
useful to consult some of the material to extend their knowledge and to obtain a
different viewpoint when studying a particular topic. However, students are not
expected to have read all of the items on the list.
Most items are available from the Institute and Faculty of Actuaries libraries
(e-mail: libraries@actuaries.org.uk). Articles from the British Actuarial Journal
(BAJ) are available via:
http://www.actuaries.org.uk/research-and-resources/pages/journals
after member login to the Institute and Faculty of Actuaries website. Members
can access full text of BAJ articles cited below via the links shown if they have
logged into Athens first and find British Actuarial Journal through Cambridge
Journals. Members who have registered to use Athens online resources (please
ask libraries@actuaries.org.uk for an Athens account) can access the archive of
BAJ articles through Cambridge Journals.
A learning portal has been set up for Subject SA3, containing links to much of the
suggested reading material. It can be accessed here:
http://www.actuaries.org.uk/research-and-resources/pages/sa-exams-reading.
Topical issues are discussed further on the ActEd Discussion Forums at

www.acted.co.uk/forums/.
There is also a Guide to the Specialist Applications Examinations, which may be found
on the Institute and Faculty website at:
http://www.actuaries.org.uk/students/syllabus/guide_sa_exams.
This gives an overview of what can be expected in the Specialist Applications exam.

Page 2 SA3-18: Further reading
A question you may be asking yourself is:
How much further reading should I do to prepare for the Subject

SA3 exam?
There is no right or wrong answer to this, and the amount of further reading that a
student does will have to depend on the spare time available for instance, time may
be short if you are studying other subjects simultaneously. However, you will see when
you look at past papers that current topics are frequently examined, and current topics
are often the subject of the further reading material.
Be selective about which publications you read and how much time you spend on each.
There is no point reading and memorising an advanced text on statistical rating
techniques, since you are unlikely to have to reproduce something similar in the exam.
Your time would be better spent reading papers that cover important broad topics, such
as risk, capital and return.
Do not try to memorise all the content of these papers rather, use them to get an idea
of the sorts of issues that general insurance actuaries are concerned about.
Be aware that when examiners set questions for the forthcoming exam, they are
undoubtedly going to be thinking about topical subjects and issues that currently
concern general insurance actuaries.
Indeed, to quote a past Examiners Report:
The better candidates showed that they had prepared for the exam by reading
around the subject in respect of important factors affecting the general insurance
industry at the moment.
It is particularly advisable to familiarise yourself with the topics presented at the last
GIRO conference. These were presented, hence topical, at the same time that the exams
were being prepared. You might like to start with the Brian Hey prize winner!
The GIRO papers are discussed in Section 2.38.
When doing further reading, don't worry about feeling that you're not taking everything
in. It is bound to feel like this as you haven't got a specific syllabus objective in mind.

However, sometimes your further reading can give you a big advantage when answering
an exam question. For example, in 2000 there were questions on financial engineering
that werent (at the time) covered in the Core Reading. The solution was based on
material from some background reading (in that example, it was a Sigma report). And
in 2008 there was a question on stochastic reserving methods not covered at all by the
course material at the time.
Other times, you may just use your background reading knowledge to add strength to an
answer by giving specific examples of topical events. Look in past Examiners Reports
and you'll see things mentioned (and it really is just a mention) like Spitzer, or Berquist
Sherman. These werent covered by the Core Reading at the time, but could be gleaned
from general background reading.
Even if you dont use the background reading explicitly in any of your answers, simply
reading around generally will boost your knowledge of whats important in the general
insurance world at the moment, and what actuaries are currently thinking about. This
should allow you to realise whats important when answering questions, which should
help to take your answer in the right direction.

1 List of reading
The list that the Core Reading recommends is as follows:
The actuarial practice of general insurance

Hart, D.G.; Buchanan, R.A.; Howe, B.A. 7th ed. Institute of Actuaries of Australia,
2007. 880 pages. ISBN: 9780858130739
You can order from Institute of Actuaries Online Bookshop:
http://www.actuaries.asn.au/TechnicalResources/OnlineBookshop.aspx
http://www.actuaries.asn.au/Publications/Publication.aspx?id=43
Foundations of casualty actuarial science

Casualty Actuarial Society. 4th ed. CAS, 2001. 817 pages. ISBN: 0962476226
You can order from Casualty Actuaries Society Online Store:
http://www.casact.org/pubs/index.cfm?fa=books
http://www.casact.org/pubs/index.cfm?fa=castext
Loss reserves in the London Market

Maher, G.P.M. BAJ (1995) 1(4): 689760
http://dx.doi.org/10.1017/S1357321700001288 (Member login first required to view
full text)
The cycle survival kit an investigation into the reserving cycle and other issues
Archer-Lock, P.; Fisher, S.; Hilder, I.M., et al. 2003 General Insurance Convention
103145
http://www.actuaries.org.uk/giro2003/line.pdf
A change agenda for reserving;

Report of the General Insurance Reserving Issues Taskforce (GRIT)
Jones, Tony; Copeman, Peter J.; Gibson, Lis R., et al. BAJ (2006) 12(3): 435619
http://dx.doi.org/10.1017/S135732170000461X (Member login first required to
view full text)
Quantification and reporting of uncertainty for GI reserving

Reserving Oversight Committee
Jones, Tony; Copeman, Peter J.; Gibson, Lis, et al. (2007)
http://www.actuaries.org.uk/papers/giroc_reservingpaper_0807.pdf
Reinsurance pricing Practical issues and considerations

Reinsurance Matters Working Party
Flower, Mark; Cook, Ian; Lee, Laurence, et al. 2006 General Insurance
Convention
http://www.actuaries.org.uk/giro2006/Flower2.pdf
GRIP General Insurance Premium Rating Issues Working Party [report]

Anderson, Duncan; Bolton, Clive G.; Callan, Gary L., et al. (2007)
http://www.actuaries.org.uk/papers/grip_report_jan07.pdf

Statistical motor rating: Making effective use of your data

Brockman, M.J.; Wright T.S. JIA (1992) 119: 457543
http://www.actuaries.org.uk/jia 119/0457-0543.pdf
Competitive market analysis: An example for motor insurance

Santoni, A.; Folch, E.; Sanche, B. (2007)
http://www.actuaries.org/ASTIN/Colloquia/Orlando/Papers/Santoni.pdf
Advisory note on Lloyds US opinions

General Insurance Board. 1999. 14 pages
http://www.actuaries.org.uk/research-and-resources/documents/advisory-note-
lloyds-us-opinions
http://www.actuaries.org.uk/sites/all/files/documents/pdf/advisnote.pdf
Review and comparison of rating agency capital models

Lebens, J.R.; Morin, F. on behalf of the Casualty Actuarial Society (2006)
http://casualtyactuarialsociety.org/research/drm/lebens.pdf
The management of losses arising from extreme events

Sanders, D.E.A.; Brix, A.; Duffy, P., et al. 2002 General Insurance Convention 2:
1257
http://www.actuaries.org.uk/giro2002/Sanders.pdf
Quantifying operational risk in general insurance companies

Tripp, M.H.; Bradley, H.L.; Devitt, R., et al. BAJ (2004) 10(5): 9191026
http://dx.doi.org/10.1017/S1357321700002919 (Member login first required to
view full text)
Fair value accounting: Implications for general insurers

Leigh, J.C.T. SIAS, 2004, 46 pages
http://www.sias.org.uk/data/papers/FairValueAccounting/DownloadPDF
UK asbestos the definitive guide

Lowe, J.A.; Gravelsons, B.P.; Hawes, W., et al. 2004 General Insurance
Convention (2004) 135354
http://www.actuaries.org.uk/research-and-resources/documents/uk-asbestos-
definitive-guide
http://www.actuaries.org.uk/sites/all/files/documents/pdf/Lowe_0.pdf
UK asbestos working party update 2009

Gravelsons, B.P. et al
http://www.actuaries.org.uk/research-and-resources/documents/b12-uk-
asbestos-working-party-update-2009-5mb
http://www.actuaries.org.uk/sites/all/files/documents/pdf/b12asbestoswp.pdf


Brooks, R. et al
http://www.actuaries.org.uk/research-and-resources/documents/b11-uk-
asbestos-working-party-update
http://www.actuaries.org.uk/sites/all/files/documents/pdf/workshop-b11-robert-
brooks-darren-michaels.pdf

Brooks, R. et al
http://www.actuaries.org.uk/research-and-resources/documents/f10-update-uk-
asbestos-working-party
http://www.actuaries.org.uk/sites/all/files/documents/pdf/f10-giro-2011-awp-
f10.pdf
Asbestos briefing note

http://www.actuaries.org.uk/research-and-resources/documents/asbestos-
briefing-note
Injury liabilities (US Asbestos)

Cross, S. and Doucette, J.
http://www.casact.org/pubs/forum/94sforum/94sf161.pdf
The valuation of general insurance companies

Ryan, J.P.; Larner, K.P.W., JIA (1990) 117: 597669
http://www.actuaries.org.uk/jia 117/0597-0669.pdf
The cost of compensation culture

Lowe, J.A. et al (2002)
http://www.actuaries.org.uk/giro2002/Lowe.pdf
Reserving and uncertainty. A meta-study of the General Insurance Reserving

Issues Task Force and Reserving Oversight Committee research in this area
between 2004 and 2009
Gibson, E.R. et al (2009) BAJ (2011) 16(1): 63-80
http://dx.doi.org/10.1017/S1357321711000067 (Member login first to Athens
required to view full text)
Mapping out the route to internal model approval

Morgan, K. (2009)
http://www.insuranceerm.com/analysis/mapping-out-the-route-to-internal-model-
approval.html
Please note that this is a subscription-based site; students will have to register
for a free trial to access the paper this way.
Lloyd's guidance on technical provisions under Solvency II

Look for latest guidance on http://www.lloyds.com

Economic scenario generators and Solvency II; A discussion paper

Varnell, E.M. (2009)
http://www.actuaries.org.uk/sessional/sm20091113.pdf
Schemes of arrangement and business transfers

David Hindley et al (GIRO 2009)
http://www.actuaries.org.uk/research-and-resources/documents/schemes-
arrangement-and-business-transfers-0
Measurement of US pollution liabilities

Bouska, Amy S.; McIntyre, Thomas S.
Shelved at: Per: CAS Forum (Oxf) (Institute); [RKN: 14611]
Casualty Actuarial Society Forum (1994) Summer: 73-160
Available for downloading from: http://www.casact.org/pubs/forum/
Asbestos liabilities & the new risk margins framework. - Sydney: Finity
Consulting, 2009. - 64 pages. [RKN: 43615]
Riley, Brett; Watson, Bruce (2009).
http://www.finity.com.au/publication/asbestos-liabilities-and-the-new-risk-
margins-framework/
Back-testing the ODP bootstrap of the paid chain-ladder model with actual
historical claims data.
Leong, Jessica; Wang, Shaun; Chen, Han (2012). (GIRO Conference and
Exhibition 2012)
http://www.actuaries.org.uk/events/paper-presentation-archives/2012
Best estimates and reserving uncertainty

Gibson, Lis R.; Archer-Lock, Philip R.; Bruce, Neil A.; Collins, Anthony; Dunne,
Gary; Felisky, Kendra; Hamilton, Alex J.; Jewell, Malcolm; Lo, Joseph; Locke,
Jacqueline; Marshall, David; Nicholson, Erica J.; Thomas, Luke; Wilcox,
Stephen; Winer, Joseph; Wright, Tom (2007). General Insurance Convention
(Celtic Manor Convention, 24 July 2007). [RKN: 37839]
http://www.actuaries.org.uk/research-and-resources/documents/best-estimates-
and-reserving-uncertainty
Distribution-free calculation of the standard error of chain ladder reserve

estimates
Mack, Thomas (1993). ASTIN Bulletin (1993) 23: 213-225. [RKN: 13901]
http://www.actuaries.org/LIBRARY/ASTIN/vol23no2/213.pdf

A framework for assessing risk margins

Marshall, Karl; Collings, Scott; Hodson, Matthew; O'Dowd, Conor (2008). Coolum,
2008. - 43 pages. [RKN: 43614]
http://www.actuaries.asn.au/Libraries/HomePage/Framework_for_assessing_risk
_margins_final.sflb.ashx
Modelling the claims development result for solvency purposes

Merz, Michael; Wthrich, Mario V. (2008). [RKN: 43612] Casualty Actuarial
Society Forum (2008) Fall: 542-568.
http://www.casact.org/pubs/forum/
A note on the overdispersed Poisson family

Schmidt, Klaus D. (2002). [RKN: 31541]
Insurance: Mathematics & Economics (2002) 30 (1): 21-25.
http://fa319.voila.net/Schmidt.pdf
Predictive distributions of outstanding liabilities in general insurance

England, Peter D.; Verrall, Richard J. (2006). [RKN: 37248] Annals of Actuarial
Science (2006) 1(2): 221-270.
http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=8249
845
Stochastic claims reserving in general insurance

England, Peter D.; Verrall, Richard J. (2002). [RKN: 29637] BAJ (2002) 8(3): 443-
544.
http://www.actuaries.org.uk/research-and-resources/documents/stochastic-
claims-reserving-general-insurance
Stochastic re-reserving in multi-year internal models - an approach based on

simulations
Diers, Dorothea (2009). [RKN: 43613] ASTIN Colloquium (Helsinki, 1-4 June 2009)
S4: 1-20.
http://www.actuaries.org/ASTIN/Colloquia/Helsinki/Papers/S4_11_Diers.pdf
In addition, the online Pricing Wiki and Toolkit Wiki are useful resources for the
practicing General Insurance actuary.
Various, Pricing Wiki

http://www.ratemaking.org/
Various, Toolkit Wiki

http://toolkit.pbwiki.com/
Other papers from General Insurance Research Organisation (GIRO) can be

accessed from the GIRO Convention papers archive:
http://www.actuaries.org.uk/research-and-resources/pages/giro-convention-
papers-archive

2 Review of recommended reading
2.1 The actuarial practice of general insurance
Despite being Australian, the actuarial principles are very similar to those in the UK
(and South Africa, The Caribbean, Hong Kong and probably anywhere else that you
might be reading this). The book covers many of the same areas as the Course Notes,
such as regulation, reserving, premium rating and reinsurance. If you want a different
approach to that given in the Course Notes and the Core Reading, then this book might
help.
2.2 Foundations of casualty actuarial science
Another textbook that might be useful for background knowledge, but this one is
American. This book is more mathematical and statistical than the Australian book, so
in terms of passing the exam perhaps the Australian textbook might be more useful.
2.3 Loss reserves in the London Market
An important paper, which is relatively easy to read, and includes lots of information
and examples to give you quite a practical feel for this area.
2.4 The cycle survival kit
A short and very readable account of both the Reserving Cycle and the Underwriting
Cycle (not the same thing!).
2.5 A change agenda for reserving (GRIT report)
This report is arguably one of the most important General Insurance reports in recent
years and, as such, is compulsory reading. It challenges fundamentally the reserving
methodology in use today. Many of the subsequent GIRO papers stemmed from
material given in this report in particular, the GIRO 2007 paper Best estimates and
reserving uncertainty (discussed later), which has been the topic of some recent
Subject SA3 exams.

2.6 Quantification and reporting of uncertainty
This is another (very short) paper that stemmed from the report discussed in Section 2.5.
It discusses in more detail the considerations to be taken into account when
communicating uncertainty in reserve estimates. This is a topic that has been examined
in recent Subject SA3 exams.
2.7 Reinsurance pricing practical issues and considerations
A long and interesting paper (from GIRO 2006) on some of the more exotic features of
reinsurance, many of which have appeared in the exam. Many of the techniques
described can also improve your understanding of pricing primary business.
2.8 GRIP report
GRIP was established by the Profession's General Insurance Board in late 2005 to
review actuarial involvement in premium rating issues. This report comes from GIRO
2006.
GRIP is the pricing equivalent of GRIT (see Section 2.5) and, as such, should be seen as
compulsory reading.
2.9 Statistical motor rating: making effective use of your data
This is a very long and heavily mathematical paper that explores the intricacies of the
statistical models than can be used when rating motor business. It was written in 1992
but the content is still very much valid today. It starts very simply with one-way tables
and GLMs, but rapidly progresses into advanced maths which perhaps wouldnt be so
useful for the exam.
2.10 Competitive market analysis: an example
This is a short statistical paper that gives an overview of a possible method for
analysing an insurers competitive position, using decision trees. For those interested in
these statistical techniques there is a list of further references at the end. Whilst the
objective is of interest, it is difficult to imagine an exam question focussing on the
technical content.

2.11 Advisory note on Lloyds US opinions
This advisory note was produced by the General Insurance Board and supplements
APS G2. Therefore we recommend that you read this in conjunction with APS G2.
2.12 Review and comparison of rating agency capital models
This actuarial consultancys report, on behalf of the Casualty Actuarial Society, gives
an overview of the capital adequacy models of the main rating agencies. It will give
you an idea of the sort of factors that capital models should normally consider.
2.13 The management of losses arising from extreme events
This extensive paper presents a discussion on many facets of extreme events.
It gives practical examples from, for example, a geological viewpoint, as well as the
mathematical principles developed in Extreme Value Theory, which is covered in
Chapter 12. The use of catastrophe models is also discussed, as are other management
controls of extreme events. The paper finishes with a discussion on risk measures.
2.14 Quantifying operational risk in general insurance companies
This paper originated from a GIRO conference in 2002.
It covers many aspects of this topical subject, given the PRAs heavy slant towards risk
management in recent years. It covers mainly soft issues, but there are still some
formulae every now and again to keep the mathematicians happy. It gives a useful
insight into the risks covered by PRU that you met in Chapter 4, Legislation.
It also covers modelling techniques such as DFA.
2.15 Fair value accounting: implications for general insurers
This paper builds on those presented at the GIRO 2002 and 2003 conventions (see
section 2.38). It is best read in conjunction with those papers.

2.16 UK asbestos the definitive guide
A strongly educational paper, covering this important topic in considerable detail. It is

best read when studying Chapter 10 (Reserving for latent claims and diseases).
2.17 UK asbestos working party updates 2009, 2010 and 2011
These papers provide important updates on developments since the guide mentioned
above was produced.
2.18 Asbestos briefing note
Much of this material is already covered in the Core Reading but it provides a good
summary of the topic. Topics covered include the properties and uses of asbestos, the
associated diseases and, for the UK and US separately, legal developments and losses to
the industry.
2.19 Injury liabilities (US asbestos)
This is quite an old paper (1994) so some of the material in Sections 1 and 2 may be in
need of an update. However, it is it very readable and provides a good insight into how
asbestos bodily injury claims can be modelled. A model is described in Section 5 of the
paper and relies on categorising defendants into five tiers according to the nature of
their exposure to asbestos bodily injury claims.
2.20 The valuation of general insurance companies
Valuing general insurers is an important topic, especially in a world of takeovers and

increasingly sophisticated shareholders. This paper is an approachable treatment of this
area, with the heavy appendices being some quite manageable spreadsheets rather
than, as in many other papers, some almost indecipherable maths!
2.21 The cost of compensation culture
At the time, this was one of the most topical discussions of the day, highlighting the
ever-increasing litigiousness of society. An interesting read, although of course there
have been plenty of developments since then.

2.22 Reserving and uncertainty
This very readable paper summarizes the results of papers produced by GRIT, ROC and
others in relation to reserving and uncertainty. Topics touched upon include the
difference between a range of reasonable estimates and a range of possible outcomes,
possible problems with current practice in determining best estimates, the reserving and
underwriting cycles, the choice of method for determining the uncertainty around the
best estimate, and communicating uncertainty to non-actuarial stakeholders,
2.23 Mapping out the route to internal model approval
This short article provides insight from a technical specialist at the PRA who is a
member of EIOPAs internal models expert group. Some aspects of consultation paper
56 (which sets out tests and standards for internal model approval) and model validation
are discussed, amongst other topics.
2.24 Lloyds guidance on technical provisions under Solvency II
This gives detailed Lloyds guidance on the calculation of technical provisions under
Solvency II. At 121 pages, this is quite a comprehensive text covering a whole range of
issues including contract recognition, binary events, the risk margin, reinsurance
recoveries, expenses, discounting and data implications.
2.25 Economic scenario generators and Solvency II
This paper discusses the use of Economic Scenario Generators (ESG models) in the
context of Solvency II. It explains how ESG models will be used under Solvency II and
the issues that will need to be considered. It considers ESG models in relation to Pillars
two and three, internal models and market consistent valuation. The author avoids
technical details as far as possible, making the paper quite easy to read.
2.26 Schemes of arrangement and business transfers
This is a very readable paper which expands upon the material on this topic already
covered within the Subject SA3 Course Notes. There is an interesting section covering
the various stages of preparation that occur prior to a Scheme being implemented.
Other topics covered include the role of actuaries and the PRA, estimation guidelines,
reporting considerations and dealing with objections to a Scheme.

2.27 Measurement of US pollution liabilities
This paper explains why traditional actuarial methods are unsuitable for estimating
pollution liabilities as well as the distinctions between analysing asbestos and pollution.
Estimation methods and analysis appropriate for pollution are then described in detail.
2.28 Asbestos liabilities & the new risk margins framework
In Australia, the calculation of risk margins has been mandatory since 2002. However,
this is often a challenging exercise, especially for classes with long latency periods and
limited data. This paper proposes a new approach for determining risk margins above
central reserve estimates and quantifying uncertainty, in particular for asbestos-related
liabilities.
2.29 Back-testing the ODP bootstrap of the paid chain-ladder model

with actual historical claims data
See below under 2012s GIRO papers.
2.30 Best estimates and reserving uncertainty
See below under 2007s GIRO papers.
2.31 Distribution-free calculation of the standard error of chain

ladder reserve estimates
This paper explores how significant the differences are between chain ladder methods
and the results of other reserving methods. It does this by considering the standard error
of the chain ladder reserve estimates. There is a lot of maths in this short paper, so you
may want to read the introduction and then skip to the conclusions at the end.
2.32 A framework for assessing risk margins
This is an Australian paper, written in 2008, which considers the key sources of
uncertainty in the claims process. It starts by considering the current approaches to
assessing risk margins around a central estimate, and then proposes a new
comprehensive framework for assessing insurance risk margins, with practical advice
on how to implement the framework.

SA3-18: Further reading Page 14a
2.33 Modelling the claims development result for solvency purposes
This paper considers the problem of quantifying the uncertainty associated with the
development of claims reserves for prior accident years in general insurance. It is quite
mathematical, so may not be the most likely thing to be examined in Subject SA3.
2.34 A note on the overdispersed Poisson family
This is a very short, very mathematical paper containing theorems, lemmas and proofs
which show that every overdispersed Poisson model (for loss reserving) can be
transformed into the Poisson model by rescaling all incremental claims by a common
factor.
2.35 Predictive distributions of outstanding liabilities in general

insurance
This paper describes a general procedure for bootstrapping and shows how predictive
distributions of outstanding liabilities can be obtained using two alternative methods:
a) bootstrapping and b) Bayesian techniques implemented using Markov chain Monte
Carlo techniques. The two approaches are compared and the similarities and
differences are highlighted.
2.36 Stochastic claims reserving in general insurance
This paper considers a wide range of stochastic reserving models, beginning with
stochastic models that reproduce the traditional chain-ladder reserve estimates. These
models are then extended to consider parametric curves and smoothing models for the
shape of the development run-off. The Bornhuetter-Ferguson technique is also
considered within a Bayesian framework. The techniques are illustrated with examples
throughout.

Page 14b SA3-18: Further reading
2.37 Stochastic re-reserving in multi-year internal models - an

approach based on simulations
Most stochastic reserving methods (eg Mack, bootstrapping, Bayesian methods)

consider the position to ultimate, ie they try to quantify the uncertainty of the full
run-off of liabilities. However, in contrast, Solvency II requires the one-year insurance
risk to be quantified. This paper presents the idea of re-reserving, which can be applied
when modelling reserve risk and premium risk; based on this approach, one-year risk
capital and multi-year risk capital can be quantified.
2.38 Selected papers from GIRO
Many papers are presented at each years GIRO (General Insurance Research
Organisation previously called General Insurance Study Group, ie GISG) Convention.
Some are better than others, but several of them are excellent. Moreover, they are
generally easy to follow and are quite reader friendly, the kind of thing that you could
read on a train. Topics are wide ranging, with current issues always well represented
and most other significant topics coming round every few years. For most years, you
can get bound copies of the papers from Napier House, or maybe a colleague will lend
you a set. The papers are also freely available on the Institutes website.
The number of working party papers presented at the Convention has increased rapidly
over the last few years. The topics covered by the papers have often appeared in the
exam, and indeed many of them were the source of inspiration for much of the Core
Reading. We have already mentioned many GIRO papers in Sections 2.1 2.18.
Do not be put off by the size of some of the older publications! Many of the papers are
only references to the workshops held at the Conference and do not contain any useful
information beyond that. However, there are many papers worth reading.
We suggest that you glance through each paper first to assess its relevance, and then
read through the papers that you think are broad enough to be examinable topics. Some
of the more interesting and meaty papers are listed here for you (if not already
mentioned earlier), but you are encouraged to make your own mind up about which
have most relevance.

SA3-18: Further reading Page 14c
2012s papers
Catastrophe model blending
This paper takes an in-depth look at how catastrophe models can be integrated within a
general insurer. It makes excellent further reading building on the topics discussed in
Chapter 8, Catastrophe models, and is a topic that has been examined a number of
times. It is particularly topical given the emphasis on catastrophe modelling within the
Solvency II framework.
Back-testing the ODP bootstrap of the paid chain-ladder model with actual historical
claims data
Does bootstrapping of the paid chain-ladder model produce reliable reserve estimates?
If you want to know, youll have to read the paper, which uses actual historical data to
justify its conclusions. Useful for those wanting to see a practical example of how the
method is used, in more detail than is given in the Core Reading.
Game theory in general insurance
This mathematical paper looks in depth at how game theory can be used within the
pricing methodologies of a general insurer. If youre interested in the topic then this
could be for you, although we would guess its unlikely to be the topic of an exam
question.
Practical issues in the Solvency II Internal Model Approval Process (IMAP) for
general insurance actuaries
This lengthy paper gives detailed coverage of the IMAP process and its surrounding
issues. It is very useful indeed, particularly if you do not have practical experience of
Solvency II, and the topic has appeared in a recent Subject SA3 exam.
Triangle-free reserving
This paper gives an insight into various reserving methods, and their pros and cons, in
particular those that do (and dont) use triangulations of claims data. Whilst some of
the mathematical explanations may be arguably beyond the exam, the general principles
behind the paper make very relevant reading.

Page 14d SA3-18: Further reading
2011s papers
Role of the actuarial function under Solvency II
This paper discusses the role of the actuarial function by referencing and expanding
upon each of the paragraphs defining this role within the Solvency II Directive. It is a
concise and useful read.
Risk appetite for a general insurance undertaking
This is a well-written paper providing an introduction to the subject of risk appetite for
actuaries who are involved with general insurance undertakings. Topics covered
include the role and importance of risk appetite, risk appetite within ERM, risk appetite
concepts, drivers of risk aversion, risk appetite articulation and effectiveness, risk
appetite characteristics and risk appetite disclosures.
Risk adjustment for loss reserving by a cost of capital technique
This paper is concerned with the cost of capital approach for determining a risk margin
(under Solvency II). Such an approach involves computing a fair value, which is the
amount for which liabilities may be settled between knowledgeable, willing parties in
an arm's length transaction. The paper describes how such a fair value may be
calculated.
Periodic payment orders revisited
This paper provides important updates on developments since the original paper on
periodic payment orders (mentioned below in 2010s papers) was published.
2010s papers
Defining the scope of your internal model
This paper provides an example model scope, although the authors stress that it is
designed to stimulate debate rather than form a template. The paper discusses what
(risks, classes, processes etc) should be in scope and what should be out of scope.
ERM for emerging risks in General Insurance
Through three case studies (American International Group, Long Term Capital
Management and Union Carbide), this paper looks at risk and opportunity management
within general insurance. In particular, it seeks to identify early warning indicators that
might have been useful in each case and lessons that can be learned for the future.

SA3-18: Further reading Page 14e
Periodic payment orders
This paper gives an overview of PPOs (periodic payment orders), reviews some relevant
court cases and considers what impact PPOs will have on companys profits. It
considers the impact of PPOs on reserving, capital modelling, pricing and reinsurance
and how this impact can be mitigated. Practical issues, such as how to administer
payments which may last for fifty or more years are also covered.

Page 14f SA3-18: Further reading

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SA3: CMP Upgrade 2013/14 Page 1

This CMP Upgrade contains:

All changes to the Syllabus objectives and Core Reading.

The Actuarial Education Company IFE: 2014 Examinations

1 Changes to the Syllabus objectives and Core Reading

1.1 Syllabus objectives

Syllabus objective (a) has been changed to:

Define the principal terms in use in general insurance.

Syllabus objective (n) has been changed to:

1.2 Core Reading

IFE: 2014 Examinations The Actuarial Education Company

In most insurance companies, the activities are vertically integrated: the

In the fourth paragraph, change FSA to PRA.

At closure, any profits are distributed amongst the Names.

In the fifth paragraph, change FSA to PRA.

Change the six occurrences of FSA on this page to PRA.

In the seventh paragraph, change 1 January 2014 to some future date.

Change the three occurrences of FSA on this page to PRA.

Change the four occurrences of FSA on this page to PRA.

Change the two occurrences of FSA on this page to PRA.

The Actuarial Education Company IFE: 2014 Examinations

Change the first sentence on the page so that it now reads:

Change the two occurrences of FSA in the third paragraph to PRA.

In the second paragraph, change year-end 2011 to year-end 2012.

IFE: 2014 Examinations The Actuarial Education Company

There have been significant changes made to Sections 0, 1, 2, 3, 4 and 5. Remove

In the last paragraph, change (May 2012) to (April 2013).

The Actuarial Education Company IFE: 2014 Examinations

In the last paragraph, change the FSA to the PRA.

In the last paragraph, change The FSA to The PRA.

IFE: 2014 Examinations The Actuarial Education Company

The Actuarial Education Company IFE: 2014 Examinations

What claims have been experienced?

This is perhaps the most fundamental question in client understanding as a

At the end of the discussion on underwriter licensing, add the following:

Similar limits and processes will apply to the purchase of facultative

retroactive employers liability or public/products liability covers (these

IFE: 2014 Examinations The Actuarial Education Company

how much data to use and the relevance of old years

The Actuarial Education Company IFE: 2014 Examinations

Catastrophe models will typically consider separately the following types of

We have to make many assumptions in this modelling process. We will discuss

IFE: 2014 Examinations The Actuarial Education Company

A more recent development has been the preparations made by insurance

In Section 6.3, change all six incidences of FSA to PRA.

The Actuarial Education Company IFE: 2014 Examinations

In the last paragraph, change FSA to PRA.

The final phrase has been deleted. This was:

The definition of a bordereau has been updated to read:

A detailed list of premiums, claims and other important statistics provided by

The definition of a claim cohort has been updated to read:

A group of claims with a common period of origin. The period is usually a

IFE: 2014 Examinations The Actuarial Education Company

Acquisition costs relating to unexpired periods of contracts in force at the

... a collar or corridor.

A new definition of fronting has been included. This reads:

Fronting occurs when an insurer, acting as a mere conduit, underwrites a risk

The Actuarial Education Company IFE: 2014 Examinations

The definition of Value at Risk has been changed to:

Value at Risk (VaR)

In financial mathematics and financial risk management, Value at Risk (VaR) is a

The following items have been added to the list of abbreviations:

ATAFs Age to age factors