Derivatives: Forwards vs Futures

  Before understanding what is derivative, let’s learn what is underlying asset. Underlying asset: Underlying asset can be real asset such as commodities, gold etc or financial assets such as index, interest rates etc. Derivatives: ·         These are financial instruments who value depend upon or is derived from some underlying asset. ·         A derivative does not have its own physical existence, it emerges out of contract between the buyer and seller of derivative instrument. ·         Its value depends upon the value of underlying asset. Hence returns from derivative instruments are linked to returns from underlying assets. ·         The most common underlying assets are stocks, bonds, commodities, market indices and currencies. ·         Derivatives are mainly used to control risks. They can be used to reduce risks (a process known as hedging) or to increase risks in order to enhance returns (speculation)   Classification of Derivatives: ·         Broadly we c

Actuarial Terminologies for General Insurance

 Let's discuss some of the Actuarial Terminologies specific to General Insurance:

Gross Direct Premium : Premium received from direct business written

Gross Written Premium : Gross Direct Premium + Premium received on reinsurance accepted

Net Premium: Gross Written Premium- Premium paid on reinsurance ceded.(by ceded we can say passed)

These three are very simple and related to each other. Now lets move further towards claims.

Gross Claims Paid: Claims paid on direct business written + Claims paid on reinsurance accepted.

Net Claims Paid: Gross Claims Paid - Claim amount received from reinsurance ceded(i.e. passed)

These two are also very simple. Lets move further to Commissions.

Gross Commissions: Commission paid on direct written business + Commission paid on reinsurance accepted.

Net Commission: Gross Commission - Commission received with respect to reinsurance ceded.

"So what happens basically is that when as an insurer, i take a reinsurance then reinsurer will pay me commission because i am bringing a business for him (such as in case of quota share reinsurance). So that's why reinsurer will pay me commission and i deduct that from the net commissions to come at a result that how much i am paying a commission" SEEMS EASY!!

Net Earned Premium(NEP) : Net Premium +/- Adjustment for changes in reserve for unexpired risk(i.e. URR, we will come to that what it is)

OR Premiums received from direct business written + Premium received from reinsurance accepted - Premium paid on reinsurance ceded +/- change in URR = NEP

Net Claims Incurred: Net Claims paid + Claims outstanding at the end of the year - Claims outstanding at the beginning of the year

OR Claims paid on gross business written + claims paid on reinsurance accepted business - claims amount received from reinsurance ceded + change in Claims O/S.

When i was talking about Commissions paid on Direct Business, it means commissions paid to brokers, agents, corporate agencies and web aggregators.

Loss Ratio : Incurred Claims / Earned Premium. It can be bifurcated into gross or Net. Companies usually specifically mentions in their financials whether its gross or net

Retention Ratio: Net Written Premium / Gross Written Premium

Solvency Ratio: ASM / RSM, where SM means Solvency Margin. A= Actual and R = Required. In India insurance industry solvency should be minimum 150% or 1.5

Underwriting Profit: Net Earned Premium - Net incurred claims +/- Net commissions - Operating expenses.

Ahh!! Expenses

Okay so we divide into Two parts basically ALAE and ULAE.

ALAE: Allocated Loss Adjustment Expense: Which can be allocated to a specific claims for example fees paid to loss adjusters, legal counsels

ULAE: Unallocated LAE. Which cannot be allocated to a specific claims. Example: Salaries, rent and computer expenses of claims department.

"Now as Promised Lets Talk about URR"

For that lets understand how earned premium comes?

I have to prepare my financials on 31st March 2019. Now I sold one policy for 1 year on 1 Feb 2019 for Rs.1200. So at 31st March 2019 i have earned 200rs premium (1200*2/12). I have done that calculation on the assumption that exposure remains constant throughout the policy period, however it will not be case in some policies.

So what about the rest rs.1000 (1200-200). That will be my Unearned Premium.

Unearned Premium Reserve: A reserve for Unexpired risks shall be created as the amount representing that part of the premium written which i attributable to and to be allocated to the succeding accounting periods.

But lets say we do our analysis and it comes to know that Remaining unearned premium is not sufficient for Expected Claims costs (inclusive of expenses). Then it means premium is not enough so i have to make the reserve for the same. Thats where Premium Deficiency comes.

Premium Deficiency Reserve: Premium Deficiency shall be recognized if the sum of expected claim costs, related expenses and maintenance costs exceeds related reserve for Unearned Premium reserve. As per IRDAI, we recognized where deficiency is at entity level.

So what is URR



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