CAS Exam 9 Spring 2016, Question 22
Study guide: Exam 9
A newly formed insurance company is considering whether to write one or all three of the lines shown below. The insurer will base its decision on the expected risk-adjusted economic performance of each of the choices available. Given the following:
| Line of Business | Premium | Discounted Loss Ratio | Expense Ratio | Stand Alone Capital |
|---|---|---|---|---|
| A | 1,493,000 | 65.0% | 27.5% | 800,000 |
| B | 1,750,000 | 75.0% | 15.0% | 1,250,000 |
| C | 2,520,000 | 57.5% | 30.0% | 2,250,000 |
| Total | 5,763,000 | 4,300,000 |
| Lines of Business | Line of Business Added | Merton-Perold Marginal Capital | Myers-Read Marginal Capital |
|---|---|---|---|
| A&B | C | 700,000 | 800,000 |
| A&C | B | 900,000 | 1,200,000 |
| B&C | A | 1,250,000 | 1,350,000 |
| Total | 2,850,000 | 3,350,000 |
- Cost of capital is 15%.
- Expenses are paid at the beginning of the year.
- Assume no investment income on capital.
Part a (0.5 points)
Based on the information provided, recommend a total amount of capital needed to write all three lines.
Part b (0.25 points)
Explain why Merton-Perold's total allocated capital is lower than the sum of the standalone capital.
Part c (1 point)
Discuss whether the company should write a standalone line of business or all three lines together.
Answer this question and see the worked solution