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Disadv of fixed profit margin pricing model
- lack of theoretical justification of fixed margin
- high int rates imply margin could be too low
- incr competitiveness imply periods of reduced profits
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2 points of view to look at insurance
- financial mkt: exp return influenced by shareholders
- product mkt: premium affected by supply / demand
- interrelated: high demand = better return, inadequate rate = pull reserves
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IRR Model
- IRR = rate which sets NPVof CF = 0
- as long as IRR > opportunity cost, accept project
- CF inversed: need surplus contrib at inception, then payout
- assumptions: amt of S req; timing of commitment; of release
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NPV vs IRR differ when
- unusual CF: rare unless simplify CF
- mutually excl: rare (1) if IRR > COC use profits to grow (2) usually set IRR = COC
- NPV preferable: does not make assumption that CF reinv @ IRR
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Practical criticisms of IRR
- if 0 < IRR < COC or inv yield < IRR < COC, cpy is unprofitable but appears to make money for regulators
- insr more likely to run into that situation: C isn't fixed
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Insurance risks
- asset risk: depreciation
- pricing risk: L + E > expected
- reserving risk: insufficient
- A-L risk: chg in int rate has different impact
- cat risk
- reins risk: recoverables
- cr risk: agents & ph premium receivables
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Surplus vs policy form
- claims made: no pure IBNR -> less surplus
- service contracts: no ins risk
- retro: share risk -> S need btwn prosp & service
- some models make no dist: overstate retro, understate XS
- other allocate in prop to ins risk: understate retro, XS, large ded (volatility)
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Manufacturer fixed assets vs Insurer surplus
- manuf can objectively measure assets
- manuf can divide assets into products (similar to LOBs)
- amt of surplus heavily dependent on past profits
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