Chapter 3 Exercises

Work these with the chapter's habit of mind: behind every risk on your desk stands a structure — who owns the carrier, who brought the submission, who reinsures it, who rates it — and in front of every decision sits one number, the combined ratio. Ask of each problem how does this affect the dollar in and the dollar out, and how would I defend it? Items marked with a dagger (†) have worked solutions in Appendix: Answers to Selected Exercises; the rest are for discussion or self-test. Section references like (§3.5) point you back to the relevant part of the chapter.

A. Recall and definitions

  1. † Name the four carrier structures from §3.1 and say, in a phrase, who owns each one. (§3.1)
  2. Distinguish an agent from a broker by whom each one legally represents, and say which one may have binding authority. (§3.2)
  3. † Define a managing general agent (MGA) and explain what "delegated underwriting authority" means and why it obligates the carrier to audit the MGA. (§3.2)
  4. What is a wholesaler (wholesale broker), and whom does it serve — the insured, or the retail broker? (§3.2)
  5. Write the formula for the combined ratio in terms of its two components, and state what a result below 100% and above 100% each means. (§3.5)
  6. Define the loss ratio and the expense ratio, and explain which one the underwriter most directly controls. (§3.4, §3.5)
  7. Distinguish a soft market from a hard market along two dimensions: price and terms. (§3.6)
  8. † Distinguish the admitted market from the surplus-lines market along three dimensions: rate/form filing, guaranty-fund backing, and the kind of risk each writes. (§3.7)
  9. What does a rating agency assess, and why does the name AM Best matter specifically in insurance? (§3.3)

B. Carrier structure and distribution

  1. For each scenario, name the carrier structure that best fits and give your reasoning: (a) a company owned by physicians who insure one another's malpractice exposure, run by a professional manager for a fee; (b) a company that issues shares on a stock exchange and reports quarterly earnings to investors; (c) a company owned entirely by its policyholders that returns surplus to them as dividends; (d) a marketplace where syndicates backed by members' capital subscribe to shares of large marine risks. (§3.1)
  2. † A direct writer and an independent-agency carrier both run a 65% loss ratio. The direct writer posts a 92% combined ratio; the independent-agency carrier posts a 98%. Explain, using the distribution channel and the expense ratio, how two carriers with the same loss experience end up eight points apart on the combined ratio. (§3.2, §3.4, §3.5)
  3. A submission reaches you having passed through a retail broker, then a wholesaler, then an MGA before landing on your desk. List three distinct things that path tells you before you read the numbers, and say why each is worth weighing. (§3.2)
  4. Your company writes for a conservative mutual; a competitor writes for a growth-pressured stock company. The same marginal-but-improving account is on both your desks. Explain how the ownership structure could lead the two of you to different decisions on identical facts. (§3.1)

C. The premium dollar and the combined ratio (price/compute this)

  1. † A book of business earns \$8,000,000 in premium, incurs \$5,200,000 in losses and loss adjustment expense, and runs \$2,400,000 in underwriting expenses. Compute (a) the loss ratio, (b) the expense ratio, (c) the combined ratio, and (d) the underwriting profit or loss in dollars and in cents on the premium dollar. Did the underwriting make money? (§3.4, §3.5)
  2. † Take the book from Exercise 14 and hold the expense ratio constant, but let a soft-market round of underpricing push the loss ratio up by 12 points. Recompute the combined ratio and the underwriting result in dollars. By how much did the underwriting profit swing, and what single input changed? (§3.5)
  3. A line of business runs a combined ratio of 103% but the carrier reports it as profitable overall. Explain how both statements can be true at once, and state the underwriter's stern view of relying on that. (§3.4, §3.5)
  4. † Draw (in text) the premium-dollar waterfall for a policy whose pure-loss block is \$0.60, acquisition expense is \$0.20, and general expense is \$0.13. What is the underwriting profit or loss per dollar, and what is the combined ratio? Now show what happens if the broker wins a 10% rate cut and the losses come in exactly as expected. (§3.4, §3.5)
  5. Explain why "we'll make it up on volume" is, in combined-ratio terms, a mathematically backwards response to a book running above 100%. What does volume actually multiply? (§3.5)

D. The underwriting cycle

  1. † Put the following stages of the underwriting cycle in order, starting from a hard market, and explain the causal link between each step and the next: (i) capital exits and capacity shrinks; (ii) profit attracts new capital; (iii) prices rise and terms tighten; (iv) carriers cut prices to compete; (v) underpriced losses develop and the combined ratio climbs past 100%. (§3.6)
  2. The chapter says the temptation to underprice is strongest exactly when underpricing is most dangerous. Explain why the soft-market bottom is both the moment of maximum competitive pressure and the moment the deferred losses are being created. (§3.6)
  3. Name three real, public events from the chapter that hardened an insurance market, and for each say (in qualitative terms, no invented figures) why it consumed capacity. (§3.6)

E. Admitted vs. surplus lines

  1. † A trampoline park, a coastal chemical plant, and a brand-new kind of cyber risk all cannot be placed in the admitted market at filed rates. For each, name the feature (hazard, catastrophe, novelty) that pushes it to surplus lines, and state the freedom the surplus-lines market gives the underwriter to write it. (§3.7)
  2. An insured is choosing between an admitted carrier and a surplus-lines carrier for the same coverage. List two advantages of the admitted placement and two advantages of the surplus-lines placement, from the insured's point of view. (§3.7)
  3. Explain the "diligent search" requirement and why it exists. What is the broker required to document before a risk may be exported to surplus lines? (§3.7)

F. Find the red flag

  1. A broker brings you a "clean, easy" middle-market account and mentions, almost in passing, that the expiring admitted carrier is non-renewing it and that two other admitted markets have already declined. The broker is steering you toward writing it on your admitted paper at standard filed rates. Identify the red flag and explain what it suggests about which market this risk may actually belong in. (§3.6, §3.7)
  2. † Your underwriting assistant proudly reports that the team's premium volume is up 22% year over year and recommends celebrating. You pull the numbers and see the combined ratio moved from 96% to 107% over the same period. Identify the red flag, explain in combined-ratio terms why the growth is bad news, and name the cycle dynamic that probably produced it. (§3.5, §3.6)

G. Memo and communication

  1. † Write a short internal memo (150–250 words) to a new underwriting trainee explaining why the combined ratio — not premium growth, not market share, not investment returns — is the number by which you judge whether their book is succeeding. Include one worked illustrative figure and the "we'll make it up on volume" trap. (§3.4–§3.6)
  2. A broker emails you frustrated that your quote is 12% higher than a competitor's on a catastrophe-exposed property account in a soft market. Draft a brief, professional reply (100–200 words) that holds your price without burning the relationship, grounded in rate adequacy and what the cycle does to underpriced cat risk. (§3.6)

H. Ethics and judgment

  1. A stock insurer's quarterly investor call is approaching and senior management signals, informally, that the underwriting team should "lean into growth" this quarter. You have several catastrophe-exposed accounts you could write quickly by shaving terms. Lay out the ethical and professional tension between the growth pressure and your duty to the combined ratio, the policyholders, and the company's solvency. What do you do, and how do you document it? (§3.1, §3.5, §3.6)
  2. † Is it ethical for a surplus-lines carrier to write a risk on a non-admitted basis — outside the guaranty fund — at a much higher price than any admitted carrier would charge? Argue both sides (access-to-coverage vs. consumer-protection), then state where you land and why, using the chapter's framing of the surplus-lines market as a pressure-relief valve. (§3.7)

I. The Underwriting File

  1. † Place Harbor Steel in the market. State (a) the distribution channel it arrived through and whom that intermediary represents, (b) the carrier type best suited to write it, and (c) the open question about which market — admitted or surplus lines — it belongs in, and what will decide that question. (§3.2, §3.7, The Underwriting File)
  2. The chapter says writing Harbor Steel "to win the deal" would take a catastrophe-exposed risk into your pool at an inadequate rate, with the bill arriving two or three years later. Connect this specific account to the general combined-ratio and underwriting-cycle lessons of §3.5–§3.6: what is the mechanism by which an inadequate price today becomes a loss-ratio problem later? (§3.5, §3.6, The Underwriting File)
  3. Suppose your reinsurance treaty (previewed in §3.3, owned by Chapter 27) has no room left in the Port Hadley coastal zone this year. Explain how that single structural fact — about the reinsurance behind your book — could force you to decline Harbor Steel even if its price and risk grade were perfectly acceptable. (§3.3, The Underwriting File)