Chapter 26 Exercises

Work these the way a specialty underwriter works: where the data is thin, reason from the structure of the risk — small pool, correlated catastrophe, unusual exposure, delegated pen — and ask what device the market uses to write it anyway. 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 (§26.3) point you back to the relevant part of the chapter. Numbers in these problems are illustrative teaching figures, not real rates.

A. Recall and definitions

  1. † Define ocean marine and name its four classic coverages (hull, cargo, P&I, freight), saying in a phrase what each protects. (§26.1)
  2. Explain why inland marine, despite its name, is mostly about property that is not on the water. What historical accident made it the flexible, manuscript-friendly line? (§26.1)
  3. † Define aviation insurance and explain in one sentence why it is described as a "low-frequency, high-severity" line. (§26.2)
  4. Define crop insurance / MPCI and name the two roles the federal government plays in the partnership that a private insurer does not. (§26.4)
  5. Define parametric insurance and state, in one sentence, how it differs from indemnity insurance. (§26.5)
  6. † Define program business and explain what a managing general agent (MGA) does in a binding-authority program that an ordinary distributor does not. (§26.6; recall the MGA from Chapter 3)
  7. State the chapter's working definition of a specialty / niche line, and list the four conditions that can push a line into the specialty world. (§26.7)

B. The marine family

  1. For each exposure, say whether it belongs on a commercial property form (Chapter 19) or an inland-marine form, and why: (a) a fixed printing press bolted to the factory floor; (b) a bulldozer that moves between job sites; (c) fabricated steel on a flatbed truck; (d) a building under construction; (e) customers' watches in a jeweler's repair shop. (§26.1)
  2. † Explain the "movement, mobility, or instrumentalities of transportation/communication" rule of thumb for distinguishing inland marine from property, and apply it to a radio broadcast tower and to a warehouse full of finished goods. (§26.1)
  3. A broker says, "I can't get the property carrier to cover Harbor Steel's steel once it leaves the yard." Write the one-sentence answer that solves the problem, and name the coverage. (§26.1, The Underwriting File)
  4. Why is the doctrine of general average (Chapter 2) and the duty of utmost good faith (Chapter 4) especially load-bearing in ocean marine specifically? (§26.1)

C. Aviation, energy, and the large risk

  1. † Explain why aviation cannot be written the way personal auto (Chapter 14) is written. Reference the size of the pool and the credibility (Chapter 10) of any one operator's loss history. (§26.2)
  2. List four underwriting factors specific to aviation that a property underwriter would never touch, and say why each matters. (§26.2)
  3. † A corporate-jet operator has flown eight years with no claims and asks for a steep premium credit "because the record proves it's a good risk." Write the two- or three-sentence response a senior aviation underwriter would give, naming the trap. (§26.2)
  4. Explain why an oil refinery is "essentially uninsurable by ordinary means," naming the three structural problems (no pool, enormous value, exotic correlated perils) and the device the market uses to address each. (§26.3)
  5. † In energy underwriting, what is the central document that replaces the loss run, and why does probable maximum loss (PML) (Chapter 30) rather than total insured value drive the capacity and the price? (§26.3)
  6. Explain why energy is one of the most reinsurance-dependent lines in insurance, connecting the shared/layered tower (Chapter 19) to the carrier-level cession of risk (Chapter 27). (§26.3)

D. Crop and the public–private partnership

  1. † Explain precisely why crop risk fails the independence assumption of the law of large numbers (Chapter 1), and why that failure historically wiped out private-only crop insurers. (§26.4)
  2. Describe how the MPCI partnership inverts the underwriter's job relative to ordinary commercial lines. Name three places where competitive craft still lives even though rates and forms are set federally. (§26.4)
  3. Why is crop-hail insurance a private line that insurers can write profitably on their own, while multiple-peril drought/freeze coverage needs a federal backstop? (Hint: the geography of the peril.) (§26.4)
  4. † The chapter says crop "advances the theme that insurance serves a social function." Explain that claim, and connect it to the protection-gap idea you will meet again in Chapter 30. (§26.4)

E. Parametric insurance

  1. † Define basis risk in your own words and give one example where the insured suffers a large loss but collects nothing, and one where the insured collects a windfall with little loss. (§26.5)
  2. List the three weaknesses of traditional indemnity insurance that parametric coverage is designed to attack, and explain how the trigger mechanism addresses each. (§26.5)
  3. † A coastal resort with little hurricane physical damage exposure but enormous hurricane-driven revenue exposure asks what product fits. Recommend a structure, name what it can and cannot do, and state the doctrine (Chapter 4) that must still be satisfied for it to count as insurance. (§26.5)
  4. Why is parametric coverage best understood as a complement to indemnity insurance rather than a replacement? Name two situations where it clearly shines. (§26.5)

F. Program business and the MGA model

  1. † Explain the structural moral hazard (Chapter 1) built into a commission-only MGA program. Who makes the underwriting decision, who bears the loss, and why does that misalignment matter? (§26.6)
  2. The chapter calls "the program is running at a great loss ratio — let's grow it" the most dangerous sentence in specialty insurance. Explain why, using Chapter 10's trend-and-development concept. (§26.6)
  3. † List the five controls a disciplined carrier puts around a delegated-authority program. For each, say what failure it prevents. (§26.6; tie to Chapters 7 and 38)
  4. Underwrite this submission. An MGA proposes a binding-authority program for food-truck operators: a ready-built book of roughly \$15M premium, the MGA to select, rate, and bind property and GL under your paper, paid a flat 25% commission on premium with no profit-share and no retained risk. The MGA shows a 52% loss ratio over its first 18 months and projects doubling the book next year. State your decision (accept / decline / modify), the specific conditions you would attach, and how you would price it. (§26.6; Chapters 10, 38)

G. Pricing and structuring (illustrative figures)

  1. † Price this risk (parametric trigger design). You are structuring a parametric earthquake cover. Historical data (illustrative) suggests a magnitude-6.0+ quake within the trigger zone occurs about once every 50 years (a 2% annual probability), and the agreed payout is \$10,000,000. (a) What is the pure premium (expected annual cost) of the trigger payout, before expenses and profit? (b) If you load for expenses and profit at 40% of pure premium, what is the indicated premium? (c) In one sentence, what is the residual basis risk the buyer still bears at this price? (§26.5; pure-premium method from Chapter 11)
  2. Structure this (inland marine). Harbor Steel ships steel on its own flatbeds; the typical load is worth about \$120,000 and the *maximum* single load about \$400,000. Recommend a per-conveyance limit for the transit floater and explain why you would set it nearer the maximum than the typical load, and what one piece of information you would verify with the broker first. (§26.1, The Underwriting File)
  3. † Find the red flag. A submission for a "marine cargo" program covering high-value electronics moving cross-country shows: average load value \$2M, routes through known cargo-theft corridors, a 30% loss ratio in year one, and an MGA paid on commission only with authority to bind up to \$5M per conveyance with no carrier referral. Identify the three most serious red flags and what you would require before putting your paper behind it. (§26.1, §26.6; Chapters 10, 38)

H. Memo, ethics, and the Underwriting File

  1. Write the memo. In one short paragraph to your underwriting manager, recommend whether to enter the delegated-authority program in Exercise 29, stating the single condition you consider non-negotiable and why. Keep it to the structure of a real referral note. (§26.6)
  2. † Ethics dilemma. A government in a hurricane-exposed developing nation wants parametric disaster cover so it can pay for relief within days of a storm. Your modeling shows the most affordable trigger leaves meaningful basis risk: in some severe-but-just-below-threshold storms, the country would suffer badly and collect nothing. The broker urges you to sell the cheaper structure and "not overcomplicate the pitch." What is your obligation regarding disclosure of basis risk, and how do you reconcile the social-function value of fast disaster cash (§26.4, §26.5) with honesty about the product's limits? (§26.5; Chapter 1, theme 6)
  3. The Underwriting File — extension. Suppose Harbor Steel begins importing specialty steel alloys by sea from an overseas mill. (a) Name the coverage now required and which marine family it belongs to. (b) List three new exposures the ocean voyage introduces that the inland-transit floater never had to consider. (c) Explain why utmost good faith (Chapter 4) becomes more demanding once the cargo is on the ocean. (§26.1, The Underwriting File)
  4. The Underwriting File — judgment. The chapter added an inland-marine sublimit for Harbor Steel's steel in transit and contractors' equipment, but flagged that "the values must be verified." Explain why an agreed-value, all-risk inland-marine form makes verifying the schedule more important than it would be under a coinsurance-based property form (Chapter 19), and what could go wrong at claim time if the schedule is stale. (§26.1, The Underwriting File; Chapters 12, 19)

I. Synthesis

  1. † Across marine, aviation, energy, crop, parametric, and programs, name the single problem they all confront and the different solution each one uses. Then state, in one sentence, what this pattern implies about whether specialty underwriting will be automated (Chapter 36). (§26.1–§26.7)
  2. The chapter argues specialty underwriting is among the least automatable corners of the profession. Build the strongest counter-argument (where could data and models encroach — think crop and parametric), then rebut it. (§26.4, §26.5, §26.7; Chapter 36 preview)
  3. Choose any two specialty lines from this chapter and explain how each one would interact with the combined ratio (Chapter 3) differently over a ten-year cycle than a stable line like small-commercial BOP (Chapter 20). Why does "judged over the cycle, not the quiet year" matter more in specialty? (§26.7; Chapter 3)
  4. † A colleague says, "Specialty is just regular underwriting with bigger numbers." Using at least three specific lines from the chapter, explain what that view gets wrong about why specialty is genuinely different — not just larger. (§26.1–§26.7)