Fundamentals of the Insurance Business

The first chapter offers an overview of how insurance originated and evolved. Historically, mutual solidarity has been the foundation of the concept of insurance: giving mutual assistance to the needy, indemnification for those suffering injuries from an economic damage, group solidarity in marine traffic etc. From the tenth century the European population began to grow rapidly for at least three centuries so there was a significant growth in maritime traffic in the Mediterranean. One consequence was the birth of the first insurance contracts which responded to the need for protection against the risk of loss of cargo or ship during shipments. The first pre-insurance legal institutions were loans of maritime exchange (bottomry) and contracts of commenda. The forms of mutual solidarity described above represent archaic forms of insurance, and in the fourteenth century, there was the passage from mutual insurance to insurance for a premium. Since then and up until our time, four stages can be identified that mark out the development and sophistication in covering insurance needs over the course of time: the development of traffic and maritime routes, the growth in overland commerce, the expansion of urbanization and the effects of the first industrial revolution. The final paragraphs describe the different historical development of life insurance.

This chapter introduces the concept of risk. Many definitions have been offered to explain what is meant by risk in the literature. Notion of probability is described and differences between classical (or mathematical) probability, statistical (or frequentist) probability and subjective probability are explored. The information asymmetries between the insurer and the insured are defined. The reader can learn the definition and examples of adverse selection; morale hazard and moral hazard. In the paragraphs, it is explained that everyone has their own risk appetite. Based on to the utility function of Von Neumann–Morgenstern it is possible to determine the behaviour of individuals according to their attitude towards the benefit/result obtained. Behavioural finance and cognitive psychology on decision-making processes in conditions of uncertainty shown how often the consumer, in complex situations, makes choices based on simplified judgement mechanisms.

This chapter aims to explain how insurance works. The insurance undertaking offers insurance cover to an insured and receives a premium by way of counter performance. Differently from other productive sectors, the insurance sector also plays a delicate social role. The basic function of an insurer consists in fact of increasing the security of persons and undertakings by protecting individuals and society against risks. This applies both in respect of events or situations that are unknown and unforeseeable, that relate to old-age pensions and healthcare insurance given the tension there is a number of state public accounts. The equilibrium of an insurance undertaking is based on the economic and financial issues of management. This equilibrium changes over time as the make-up and trends of a portfolio of risks that an undertaking has built up over years is subject to variation. Finally, an insurance undertaking is subjected to several risks as it carries on its business: technical actuarial risks, financial risks and business risks.

The chapter aims to explain the main sources of insurance legislation in Europe. The first paragraphs offer the overview of the evolution of the insurance legislation, as the current structure of legislation in the insurance industry is the outcome of a long process of European harmonising started with the Treaty of Rome in 1957. As explained in the chapter, the European approach of discipline of the insurance industry had been first developed over three issues of directives (freedom of establishment, freedom of services and home country control), and more recently developed in a definitive set of regulations in four macro-areas: customer protection and distribution of insurance products, risk control and corporate management, supervision of insurance undertakings and pension provision.

In this chapter, the reader can understand the models for macro and micro-prudential supervision in the European financial market. In the sector, locally we can observe different examples based on focus by subject, objectives, single supervision etc. The European system of financial supervision is the result of a long path, started with the Lamfalussy reform. That framework has been replaced by the new reform de Larosière. The de Larosière reform introduced the current architecture of European financial supervision. Based on this, the existing European system of supervision of financial services in Europe foresees a European Systemic Risk Board (ESRB). Near to this, three European Supervisory Authorities (ESAs): European Banking Authority (EBA), European Insurance and Occupational Pensions Authority (EIOPA), European Securities and Markets Authority (ESMA) were instituted. For each of them the following paragraphs describe in detail the bodies, the functions, the organization, the powers and the mission.

In this chapter, the fundamental aspects of insurance business are explored. The main rules governing the authorisation and carrying on of insurance business are described. The aspects concerning the legal form (corporate form, European company etc.) are deepened. The authorisation procedure and related activities (scheme of operations, single authorisation, cross-border business, registry etc.) are explained. The reader can understand the classification of risks according to classes of insurance underlying the lines of business (LoB), as required by the European legislation. Then, the classes of risks (for life and non-life) and the related classification are illustrated in detail. The following paragraphs illustrate the three fundamental pillars to understand the functioning of the insurance industry: solvency margin, technical reserves and investments in accordance with the directive in force. The legal discipline of equity investments, of an insurance group, and financial conglomerates is described. At the end, extraordinary events (mergers and spin-off) and the crisis management of an insurance undertaking are explained.

In this chapter, the contract of insurance is explained. The differences existing between a non-life insurance contract and a life insurance contract are explored. The obligation foresees that an insurer undertakes a risk in return for consideration in the form of an insurance premium. An assured is obliged to the payment of the premium and for the truth and accuracy of the information given.In non-life insurance contract, the settlement of a claim is bound by an indemnity principle according to which the insurer will pay only if the loss occurs and to the precise extent this is suffered by the assured. In life insurance contract, the insurer will pay a lump sum or an annuity upon the occurring of an event tied to the life of the assured. The involved parties (insurer, policyholder, assured and beneficiary) are explained.Contractual documentation foresees some standard documents, such as proposal form, acceptance, policy, scheduled, endorsement, certificate of insurance (if required Health History Questionnaire (HHQ).In the end, the current developments in Europe are illustrated. The paragraphs describe the life product classification (PRIIPs, IBIPs, PRIPs) and the related new pre-contractual documents required (KID and IPID for non-life business).

This chapter illustrates the main life insurance products. Different types of cover have been divided into four macro-categories, based on the individual’s needs, and the characteristics of each are described: 1. Covers for the risk of death include “traditional” life insurance policies with death benefit: ordinary life insurance, Term life insurance and decreasing term policy. 2. Accumulation and savings consist of two main areas: life insurance products for family planning and financial insurance products. 3. Retirement provision products describe pension funds and Pan-European Pension Product (PEPP). Capitalisation system and PAYGO system. 4. Protection of health places special focus on health policies similar to life products (SLT Health), based on the duration of the covered risk. Serious illness (Dread Disease), Long-term care (LTC) and Activities of Daily Living (ADLs). A special section describes the insurance products for professional investors, such as Portfolio bonds (or wrapper products), Reverse Mortgage (or Equity release), impaired life annuity (or enhanced annuity), preferred lives, Longevity bonds, Constant Proportion Protection Insurance (CPPI). Finally, the classifications of PRIIPs insurance products and IBIPs are illustrated.

This chapter describes the non-life insurance products for individuals and families. For a better understanding, types of cover have been divided into five macro-categories and description provided: 1. Personal accident and sickness insurance includes personal accidents, healthcare and care of dental treatment; description of wearable device and Internet of Things (IoT) included. 2. Insurances on the property consist of fire, theft, cover for household appliance. 3. Liability insurance describes civil liability protection and actions brought by a party against the assured for alleged torts or breaches of contract. 4. Personal automobile insurance includes civil liability (or Motor TPL) and property covers. The section also describes the variables for determining the tariff, property covers for damage, principles for damage indemnified and telematic services. 5. Homeowners insurance is a comprehensive insurance (i.e. All-risk policy) covering risks that might strike the home and family, including the Internet of Things (IoT) and related smart devices. Finally, a miscellanea of risks is illustrated (i.e. unemployment insurance, travel insurance, pet insurance and Condominium insurance). Concerning reimbursement, different formulas are explained. Replacement cost value (RCV), Actual Cost Value (ACV), Current market value (Open Market Valuation OMV).

This chapter illustrates insurance products for commercial line. For a better understanding, types of cover have been divided into four macro-categories and described. 1. Property and Liability. Property includes insurance for damage to property (i.e. Fire, Theft, Property, “All Risks” coverages C.A.R. and E.A.R). Liability includes insurances for Businessowner liability, Employers’ Liability, Product Liability and Product recall, insurance product covering environmental pollution risk, Professional indemnity and Directors and Officers (D&O). 2. Marine, Aviation and Transport (MAT) includes covers for commercial transportation both for damage to hulls (vessels or airplanes) and damage to goods carried and liabilities of the parties concerned. 3. Business credit and Surety bond. Business credit offers protection against the risk of debtor insolvency. Surety bond meets the need of an enterprise to back a commitment received by a party identified as assured. Policies can be divided based on the subject matter of the obligation. 4. Covers for employees mainly include products concerning the protection of employees of an enterprise (accident, key person dead, reimbursement of a loan granted by a credit institution to a firm itself and cover for business trips).

This chapter explains the approach for calculating a non-life insurance premium. The reader can follow the pricing procedure step by step. The method begins from the frequency of an event occurring and the average cost of loss events. These two factors contribute together to defining the first step, also called an equitable premium. A safety loading is then added to this first kind of premium. This kind of premium is defined as net premium and is the basis of insurance technique. During this chapter, other safety loadings are presented that by way of addition are added to the net premium. Each of these safety loadings has the purpose of covering management expenses and acquisition costs of contracts. At the end of this addition operation, it is possible to know the final value of the premium. In the paragraphs that follow, each of these components is analysed in detail. Multivariate analysis in determining the premium is explained: from the frequency to the equitable premium, from safety loading to additional charges, illustrating with simple examples the process adopted for their formulation.

In this chapter, the reader can learn the concept of an insurance claim. Starting from this notion the run-off triangle is explained, i.e. the scheme representing claims that underlies the estimation of reserve amounts. The following paragraphs present reserve valuation methodologies, distinguishing between deterministic and probabilistic or stochastic methods. Deterministic methods are based on forecasting the value of the claims reserve through a projection into the future of expected costs, and using assumptions inferred from time series. In the course of the discussion, among the most important ones are presented: grossing up, chain ladder method and Fisher Lange method. In addition, the main outlines of Taylor’s separation method and the method of Bornhuetter and Ferguson are described. The stochastic methods are based on a probabilistic distribution of results. These include the Mack method, GLM models and bootstrapping. In the end, the evaluation principles for premium technical reserve are explained.

The aim of this chapter is to explain the calculation of insurance premium in life insurance. The premium is determined by two factors: financial factor and demographic factor. The financial factor depends on the expected value of the economic disbursement foreseen when an event occurs. This event is based on the duration of human life, due to death or survival of one insured. Additionally, it takes into account the interest generated between when it is paid and when any performance is met. The demographic factor is based on mortality tables, which contain the rate of mortality and likelihood of survival. The combination of these two factors defines the first level of premium. A safety loading is then added to this premium. Then further explicit loadings are charged. They have the purpose of covering management expenses and acquisition costs of the contracts. In the paragraphs that follow, the classification of life insurance on the basis of performance is explained. The actuarial formulas for Capital performance insurance products (term life and deferred capital) are explained. In the end, the actuarial formulas for annuity insurance products are detailed.

This chapter explains the concept of life technical reserves. In the life business, the generic reference made to technical reserves includes various types of reserves, among which the mathematical reserve is the most significant. The mathematical reserve expresses a debt towards assureds under contracts issued in the past for performances that may still be demanded by assureds in the future. At the beginning of the discussion, the principle of equivalence between premiums and performances is illustrated. The three methods for calculating the mathematical reserve are presented: the prospective method, the retrospective method and the recurring method. For each method, the actuarial formula are described. In the paragraphs that follow, for better comprehension, the progress of the mathematical reserve over time graphs are illustrated.Then, the components of the reserves for future expenses are described in the last part of the chapter. Reserve assessment criteria are illustrated in the final part.

The chapter starts with the definition of with-profits life insurance products. These products foresee an annual increase in the capital sum or annuity insured through awarding part of the profits earned from the investment of assets in funds. The formula of the actuarial equilibrium of performance is explained. In the following paragraph, the reader can learn the three elements distinguishing a with-profits contract. They are the technical rate, the minimum guaranteed return and the profit-sharing clause. At the end of the chapter, a numerical demonstration is offered for ease in comprehending the mechanics of how the revaluation of performances works.

This chapter explains the components of profit for life insurance products. The components of profit are four: demographics, financial, surrender and expense loadings. Regarding the realistic assumptions for expected mortality and the expected rate of interest, the actuarial equilibrium is demonstrated by the Kanner equation. In the following paragraph, the Homans formula is analysed in detail. This equation breaks down the insurance profit into demographic profit and financial profit. Then the reader can learn the factors underlying profit for surrender and expense loading. In the chapter, a numerical demonstration is offered for ease in comprehending the mix and the importance of each component in forming expected profit. Several graphs are presented to increase the reader’s understanding. At the end of the chapter, the concept and formula of the profit margin are explained. The profit margin is a measurement tool for the expected profit from a life insurance product, typically a newly issued one.

This chapter aims to introduce reinsurance and explain how it works. The paragraphs describe the nature of reinsurance that may be divided into outwards reinsurance and inwards reinsurance. The reader will understand the types of contracts for treaties. The contracts can be put into two categories: facultative reinsurance, obligatory reinsurance. In the paragraphs that follow, the methods of transfer of risks and losses are described. Reinsurance makes a distinction depending on whether the method is proportional or non-proportional. Each type of reinsurance is analysed in detail with numerical examples and graphs. Proportional reinsurance (Quota Share reinsurance and Surplus reinsurance) takes place through a sharing of risks, whereas non-proportional reinsurance (Excess of loss reinsurance and Stop loss reinsurance) is based on the reimbursement of the loss suffered. Then, the process of reinsurance in an insurance undertaking is presented. At the end of the chapter, coinsurance is described.

This chapter aims to illustrate the business models of the insurance industry. There are five business models for insurance undertakings in the insurance industry: an elementary structure, a functional structure, a divisional structure, a matrix structure and a network structure. Each of these five structures has its own peculiarities and related advantages and disadvantages. Alongside the five models shown, a hybrid structure is also illustrated, and which arises from combining those that already exist. Furthermore, the new "insurtech" business model that is changing the traditional approach is described.Dealing with these continues by explaining the concept of process is explained. We then move on to a description of the value chain. This model allows us to describe the structure of an organisation as a series of processes and activities (primary and supporting) that are linked together. Primary activities contribute directly to creating an output, whereas supporting activities do not contribute directly to creating an output but are rather needed for this to be produced.Finally, the chapter concludes by dealing with the IT system of an insurance undertaking. This is presented as a series of information technologies, IT infrastructure and applications that allow the activities and processes of an insurance undertaking to be managed in an automated fashion.

This chapter begins by defining an organisational chart. This chapter describes in detail the activities and roles played by each of the components of the organisational structure. It commences with a description of the governing body. After this, two other types are described: the organisational units of coordination and direction and staff organisational units. The former oversees the achieving of strategic guidelines defined by Top management. The latter deal with managing relations outside the insurance undertaking with bodies and institutions.Special attention is given to describing the activities performed by the functions of control, which inquire into actual achieving of the objectives set by the apex through monitoring the various activities of the undertaking.Lastly, service organisational units, technical insurance organisational units and commercial-distribution organisational units are described.Finally, the activities and tasks of coordination committees and which watch over collegial decisions, mainly of a technical and institutional kind, are explained.

This chapter aims to illustrate the process of product development and launch. This process can be split into six stages: identifying the product concept, defining the macro-structure and model of the product, product realisation, internal validation of the product, presenting the product and sharing it with channels, final release of the product in the industry. In the following paragraphs, we provide the details of the activities. At the end of the chapter, we describe the recent regulation Product Oversight Governance—POG. Nowadays the process of developing and launch of a product must abide by what is laid down under the new regulations. For the first time, lawmakers have defined rules for a new system of governance and monitoring of the process of product development in the insurance industry.

The aim of this chapter is to illustrate the process of underwriting risks and issuing policies. The standard process is made up of the following five stages: Acquisition information and consideration of Demand & Need quotation, processing a proposal, verification/waiver of underwriting limits, policy issuing and premium receipt.The activities that relate to three different types are illustrated: the process for non-life retail and life insurance products, the process for industrial risks and, the process for standard contracts sold via the bankinsurance channel or distance marketing. Each of these three processes has a number of differences as compared to each other.After the introduction of the IDD regulations, the traditional commercial approach has changed so as to place far greater emphasis on preliminary assessment of requests from customers and their level of knowledge and awareness.In the case of industrial risks, the process of underwriting and quotation of related risks are not standardised. Each risk has to be assessed specifically.In the process of underwriting standardized contracts, no tariff waiver is foreseen.Lastly, the two main post-sale operations tied to the underwriting cycle are explained: the renewals and the technical and administrative endorsements.

The chapter aims to illustrate the complementary nature of technical insurance management and asset-financial management. The overall profitability of an insurance undertaking depends on a synergy being found between technical insurance management and the financial wealth management.Transactions relating to asset management may conceptually be split into two logical moments: one is the asset management and the other is release disinvestment to meet claims or surrenders.By investments we mean special kinds of transaction through which a long-term deployment of substantial volumes of financial assets are made in order to achieve a flow of economic returns over periods of varying length.The investments of an insurance undertaking meet three fundamental requirements: profitability, security and liquidity. Diversification is a way in which the right combination of these requirements can be found.Typical investment and disinvestment processes can be split into six stages: Strategic planning—strategic asset allocation (SAA), Investment Portfolio build-up, Tactical Asset Allocation (TAA), Negotiation, Monitoring and benchmarking and Administration management.Within the process of investment and disinvestment, treasury has a responsibility for managing corporate liquidity. It deals with all issues tied to money flows, incoming and outgoing, as well as cash needs and relative applications.

This chapter has the purpose of explaining the process of managing loss events. In detail, the process of managing loss events is the process through which an insurance undertaking fulfils the obligations taken on vis-à-vis an assured. In life business, it delivers a reimbursement of the performances foreseen, while in performances foreseen, while in non-life business, indemnification for the loss event is the same as the claim.In what is dealt with in this chapter, the management of a loss event for various types of insurance products is illustrated. The management of a property protection product is explained (for example, a claim under a homeowner insurance). Focus is placed upon the opening and management of Automobile Liability loss events.Special focus is placed on the procedure for opening and dealing with an Automobile Liability claim, as certain further items of information must be provided.Lastly, the chapter explains the manner of reimbursement under a life policy. . Concerning this reimbursement, two procedures are in place: settlement of the lump sum in the event of decease, or reimbursement following a request for surrender (partial or total) of a life insurance product.

This chapter aims to illustrate the meaning of marketing and the marketing of services. Insurance marketing takes into account the fact that the main insurance performance is the taking on of a risk insured in return for an insurance premium and settling a loss or paying annuities/lump sum upon the occurring of a chance event. A definition of marketing is illustrated, i.e. forming competitive strategies for an insurance undertaking oriented towards acquiring, developing and keeping a competitive advantage over competing insurance undertakings over time.In later paragraphs, the difference between external and internal marketing is explained.Then, a definition of communications is provided, and its tools are illustrated, such as, advertising, promotion, the sales channels and public relations.In the final part of the chapter, the new frontier of marketing is presented, tied to the social world and new techniques of non-conventional marketing. The concept of Customer Relationship Management (CRM) is explained. Lastly, recent experiments in integrating insurance covers and digital services are illustrated. The chapter closes with a definition of Customer Experience and Customer Journey in the insurance services.

The chapter aims to lead to an understanding of the role played by an insurance intermediary. Indeed, intermediation consists of facilitating the meeting of demand for and supply of insurance covers in the industry.It is explained that in this directive the guarantee of transparency on the part of distributors, both in terms of costs and disclosures on risk/effective cover of products distributed, is of great importance Lawmakers require, additionally, that a distributor bears in mind the demands and needs of consumers and that monitoring takes place in the period after sales in order to check that the product sold is actually adequate to meet these.Then, four sets of delegated regulations implementing IDD regulations are explained: PRIIPs—Packaged Retail Investment and Insurance Products; (I)PID—Insurance Product Information Document; POG—Product Oversight Governance, i.e. governance of the insurance offering; IBIPs—Insurance Based Investment Products.After this, distribution channels through which insurance undertakings make their products available on the market directly via dedicated owned sales structures or making use of insurance intermediaries are illustrated.

The aim of this chapter is to explain the implementation of European directives concerning the representation of accounting records in the insurance industry. The legislator, taking into account the normative experiences of the single countries, has tried to reconcile opposing demands of the parties concerned with insurance financial statements.In the following paragraphs, the reader can learn the accounting principles. The Local Generally Accepted Accounting Principles (Local GAAPs) are defined. Then, the IAS/IFRS principles are illustrated. For easing in the comprehension, a comparison of the main Local GAAPs versus IAS/IFRS principles has been performed.The principles for drawing up financial statements are explained: principle of formal clarity and transparency, principle of continuity (or going concern), principle of prudence, principle of accrual, prevalence of substance over form, principle of materially, consistency principle.At the end, the components of the financial statements, in accordance with IAS 1, are described: statement of Financial Position, single Statement of Profit or Loss, statement of Other Comprehensive Income, statement of changes in equity for the period, statement of Cash Flows, explanatory notes containing a summary of accounting policies.

This chapter aims to illustrate the IAS/IFRS historical development and the requirements for consolidated financial statements. The historical development of this evolution is described in the paragraphs (i.e. the transformation from IAS to IFRS principles).The Regulations of the European Community no. 1606/2002 have been illustrated. These regulations lay down the new rules introducing IAS/IFSR in the insurance industry with effect from 2005.In accordance with IFRS 10, which defines the consolidation area, in the chapter, the area of consolidation is illustrated.IAS 1 provides the components for drafting up consolidated financial statements. They are consolidated balance sheet, consolidated statement of profit or loss, consolidated statement of comprehensive income, consolidated statement of changes in equity, consolidated statement of cash flows.Obligatory templates for drafting are consolidated Balance Sheet, consolidated statement of profit or loss, consolidated statement of comprehensive income, consolidated statement of changes in equity and consolidated statement of cash flows.

This chapter aims to illustrate the main impacts of IAS/IFRS standards on an insurance undertaking. In the paragraphs that follow the impacts deriving from IAS/IFRS are described in detail.IAS 39 defines the main changes concern the introduction of new rules of classification, and measurement of financial instruments.IFRS 9, replacing the IAS 39, foresees new classifications and different measurement criteria for assets.IFRS 7 gives the requirements for disclosure in the matter of financial instruments.IFRS 4 governs the measurement criteria for insurance contracts and relative technical components.IFRS 17 introduces a new measurement model of an insurance contract, replacing the IFRS 4.IAS 38 applies to all intangible assets included within its area of application (with some specific exclusions).IAS 36 requires an analysis being made of possible losses of value for all intangible assets.IFRS 3 foresees business combination transactions, for instance, control obtained of one or more corporate assets.IAS 12 governs the criteria for accounting of income taxes.IFRS 8 requires an entity to provide information allowing to assess the nature and effects on the financial statements of the business activities.

This chapter aims to describe the new approach introduced by European regulations Solvency II. This Directive defines the new criteria for the calculation of solvency margin for an insurance (and reinsurance) undertaking. The new system has three pillars. The first pillar quantifies the capital cover for meeting risks. The second pillar aims to arrange an internal organisation and the adoption of a series of behaviours consistent with a holistic view of risk management. The third pillar discloses the insurance undertaking’s operation transparently to the market.Regarding the first pillar, the reader can learn the steps required by the directive for: (1) calculation of solvency capital requirement (SCR) based on the risks foreseen by the EIOPA’s framework; (2) determination of Own Funds (OF) which are the capital available for covering the SCR; (3) calculation of solvency ratio which is the fraction between OF and SCR (this ratio must be greater than 1.0).The second pillar illustrates a system of governance based on the concept of risk management linked to governance and risk monitoring.The third pillar explains the use of information required for monitoring the actual state of solvency and financial stability overall of the insurance undertakings.

The aim of this chapter is to provide a practical case for easing the reader to understand, step by step, the SCR calculation.The paragraphs begin with a numerical example. A complete financial statements drawn up with IFRS data is the starting point. In order to allow the comparison with Solvency II, these statements are adjusted and transformed into Solvency II’s principles. The deltas are highlighted.In paragraphs that follow, the value of the SCR is determined via a series of stress tests applied to the value of financial statements. The reader can learn, formula by formula, the detailed procedure for the SCR calculation. The approach is based on the standard formula. A detailed explanation for each type of risk (market risks, underwriting risk, life risk, non-life risk, health risk, counterparty risk, aggregation) is provided.

In this chapter, the reader can learn the definition of Asset Liability Management (ALM). Then the paragraphs that follow describe how the embedded options work for an insurance undertaking. An explanation about the factors underlying the ALM models is provided (1. Amount of present and future cash flows, in terms of asset and liability; 2. Variance between asset and liabilities in terms of size and duration and 3. Effect of the rate of interest).ALM models are based on two possible alternative approaches: deterministic approach or stochastic approach. The second one needs a generation of a large number of economic scenarios. These scenarios can be of natural probability (or Real World) or risk neutral. In the first case, the scenarios are calibrated on historical economic data and reflect market volatility. In the second, the scenarios exclude any risk premium and are determined based on the assumption that there is no arbitrage.Replicating portfolios approach is a technique that provides that two available titles can be combined at any time together to constitute a portfolio that reproduces the performances of other structured securities (derivatives). Based on this concept, a passive contract can be modeled by building a portfolio consisting of an opportune combination of two securities.

The aim of this chapter is to explain the Embedded Value (EV) method. The related components: Appraisal Value (AV) and Net Asset Value (NAV) are described. The transition versus a new method, European Embedded Value (EEV), is illustrated. The essential difference as compared to the traditional calculation of Embedded Value lies in the calculation of the VIF, which is adjusted through the value of the options and guarantees that are implicit in the portfolio. Then, the more sophisticated method, Market Consistent Embedded Value (MCEV) is represented. In the paragraphs following, to make easier the comprehension, a numerical example is provided. Starting from three hypothetical insurance undertakings, A comparison between TEV, EV and MCEV is performed. The example shows three different impacts on the capital requirement.In the following paragraphs, the chapter introduces the concept of New Business Value (NBV) and of Annual Premium Equivalents (APE). An indicator for Embedded Value (ROEV) is illustrated. At the end of the chapter, the model for determining Goodwill is explained.

This chapter has the purpose of explaining the importance of management control within a modern insurance undertaking.Starting from the generic definition of cost, costs by type are illustrated. Three possible classifications are considered: fixed versus variable costs, direct versus indirect costs and standard versus effective costs. In addition, the difference between configurations of direct cost and full cost is explained.The passage from costs by type to cost per intended use takes place thanks to the concept of a centre of responsibility. This centre can be further classified into centre of cost, centre of revenue and centre of profit. Continuing along this line of thinking, cost centres in their turn are classified on the basis of their characteristic activity: centre of organisational costs, centre of project costs and centre of pooled costs.Finally, the three procedures to determine a full cost (attribution, allocation and imputation of costs) are explained.At the end of the chapter, the methods of Activity-Based Costing (ABC) and Activity-Based Management (ABM) are illustrated. They represent a different way than the traditional one for attributing, allocating and charging costs.

This chapter aims to explain the system of Key Performance Indicators (or KPI), for the insurance undertaking and the industry. The reader can learn a detailed explanation (with the related formulas) of the economic indicators. For non-life business they are loss ratio, expense ratio, combined ratio, profitability of sales etc. For life business, specific indicators are considered (annual premium equivalent—APE, single premium equivalent—SPE, new business margin—NBM, expense ratio, expense for asset under management—AUM). The indicators for technical reserves are analysed (i.e. Reserve ageing ratio and congruency of reserves index).The profitability is analysed with the Return On Equity (or ROE). This economic index of profitability is explained in detail. The related formulas are explored in depth. It is divided into technical financial margin and profitability from investments on free capital. Then, the indicators of capitalisation, the solvency ratio and the indicators for the reinsurance area are illustrated. The performance indicators for technical and claims area are explained with numerical examples. For instance, a comparison between the ratio in the claim area is provided.

This chapter has the purpose of explaining the preparation of the Business Plan for an insurance undertaking.Drawing up a Business Plan foresees an analysis being carried out in five stages: 1. Opportunity assessment; 2. Strategy and vision definition; 3. Business model; 4. Economic and financial analysis (also called Business case) and 5. Master plan. Each of these stages is illustrated in detail and practical examples are provided.A methodology for preparing the Business case is described: The approach for the business case based on a logic tree is illustrated in detail, step by step.The two different alternative approaches used for preparing the budget: Zero-Based Budget (ZBB) and Continuity-Based Budget (CBB) are presented.At the end, a number of main templates for the budget of an insurance undertaking are presented: a sales Budget, an overhead costs Budget, a personnel costs Budget, a Budget for the ICT area and a Budget for the Finance area, etc. For each of them, the templates and the related tables are described in depth.