4. Prudential Regulation and Solvency

Introduction and Context

Insurance is a promise to make payments in the future in exchange for premiums received today. The promise may relate to death, illness, disability, property damage, liability, longevity, or other uncertain events. Because policyholders usually cannot observe the insurer’s financial condition directly, insurance markets depend heavily on confidence. Prudential regulation exists to protect that confidence by ensuring that insurers identify risks, hold adequate financial resources, invest responsibly, maintain liquidity, and continue to meet obligations under adverse conditions.

Prudential regulation differs from conduct regulation. Conduct regulation focuses primarily on how an insurer deals with customers, including product design, disclosure, sales practices, claims handling, and complaints. Prudential regulation focuses on the insurer’s financial soundness. The two are connected: an insurer that fails financially may be unable to pay legitimate claims, regardless of the quality of its customer-facing policies.

Solvency is the central concern of prudential supervision. In broad terms, an insurer is solvent when the value of its assets is sufficient to meet its liabilities and required capital buffer. This apparently simple idea involves difficult questions. How should future claims be valued? Which assets should be recognised? How much capital is appropriate for catastrophe, market, credit, operational, and insurance risks? How should the regulator respond when an insurer’s financial position deteriorates but the insurer remains technically solvent?

This chapter examines the main concepts, tools, and managerial implications of prudential regulation and solvency. It considers technical provisions, solvency margins, risk-based capital, asset eligibility, investment restrictions, asset–liability management, liquidity, stress testing, internal models, governance, and emerging regulatory developments.

Learning Objectives

After studying this chapter, the learner should be able to:

1. Explain the purpose and scope of prudential regulation.

2. Distinguish assets, liabilities, technical provisions, available capital, and required capital.

3. Evaluate solvency margins and risk-based capital frameworks.

4. Assess the importance of asset eligibility, investment limits, diversification, and matching.

5. Analyse asset–liability management and insurer liquidity.

6. Interpret stress testing, scenario analysis, and internal models.

7. Identify governance, ethical, technological, and supervisory issues in solvency management.

8. Apply prudential concepts to an insurer case and recommend appropriate management action.

The Logic of Prudential Regulation

Insurance creates a distinctive regulatory problem because insurers collect premiums before providing protection. The time between receiving a premium and paying a claim may be short in motor insurance, several years in liability insurance, or many decades in life and annuity business. During this period, the insurer invests premium income and must estimate uncertain future payments.

Three features make prudential supervision necessary. First, insurance liabilities are uncertain. Claims frequency, severity, mortality, morbidity, lapse rates, inflation, legal decisions, and economic conditions may all differ from expectations. Second, policyholders may be unable to assess the insurer’s risk-taking or financial strength. Third, failure can have significant social and economic effects, especially where insurance is compulsory or essential to household and business security.

Prudential regulation therefore pursues several objectives:

• protection of policyholders and beneficiaries;
• maintenance of confidence in the insurance sector;
• prevention of excessive risk-taking and regulatory arbitrage;
• promotion of sound governance and risk management;
• early intervention before financial distress becomes irreversible; and
• preservation of financial stability where insurers are interconnected with banks, capital markets, or critical economic activities.

Regulation does not seek to eliminate all possibility of insurer failure. Capital is costly, risks cannot be predicted perfectly, and excessive conservatism may make insurance unavailable or unaffordable. The regulatory task is to establish a credible level of resilience while allowing insurers to innovate and compete.

A Balance-Sheet View of Solvency

The basic solvency relationship can be expressed as:

Available capital = admissible assets − technical provisions and other liabilities

An insurer is normally required to maintain available capital above a prescribed solvency requirement. A simple solvency ratio is:

Solvency ratio = available capital / required capital × 100

For example, if an insurer has available capital of 180 million and a required capital amount of 120 million, its solvency ratio is 150 per cent. The ratio alone, however, is not a complete measure of strength. The quality of capital, the reliability of asset values, the appropriateness of reserves, the insurer’s liquidity, and the volatility of its risks must also be examined.

The balance-sheet approach requires careful classification of four elements. Assets include cash, government securities, corporate bonds, equities, real estate, loans, reinsurance recoverables, and other investments. Liabilities include claims payable, policyholder benefits, expenses, borrowings, derivative obligations, and technical provisions. Technical provisions represent the present value of expected future insurance obligations, including an allowance for uncertainty where required. Available capital is the residual financial resource that absorbs unexpected losses. Required capital is the amount judged necessary to withstand specified adverse events or a defined level of risk.

A crucial distinction is between expected and unexpected loss. Technical provisions are intended primarily to cover expected obligations arising from existing contracts. Capital protects policyholders against adverse deviations from those expectations. If reserves are understated, the apparent capital position is overstated. Consequently, capital adequacy cannot compensate indefinitely for poor reserving.

Technical Provisions: Measuring Future Obligations

Technical provisions are among the most important and judgement-sensitive elements of an insurer’s financial statements. They commonly include a provision for reported claims not yet settled, a provision for claims incurred but not reported, and provisions for future benefits under life and long-term contracts. Depending on the legal and accounting framework, provisions may also include premium provisions, policyholder options, guarantees, expenses, and risk margins.

The valuation process generally involves the following steps:

1. Identify the contracts and obligations within the valuation boundary.

2. Project future cash inflows and outflows.

3. Estimate claim frequency, severity, mortality, morbidity, expenses, lapses, and other relevant assumptions.

4. Discount future cash flows where the regulatory framework requires discounting.

5. Allow for uncertainty, diversification, and a risk margin where applicable.

6. Review the results through actuarial, financial, and governance controls.

For general insurance, reserving methods may include the chain-ladder method, Bornhuetter–Ferguson method, expected loss ratio method, and stochastic reserving approaches. The chain-ladder method extrapolates historical development patterns, whereas the Bornhuetter–Ferguson method combines prior expectations with emerging claims experience. No method is universally superior; the appropriate method depends on data quality, line of business, claims maturity, inflation, and structural changes.

For life insurance and annuity business, the valuation is strongly influenced by mortality, longevity, discount rates, expenses, surrender behaviour, guarantees, and policyholder options. A guaranteed annuity rate, for example, may create substantial liability sensitivity when interest rates fall or longevity improves.

Reinsurance affects technical provisions but does not remove the insurer’s direct obligation to policyholders. Reinsurance recoverables must therefore be assessed for collectability, concentration, collateral, counterparty quality, and timing. A technically profitable insurer can experience financial stress if a major reinsurer delays or fails to pay recoveries.

Professional judgement is unavoidable, but it must be controlled. Assumptions should be documented, justified, independently reviewed, and regularly compared with actual experience. Deliberately optimistic assumptions, inadequate claims development, or delayed recognition of deterioration are serious prudential failures.

Solvency Margins and Risk-Based Capital

Traditional solvency regimes often require an insurer to maintain a minimum solvency margin, calculated as a percentage of premiums, claims, mathematical reserves, or another volume measure. Such rules are relatively simple and transparent, but they may treat insurers with very different risk profiles alike. Two insurers with the same premium volume may have different catastrophe exposures, investment risks, reinsurance structures, and operational controls.

Risk-based capital frameworks address this weakness by linking capital requirements to the risks actually undertaken. A simplified capital model may include:

• underwriting risk capital;
• market and investment risk capital;
• credit or counterparty risk capital;
• operational risk capital; and
• adjustments for diversification, correlations, or risk mitigation.

Underwriting risk arises from inaccurate pricing, adverse claims experience, catastrophe events, expense escalation, and inadequate reserving. Market risk includes changes in interest rates, equity prices, property values, foreign exchange rates, and credit spreads. Credit risk concerns the failure or deterioration of reinsurers, bond issuers, intermediaries, banks, or other counterparties. Operational risk includes failures of systems, processes, people, controls, legal arrangements, or external events.

The aggregation of risk modules is not merely an arithmetic exercise. If risks are perfectly correlated, diversification provides little benefit. If correlations are estimated from limited historical data, the resulting capital requirement may be unreliable. Regulators therefore impose prudential floors, supervisory review, and restrictions on the recognition of diversification benefits.

Capital should also be assessed by quality. High-quality capital is permanent, readily available, and capable of absorbing losses while the insurer remains a going concern. Lower-quality forms may include subordinated instruments, deferred tax assets, or other items whose loss-absorbing capacity is conditional. A regulator may limit the proportion of required capital that can be satisfied by such instruments.

Eligible Assets, Investment Limits, and Asset Quality

An insurer’s assets must be capable of supporting policyholder obligations. Asset eligibility rules determine which assets may be recognised for solvency purposes and at what value. These rules commonly consider marketability, valuation reliability, legal ownership, liquidity, diversification, concentration, and the relationship between the asset and the insurer’s liabilities.

Investment regulation traditionally relied on prescriptive limits. For example, a jurisdiction may restrict the proportion of assets that can be invested in equities, property, unlisted securities, a single issuer, or related parties. It may also require minimum holdings of approved government securities. Such limits can prevent excessive concentration and protect insurers from speculative investment strategies.

A more modern approach combines quantitative limits with the prudent-person principle. Under this principle, an insurer must invest in the best interests of policyholders, understand the risks of its investments, maintain diversification, and avoid assets that it cannot properly value or manage. Quantitative limits remain useful where markets are immature or governance quality varies, but limits cannot replace risk assessment.

Asset valuation is particularly important. An asset may have a high accounting value but be difficult to sell during a crisis. Conversely, a market price may fall sharply even when the issuer remains fundamentally sound. Prudential frameworks therefore examine valuation bases, impairment recognition, liquidity discounts, and the treatment of assets pledged as collateral.

Concentration risk is often underestimated. Exposure may be concentrated through a single issuer, corporate group, geographic region, sector, currency, custodian, or reinsurer. Related-party investments create additional concerns because they may transfer value away from the insurer or weaken independent decision-making.

Asset–Liability Management and Liquidity

Asset–liability management (ALM) is the coordinated management of assets and liabilities so that the insurer can meet payments when due while controlling market, credit, and reinvestment risks. ALM is not simply a matter of matching the total value of assets and liabilities. It also considers duration, cash-flow timing, currency, inflation sensitivity, embedded options, and the behaviour of policyholders.

For a life insurer with long-term annuity liabilities, duration mismatch is a major concern. If liabilities have a duration of fifteen years but assets have a duration of five years, falling interest rates may increase the value of liabilities more than the value of assets. The insurer may then suffer an economic capital loss even if its accounting results initially appear satisfactory.

General insurers face different challenges. Claims may be uncertain and concentrated after catastrophes. A property insurer may need immediate cash following a major storm, while some of its assets may be long-term or illiquid. Medical and liability insurers may face long-tail claims whose ultimate cost is sensitive to inflation, judicial decisions, and social change.

Liquidity is the ability to meet obligations as they fall due without unacceptable loss. An insurer may be solvent on a balance-sheet basis but illiquid if it cannot convert assets into cash quickly enough. Liquidity planning should include ordinary cash-flow forecasts, collateral requirements, claims scenarios, premium collection patterns, reinsurance recoveries, and access to emergency funding.

Effective ALM normally includes a liability-driven investment strategy, duration and cash-flow analysis, limits on mismatch, currency management, derivative controls, liquidity buffers, and escalation procedures. Derivatives may hedge interest-rate or currency risk, but they introduce collateral, counterparty, model, and legal risks. They should not be used to conceal rather than manage exposures.

Stress Testing and Scenario Analysis

Stress testing asks how the insurer would perform under severe but plausible conditions. It supplements capital ratios by examining the path through which a shock affects assets, liabilities, capital, liquidity, and management actions.

A stress test may consider a sharp fall in equity prices, a rise or fall in interest rates, widening credit spreads, a catastrophe loss, high inflation, reinsurer default, mass lapsation, mortality deterioration, longevity improvement, cyber disruption, or a combination of these events. Scenario analysis may also examine reverse stress: the circumstances that could cause the insurer to breach its minimum capital requirement or become unable to pay claims.

A useful stress-testing programme specifies:

• the risk or scenario being tested;
• the assumptions and time horizon;
• the starting balance sheet;
• the direct and indirect transmission channels;
• management actions and their feasibility;
• the effect on solvency and liquidity; and
• reporting, escalation, and remediation requirements.

Stress tests are not forecasts. Their value lies in revealing vulnerabilities and challenging assumptions. A scenario that appears improbable may nevertheless be important if its consequences are severe. Management actions should be realistic: selling illiquid assets during a market crisis, raising capital immediately, or rapidly changing reinsurance may not be feasible.

Internal Models and Supervisory Review

Some insurers use internal models to estimate capital requirements. An internal model may reflect the insurer’s specific products, portfolio, reinsurance programme, catastrophe exposures, and risk management practices more accurately than a standard formula. Models may be partial, covering only selected risks, or full, covering the major risks of the business.

Model approval should require evidence of sound governance, appropriate data, validated methodology, documentation, independent review, effective use in decision-making, and adequate controls over model changes. The use test is important: a model should not be built solely to obtain regulatory approval. It should inform underwriting, pricing, reinsurance, investment, capital allocation, and strategic planning.

Models have limitations. Historical data may not represent future conditions. Extreme events are rare and difficult to estimate. Correlations may increase during crises. Management actions may be uncertain, and model outputs can create false precision. Model risk must therefore be treated as a distinct risk. Supervisory judgement and standard formula backstops remain necessary.

The supervisory review process complements quantitative requirements. Supervisors assess governance, risk appetite, own-risk and solvency assessments, internal controls, reinsurance, liquidity, conduct-related financial risks, and the credibility of management information. Where weaknesses are identified, supervisors may require additional capital, restrict distributions, demand a recovery plan, limit business growth, or replace key controls.

Governance, Ethics, and Accountability

Solvency is a board responsibility, not merely an actuarial or finance function. The board should approve risk appetite, capital strategy, investment policy, reinsurance strategy, stress-testing policy, and recovery planning. Senior management must ensure that policies are implemented and that information reaches decision-makers in a timely and comprehensible form.

An effective control environment includes independent risk management, actuarial oversight, compliance, internal audit, model validation, data governance, and transparent reporting. Incentive systems require particular attention. If bonuses depend heavily on premium growth or short-term profit, employees may underprice risks, weaken underwriting standards, or defer recognition of adverse experience.

Ethically, solvency management concerns fairness between current and future policyholders. Excessive risk-taking may generate short-term returns for shareholders while transferring losses to policyholders, employees, guaranty schemes, or the public. Accurate reserving and truthful regulatory reporting are therefore professional obligations, not merely technical exercises.

Technology has become central to prudential management. Automated data pipelines, real-time dashboards, cloud systems, predictive analytics, and machine-learning tools can improve monitoring and early-warning capability. However, technology also creates cyber risk, data-quality problems, model opacity, vendor dependence, and potential bias. Artificial intelligence may support claims and risk analysis, but its outputs require validation, explainability, human oversight, and clear accountability.

Illustrative Case Study: Meridian General Insurance

Background

Meridian General Insurance is a fictional mid-sized insurer writing motor, commercial property, and liability business. It has grown rapidly through aggressive pricing and broker expansion. Its solvency ratio is 142 per cent, comfortably above the regulatory minimum of 100 per cent. The board therefore considers the company financially strong.

Situation and Problem

A supervisory review identifies three vulnerabilities. First, Meridian holds a large portfolio of long-term corporate bonds and property assets, while its claims profile is becoming more catastrophe-sensitive. Second, its reinsurance programme depends heavily on one reinsurer. Third, the actuarial function has not fully reflected recent claims inflation in liability reserves. A stress test involving a severe storm, widening credit spreads, and a delayed reinsurance recovery reduces the solvency ratio to 88 per cent and creates a short-term liquidity deficit.

Analysis

The headline solvency ratio concealed the interaction of several risks. The ratio used capital requirements that did not adequately capture concentration and catastrophe exposure. Technical provisions were understated because claims inflation and legal settlement trends had not been updated. The asset portfolio was not sufficiently liquid for a major claims event, and the dependence on one reinsurer created counterparty concentration. Meridian was solvent under the base case but vulnerable under a plausible combined scenario.

Approach and Strategy

The board adopts a recovery programme. It strengthens liability reserves, reduces concentrated corporate-bond and property exposures, and establishes a larger high-quality liquidity buffer. Reinsurance is diversified across several financially strong counterparties, with greater attention to collateral and settlement timing. Underwriting rates are revised for catastrophe and claims inflation risk, and high-risk property business is selectively reduced.

Meridian also introduces quarterly stress testing, reverse stress testing, an exposure dashboard, and an independent review of its internal capital model. Management incentives are changed so that growth is assessed alongside profitability, reserve adequacy, and risk-adjusted capital usage.

Outcome

The immediate effect is lower reported profit and slower premium growth. Nevertheless, the quality of capital improves, liquidity becomes more resilient, and the insurer’s risk profile is better aligned with its stated appetite. The regulator accepts the recovery plan subject to enhanced reporting.

Learning Points

The case illustrates that a solvency ratio is a decision signal, not a complete diagnosis. Capital adequacy depends on the quality of technical provisions, asset liquidity, reinsurance collectability, concentration, and the realism of stress assumptions. Prudential management is most effective when it influences pricing, underwriting, investment, and strategy before a crisis occurs.

Challenges and Common Mistakes

Several recurring mistakes weaken prudential systems. Treating the regulatory minimum as a target rather than a floor leaves little room for volatility. Relying on a single model or historical average can overlook structural change. Assuming that reinsurance eliminates risk ignores counterparty, basis, timing, and contract-interpretation risks. Focusing on accounting profit may conceal economic losses caused by duration mismatch or inadequate reserves.

Other weaknesses include poor data lineage, weak challenge by the board, excessive reliance on external ratings, failure to test management actions, inadequate liquidity planning, and underestimation of operational and cyber risk. Quantitative investment limits may also create false comfort if exposures are concentrated through affiliated entities or correlated assets.

Current Developments and Best Practices

Prudential regulation is increasingly moving toward integrated, risk-sensitive supervision. Important developments include greater attention to climate-related financial risks, cyber resilience, operational resilience, macroprudential stress testing, group supervision, recovery and resolution planning, and the interaction between insurance and non-insurance financial institutions.

Best practice requires an insurer to:

• maintain capital above the regulatory minimum with an internal buffer;
• value technical provisions using current, evidence-based assumptions;
• integrate capital, liquidity, investment, reinsurance, and underwriting decisions;
• conduct regular stress and reverse-stress tests;
• maintain diversified and high-quality assets;
• validate models and challenge their assumptions;
• ensure board-level understanding of risk information;
• align remuneration with sustainable, risk-adjusted performance; and
• maintain a credible recovery plan for deteriorating conditions.

Chapter Summary

Prudential regulation protects policyholders by promoting the financial soundness of insurers. Solvency depends on the relationship between admissible assets, technical provisions, other liabilities, available capital, and required capital. Technical provisions cover expected insurance obligations, while capital absorbs unexpected losses. Risk-based capital improves on simple volume-based solvency margins by reflecting underwriting, market, credit, operational, and other risks.

Asset eligibility, diversification, investment limits, valuation, and liquidity are essential because capital is useful only when it is reliable and available. Asset–liability management aligns investment cash flows and risk exposures with policyholder obligations. Stress testing reveals vulnerabilities under severe but plausible conditions, while internal models can improve risk sensitivity if governed, validated, and used appropriately. Effective prudential regulation also depends on board accountability, ethical reserving, independent control functions, data quality, technology governance, and early supervisory intervention.

Key Terms

Prudential regulation: Regulation designed to protect policyholders by maintaining the financial soundness and resilience of insurers.

Solvency: The ability of an insurer’s assets and capital to cover its liabilities and absorb adverse losses.

Technical provisions: Amounts recognised for the present value or estimated cost of future insurance obligations.

Available capital: Financial resources available to absorb losses after liabilities are deducted from recognised assets.

Required capital: Capital judged necessary to cover specified risks at a prescribed confidence or protection level.

Solvency margin: The excess of eligible assets or capital over prescribed liabilities or capital requirements.

Risk-based capital: A capital framework that links required capital to the risks undertaken by an insurer.

Admissible assets: Assets permitted to be recognised for regulatory solvency purposes.

Asset–liability management: Coordinated management of assets and liabilities to control financial, liquidity, and timing risks.

Liquidity risk: The risk that an insurer cannot meet obligations when due without unacceptable loss.

Underwriting risk: Risk arising from inaccurate pricing, adverse claims, catastrophe, or inadequate reserves.

Market risk: Risk of loss from changes in interest rates, prices, exchange rates, spreads, or other market variables.

Counterparty risk: Risk that a reinsurer, issuer, intermediary, or other counterparty fails to perform.

Stress testing: Assessment of the effect of severe but plausible events on an insurer’s financial position.

Reverse stress testing: Analysis of scenarios that could cause a defined failure, such as a capital breach.

Internal model: An insurer-developed model used to estimate risk exposure or capital requirements.

Model risk: Risk that a model is incorrectly designed, implemented, interpreted, or applied.

Diversification benefit: Reduction in aggregate risk arising because risks do not move perfectly together.

Recovery plan: A documented set of actions to restore financial soundness when an insurer’s condition deteriorates.

Review Questions

Short Answer Questions

1. Why is prudential regulation necessary in insurance markets?

2. Distinguish technical provisions from available capital.

3. What is meant by an admissible asset?

4. Define liquidity risk in the context of an insurer.

5. Why must internal models be independently validated?

Long Answer Questions

1. Explain the balance-sheet approach to solvency and discuss the limitations of relying solely on a solvency ratio.

2. Examine the major components of a risk-based capital framework.

3. Discuss how asset–liability management supports both solvency and liquidity.

4. Explain the role of technical provisions and the consequences of inadequate reserving.

5. Evaluate the governance and ethical responsibilities of an insurer’s board in maintaining solvency.

Analytical / Application Questions

1. An insurer has a solvency ratio of 160 per cent but holds most of its assets in illiquid property and depends on one reinsurer. What additional analysis should a supervisor conduct?

2. A life insurer’s liabilities have a duration of twelve years while its assets have a duration of four years. Analyse the likely effect of a sustained fall in interest rates and recommend management responses.

3. Design a stress-testing programme for a property insurer exposed to catastrophe losses, inflation, credit-spread movements, and delayed reinsurance recoveries.

22. Multiple Choice Questions with Answers

Question 1

Which statement best distinguishes technical provisions from solvency capital?

A. Technical provisions cover expected insurance obligations, while capital absorbs unexpected losses

B. Technical provisions are shareholder funds, while capital represents unpaid claims

C. Technical provisions apply only to investment contracts, while capital applies only to general insurance

D. Technical provisions measure liquidity, while capital measures premium volume

Correct Answer: A. Technical provisions cover expected insurance obligations, while capital absorbs unexpected losses

Question 2

An insurer has available capital of 180 million and required capital of 120 million. What is its solvency ratio?

A. 60 percent

B. 67 percent

C. 150 percent

D. 300 percent

Correct Answer: C. 150 percent

Question 3

Which feature is most characteristic of risk-based capital?

A. The same capital percentage applies to every insurer regardless of risk

B. Required capital reflects the risks actually undertaken by the insurer

C. Only premium income is used to determine capital

D. Capital requirements are eliminated when reinsurance is purchased

Correct Answer: B. Required capital reflects the risks actually undertaken by the insurer

Question 4

Why may an insurer remain vulnerable despite having a positive solvency ratio?

A. A positive ratio guarantees immediate access to cash

B. The ratio may not capture liquidity, concentration, reserve, or model weaknesses adequately

C. Solvency ratios measure only customer satisfaction

D. Positive solvency ratios apply only to banks

Correct Answer: B. The ratio may not capture liquidity, concentration, reserve, or model weaknesses adequately

Question 5

What is the principal purpose of asset–liability management?

A. To maximise premium growth without regard to risk

B. To coordinate assets and liabilities so obligations can be met while financial risks are controlled

C. To replace technical provisions with investments

D. To eliminate all investment risk

Correct Answer: B. To coordinate assets and liabilities so obligations can be met while financial risks are controlled

Question 6

Which situation most clearly illustrates liquidity risk?

A. An insurer has profitable assets but cannot sell them quickly enough to pay catastrophe claims

B. An insurer has a low expense ratio

C. An insurer increases its solvency buffer

D. An insurer diversifies its reinsurance panel

Correct Answer: A. An insurer has profitable assets but cannot sell them quickly enough to pay catastrophe claims

Question 7

What is the main value of reverse stress testing?

A. It predicts the exact date of the next claim

B. It identifies the circumstances that could cause a defined failure or capital breach

C. It replaces ordinary financial reporting

D. It guarantees that management actions will succeed

Correct Answer: B. It identifies the circumstances that could cause a defined failure or capital breach

Question 8

Which is an important control for an insurer using an internal capital model?

A. Avoiding documentation so the model remains flexible

B. Using the model only for marketing purposes

C. Independent validation and evidence that the model is used in business decisions

D. Assuming historical correlations will remain constant

Correct Answer: C. Independent validation and evidence that the model is used in business decisions

Question 9

Why does dependence on a single reinsurer create prudential concern?

A. It eliminates underwriting risk completely

B. It creates counterparty concentration and recovery-timing risk

C. It always increases liquidity

D. It guarantees lower technical provisions

Correct Answer: B. It creates counterparty concentration and recovery-timing risk

Question 10

Which board action best supports sound prudential governance?

A. Rewarding managers solely for premium growth

B. Treating the regulatory minimum as the desired operating target

C. Approving risk appetite, capital strategy, stress testing, and recovery planning

D. Delegating all solvency responsibility to external auditors

Correct Answer: C. Approving risk appetite, capital strategy, stress testing, and recovery planning