FRM Part I · FRM Exam Part I

Insurance Companies and Pension Plans for FRM Part I

This chapter covers how insurers and pension plans work, earn money and take risk. You learn life and property-casualty insurance, mortality tables, combined ratios, moral hazard, adverse selection, and defined benefit versus defined contribution plans. Solve questions by identifying who bears the risk, then applying the ratio or funding formula step by step.

What this chapter covers

This chapter looks at two large institutional risk-takers: insurance companies and pension plans. Both collect money now and promise payments later. Insurers promise payouts after uncertain events such as death, fire or accidents. Pension plans promise retirement income. In both cases the core risk is a mismatch between assets and long-dated liabilities.

The chapter splits into three blocks. First, insurer types and the products they sell: life insurance with mortality tables, and property-casualty (P&C) insurance with underwriting ratios such as the loss ratio, expense ratio and combined ratio. Second, the economics of insurance: moral hazard (behaviour changes after being insured) and adverse selection (higher-risk people are more likely to buy cover), plus how regulation responds. Third, pensions: defined benefit (DB) plans, where the sponsor bears investment and longevity risk, and defined contribution (DC) plans, where the employee does.

It connects to the rest of the paper in several ways. Present value and discounting from valuation topics drive pension liabilities. Probability and expected value from quantitative analysis drive mortality and loss estimates. Interest rate risk and duration from financial markets explain why liabilities react to rate changes. It also links to Foundations of Risk Management, where information asymmetry and risk transfer are central ideas.

This chapter is compact and mostly conceptual, so it is a good place to collect reliable marks on a 100-question, 4-hour exam. The calculations are short: ratios, simple present values and funded status. The concept questions reward precise definitions, such as telling moral hazard from adverse selection or DB from DC risk. Candidates who skip it as minor usually lose easy points, while those who learn it well gain time for harder quantitative questions. GARP does not publish a mark split per topic, so do not guess at its weight. Treat it as a short, high-yield chapter.

Insurance Companies and Pension Plans: topics in the order to study them

1Insurance Company Types and StructureStart here to learn the vocabulary: life, P&C, reinsurers, mutual and stock forms, and how insurers earn money.
2Life Insurance Products and Mortality TablesLife products and mortality tables introduce the survival and death probabilities that you reuse later for pensions.
3Property-Casualty Insurance and Underwriting RatiosThis is the most calculation-heavy insurance topic, and it builds on the structure you have just learned.
4Moral Hazard, Adverse Selection and Insurance RegulationOnce you know the products, you can see why these information problems arise and how deductibles, pricing and regulation address them.
5Pension Plan Basics: Defined Benefit vs Defined ContributionMove to pensions with the basic split of who bears risk, which sets up the funding discussion.
6Pension Plan Funding, Liabilities and Sponsor RiskStudy this last because it needs discounting, longevity and the DB framework together.

How to prepare Insurance Companies and Pension Plans

Aim to finish the chapter in a few focused sessions, then revisit it with questions. Keep your calculator and a one-page definition sheet beside you.

Read the six topics in the study order above and write a one-line definition for every key term as you go.
Learn the P&C ratios as formulas: loss ratio = losses ÷ premiums earned; expense ratio = expenses ÷ premiums; combined ratio = loss ratio + expense ratio. A combined ratio below 100% means an underwriting profit, before investment income.
Practise mortality questions: use survival and death probabilities from a table, and multiply conditional probabilities step by step. Check that your answers lie between 0 and 1.
Build a comparison table for yourself for moral hazard versus adverse selection, and for DB versus DC. For each, note who bears the risk and which tools mitigate it.
Work funding problems: funded status = plan assets − present value of liabilities. Discount liabilities at the stated rate and see how a lower rate raises the liability.
Finish with timed practice questions, about 90 seconds each, and log every miss by cause: concept, formula or arithmetic.
On the last day, reread your definition sheet and the quick revision list, not new material.

Common mistakes in Insurance Companies and Pension Plans

Mixing up moral hazard and adverse selection.
Fix: Use timing. Adverse selection happens before the contract, because of hidden type. Moral hazard happens after, because of hidden action.
Treating a combined ratio above 100% as an overall loss.
Fix: Say it means an underwriting loss. Overall profit also depends on returns on invested premiums.
Assigning pension risk to the wrong party.
Fix: In DB the benefit is fixed, so the sponsor bears the risk. In DC the contribution is fixed, so the employee bears it.
Using the wrong discount rate or direction for pension liabilities.
Fix: Use the rate given in the question and check the direction: lower rate, higher liability, worse funded status.
Errors in mortality probability calculations.
Fix: Write the event in words first. Multiply survival probabilities for several years, and use one minus survival for death.
Skipping this chapter because it looks easy.
Fix: Give it a fixed, short block of study time and test yourself on definitions, because careless errors here are avoidable.

Last-day revision: Insurance Companies and Pension Plans

Life insurers cover death and longevity; P&C insurers cover property and liability losses.
Mutual insurers are owned by policyholders; stock insurers are owned by shareholders.
Reinsurance lets an insurer transfer part of its risk to another insurer.
Loss ratio = losses ÷ premiums earned; expense ratio = expenses ÷ premiums.
Combined ratio = loss ratio + expense ratio; below 100% signals an underwriting profit.
Insurers can still profit with a combined ratio above 100% if investment income is large enough.
Mortality tables give death and survival probabilities by age.
Moral hazard: behaviour changes after cover is bought. Adverse selection: riskier people seek cover before the contract.
Deductibles, co-payments and risk-based pricing reduce both moral hazard and adverse selection.
DB plan: sponsor bears investment and longevity risk. DC plan: employee bears them.
Funded status = plan assets − present value of liabilities.
A lower discount rate raises the present value of pension liabilities.

Insurance Companies and Pension Plans practice questions

Insurance Companies and Pension Plans in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Insurance Companies and Pension Plans: frequently asked questions

Is Insurance Companies and Pension Plans a hard chapter in FRM Part I?

It is usually seen as one of the lighter chapters. Most questions test definitions and short calculations. The risk is in careless mix-ups, so practise distinguishing similar terms.

Which formulas should I memorise for this chapter?

Know the loss ratio, expense ratio and combined ratio, and funded status as assets minus the present value of liabilities. Also know how to build survival probabilities from a mortality table.

Do I need a financial calculator for this chapter?

It helps for discounting pension liabilities, where you use the present value function for a stream of payments. The insurance ratios need only basic arithmetic.

How does this chapter link to other FRM Part I topics?

It uses probability from quantitative analysis, discounting and duration from valuation, and information asymmetry from risk foundations. Reviewing those links helps you remember the material.