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FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans

Which of the following is the most accurate statement about why insurance companies are subject to prudential regulation such as minimum capital requirements?

Prudential regulation exists because policyholders are effectively creditors who cannot readily monitor an insurer's financial strength, and an insolvency would leave them without promised protection. Minimum capital and solvency rules reduce that risk, although they cannot guarantee insurers never fail.

  1. APolicyholders are creditors who cannot easily monitor the insurer's solvency, and failure of an insurer can leave them without promised protectionCorrect
  2. BInsurers are prohibited from holding any equity investments
  3. CCapital requirements remove the need for underwriting standards
  4. DRegulation guarantees that insurers will never become insolvent

Explanation

Policyholders hold long-term claims against the insurer and generally lack the information and ability to assess its financial strength, so regulators set capital and solvency standards to protect them. Regulation does not ban equities, replace underwriting or guarantee against failure; it reduces the probability and cost of insolvency.

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