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

Which regulatory rationale best explains why insurers are typically required to hold minimum capital and technical reserves?

Capital and reserve requirements exist because policyholders pay upfront for future claims and cannot easily assess the insurer's solvency. Regulators therefore require buffers to make payment of promised claims likely. These rules do not remove underwriting, freeze premiums, or eliminate adverse selection.

  1. APolicyholders cannot easily assess insurer solvency, so capital protects promised future claim paymentsCorrect
  2. BIt removes the need for underwriting and pricing
  3. CIt guarantees that premiums will never change
  4. DIt eliminates adverse selection in all lines

Explanation

Policyholders pay premiums upfront for future promises and cannot readily judge solvency, so regulators require capital and reserves to make payment likely. Capital does not remove underwriting, fix premiums or eliminate adverse selection.

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