Definitions
Insurance contract
A contract under which one party (The issuer) accepts SIGNIFICANT insurance risk from another party(The policyholder) by agreeing to compensate the policyholder if a specified uncertain future event adversely affects the policyholder.
Portfolio of insurance contracts
A group of insurance contracts that have similar risks and are managed together.
Contractual service margin
This is the proportion of the carrying amount of an asset/liability line item of a group of insurance contracts that represents the unearned profit that the insurance company will recognise as it provides it services.
When the insurance company issues 100 policies at the start of the year, a percentage of their cost is its profit, but, it can't recognise it as profit yet because things might not go as planned...
Insurance risk
A risk other than finance risk that is transferred to the finance company.
A finance risk is the risk that an investment will flop i.e not yield expected returns.
Fulfilment cashflows
This the estimated amount an insurance company will pay to fulfil insurance claims
= PV of future cash outflows- PV of future cash inflows (adjusted for non-financial risk)
Risk adjustment for non-financial risk
Compensation required for bearing the uncertainty about the amount and timing of the cash flows arising from non-financial risk.
Non-financial risk are more unpredictable than financial risk, therefore there is a probability of losing more money. So, the insurance company has to be compensated for that.