25. Analysing other risks Flashcards
Give a list of other risks
- Liquidity risk
- Non-life Insurance risk
- Demographic risk
- Climate change risks
Outline the two kinds of liquidity risk
- Funding – risk of money markets being unable to supply money when required
- Market- risk of market capacity being unable to handle asset transactions when deal is required without material impact on price
What are the difficulties of assessing liquidity risk
o Limited past data on liquidity crises
o Degree and nature of exposure diff so industry data or other analogue models may not work
List 3 ways in which liquidity risk can be assessed
- Scenario analysis
- Stress testing
- Basel III
Outline how scenario analysis can be used to determine liquidity risk
- Model cashflows for the organisation
- Assess liquidity risk by looking at scenarios where cash outflows exceed available cash in future
- Must allow for appropriate interactions between risks- esp between market and interest-rate risks
- Must consider short and long term scenarios
Give examples of scenarios for banks and insurance companies
- Rising interest rates – e.g., depositors transferring funds elsewhere for higher returns
- Rating downgrade
- Large operational loss leading to sudden reduction in cash-like assets
- Large single insurance claim or large set of claims from associated events leading to reduction in cash assets
- Losing control over key distribution channel – leading to loss of expected revenues
- Impaired capital markets- investors may be unable to provide fresh capital when needed
- Sudden termination of large reinsurance contract – insurer exposed to large outflows with no expected inflows from reinsurer
Give examples of stress test scenarios for liquidity
o Collapse of major customer = lost revenue
o Inability to refinance large debt due to mature soon
Outline the liquidity rations under Basel III
- Liquidity Coverage Ratio (LCR) – ensures banks can survive one month stress scenario
- Net Stable Funding Ratio (NSFR) – consider funding over one-year
- Must >= 100%
Define demographic risks
Risk from population changes impacting both customers and employment. Can be broken into:
o Level / underwriting risk
o Reserving risk:
What are the 3 types of reserving risk?
Volatility- uncertainty wrt actual future immediate short term morlatility experience. Only have finite data»_space; can’t precisely measure»_space; will be statistical variances
Catastrophe – extreme form of volatility risk e.g. natural disasters
Trend/cycle – future long term changes in claim incidence and intencity
How would you assess underwriting risk
- Risk rating
- Experience rating
- Can combine the two with credibility weights Z on experience and 1-Z on risk
How would you assess volatility risk
- Stochastic/ probabilistic model e.g. binomial, poisson
- Assessment must reflect that volatility varies by age
- Use Poisson MLE:
o Calc expected number of deaths at each age using model to be fitted and set it equal to poisson distribution
o Calc number of observed deaths at each age based on posson distribution derived above
o Fitted parameter found by maximising likelihood function, ie product of the probabilities (for all ages) that were determined in preceding step.
How would catastrophe risk be assessed
- Scenario analysis
Outline non-life insurance risk
- Level
- Reserving – volatility, catastrophe and trend
- Can also be divided into
o high frequency e.g. motor
o low frequency – excess of loss reinsurance
How would non-life insurance risk be modelled
o Intensity of claims must be modelled»_space; more uncertainty
o Possibility of more than 1 claim per policy
o Potential for each policy to move through many diff states over its lifetime
How can financial systems influence transition to low carbon economy?
How can financial systems influence transition to low carbon economy?
* Investors can increase investment in green tech, renewable energy sources, sustainable transport …
* …decrease investment in companies with high levels of emissions e.g. fossil fuel producers, manufacturing companies
* Investors can engage with management to put pressure to reduce emission
* … support them transitioning
* Banks can redirect financing to sustainable projects
* Corporations can issue “green” bonds
* Credit rating agencies can incorporate ESG factors into assessment of creditworthiness
* GI companies can have exclusion clauses, increase premiums or not uw risks deemed damaging to environment
* Govt policies and tax incentives …
* … and having private-public partnerships to enhance suitable economic development by providing finance and risk mitigation tools
* Regulators can require financial providers to hold solvency capital wrt climate change risk ..
* …and disclose approach to managing climate change risk
Why is climate risk hard to assess
- Future might be diff to past, so models calibrated on past data may give misleading results
- Multiple levels of uncertainty in climate change system itself, levels of greenhouse gas emissions and reactions of stakeholders to climate change targets and tech / economic developments
- Many diff pathways leading to similar climate outcomes but diff economic outcomes
