26. Risk identification and classification Flashcards
What are 5 methods of identifying risks associated with a project?
- High-level preliminary analysis=> Confirm no big risks- not worth while continuing
- Brainstorming with project experts, senior internal/external people
1. Identify likely, unlikely, upside/downside risks
2. Discuss these risks and their interdependence
3. Broadly evaluate the frequency and severity of each risk
4. Generate and discuss initial mitigation options - Desktop analysis=> Supplement brainstorming
- Consult with experts
- Risk registrar=> sets out risks and their interdependence
What categories and example of risks could be used in a risk matrix for a typical project?
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- Political - opposition to project, war, terrorism
- Natural - earthquakes, hurricanes
- Economic - interest rate or exchange rate movements
- Financial - sponsor default, incorrect cashflow estimates
- Crime - fraud, theft
- Project - time delays, budget overruns, bad design, poor planning
- Business - competition/lack of demand, operational problems, obsolescence
What techniques can be used to ensure all relevant risks have been identified in an organisation?
- Risk classification
- Risk checklists
- Experience of staff
- Consultants with knowledge of industry involved
- Organisation should gain input from everyone involved, senior management, junior management
What is market risk
- Risk related to changes in investment market values or other correlated features such as interest rates/inflation
What is credit risk?
- Risk of failure of third parties to meet their financial obligation
What is liquidity risk?
- Risk that an insurer although solvent has insufficient available capital to meet its obligations as they fall due.
- Risk for insurer is low since they hold cash, bonds and stock market assets
What is business risk?
- Business risk is risk specific to business undertaken
What is operational risk?
Risk of loss arising from inadequate or failed internal processes, people and systems or from external events
What is external risk?
- Arises from external events
- Climate change is principal risk, but impacts other risk categories
What are the subdivisions of market risk?
- Consequences of change on asset values
- Change in liability values=> where liabilities are related to interest or inflation rates
- CASHFLOWS DO NOT MATCH A and L
Why would a perfect match not always be possible in practice?
- There may not be a wide enough range of assets available to match liabilities
- Liabilities may be uncertain in amount and timing
- Liabilities may have options=> liabilities values uncertain past option date
- Liabilities may include discretionary benefits
- Cost of maintaining a fully matched portfolio=> Prohibitive
What are examples of credit risk?
- Issue of corporate bond defaulting on interest or Cap
- Credit linked event=> changes to credit quality and variations in credit spreads
- Counterparty risk=> one party to a transaction fails to fulfil their side of the bargain
- General debtors=> Purchaser of goods and services failing to pay for them
What factors should an investor or lender consider when assessing the security of a debt and the borrower?
- Nature of the debt=> secured vs unsecured
- Covenant of the borrower
- Market circumstances+ relative negotiating strength between the two parties
- What security is available and whether it can be realised if necessary
What is a credit rating?
- Rating given to a company’s debt
- Given by a credit rating agency
- Indication of the likelihood of default
- Top ratting AAA
What is a liquid asset and what makes up a market liquid?
- Close to cash in nature
- Can be converted into cash quickly
- Amount of cash it would become is almost certain
- Liquid market=> Large market+ lots of ready participants
- Marketable assets=> converted to cash quickly o How ever the amount of cash received is uncertain
Why are banks exposed to significant liquidity risk?
- Funds raised from money markets+ depositors funds=> lent by banks
- To other organisations for potentially long periods of time
- Customers may desire immediate access to their funds
- Creating the need for liquidity
- RISK MORE CUSTOMERS THAN EXPECTED DEMAND ACCESS TO FUNDS
What are 4 business risk to a financial provider?
- Inadequate underwriting standards leading to mispricing of risks
- More claims than expected
- Investment in a business project that fails to be successful
- Greater exposure than planned to a particular risk e.g. High volumes sold
What are examples of operational risk?
- Inadequate or failed internal processes, people or systems
- Dominance of a single individual over the running of a business
- Reliance on a 3rd party to carry out various functions for which the organisation is responsible for
- Failure of recovery plans following an external event
- Conduct risk (miss-selling, interest rate manipulation or money laundering)
How are operational risks likely to be identified and analysed?
- Model=> Model only as good as parameters
- Input from owners of the business
- Senior management
- Other knowlegble individuals
Give 5 examples of external risk
- Natural disaster
- Terrorist attack
- Regulatory, legislative and tax changes
- Pandemic
- Climate change
Explain the term climate risk and how climate related risk can be categorised into physical, transition and liability risks.
Climate risks refers to risks arising from adverse changes in the physical environment and secondary impacts on the economy at a regional or global level
Physical - first-order effects of environmental changes, eg greenhouse gas emissions, pollution and land use. Effects may be chronic or acute.
Transition – economic, political and market changes as a result of efforts to mitigate climate change.
Liability – from injured parties seeking compensation for the impacts of climate change. Impacts may be first-order physical impacts or second-order transition impacts.
List the typical risks faced by insurance companies under the headings:
- market
- credit
- liquidity
- operational
- external
- Market risks: change in interest rates / inflation, market crashes, mismatch of assets and liabilities, currency risk
- Credit risks: reinsurer, broker and asset default
- Liquidity risks: insufficient cash resources to meet liabilities as they fall due
- Operational risks: fraud, mismanagement, systems failure
- External risks: natural disasters, terrorist threats, legislative and tax changes, pandemics, climate change
