27. Financial products and benefit scheme risks Flashcards
What are two key risks to a beneficiary?
- Benefits may be less valuable than required
- Benefits may not be received on time
What is the key risk to the state in benefit provision?
2
- State put right any losses that the public incurs
- Provides means-tested benefits=> minimum income level in retirement
What are the key areas of benefit risk when the benefits are known in advance?
4
- Inadequate funds to provide the benefits
- Illiquid assets
- Benefit changes
- Not meeting beneficiaries needs
What are the key areas for benefit risk when the benefit is not known in advance?
- Lower than expected benefit payments=> lower than expected investment returns+ higher than expected costs
- Lower than expected benefits=> worse than expected terms for any investment vehicle
- Not meeting beneficiaries needs- inflation or failure to recognise beneficiaries needs when they were promised
- Higher than expected claim payments on non-life insurance policies
How can a DC scheme use its investment strategy to mitigate the risk of worse than expected annuity rates?
- Lifestyling=>5 + years approaching retirement
- Investment switch to assets likely to underlie the annuity=> bonds
- This way if yields fall=> annuity rates reduce
- Offset by corresponding increase in the MV of the bonds in the pension scheme fund
How might a sponsor or provider contribute to the uncertainty around benefits?
- The sponsor may:
- Default at a time when funds held are insufficient or when the funds held include loans to the sponsor.
- Fail to pay contribution in a timely manner
- Be taken over by an organisation unwilling to meet the benefit promises
- Decide to reduce future benefits
- Communicate poorly to beneficiaries on issues such as guarantees=> Complaints+ need for compensation
- Mismanage the scheme/business=> benefit shortfall
In a DB what are the key contribution risks?
- Unknown future level of contributions
- Promised benefits
- Eligibility of members to accrue/receive benefits
- Inflation returns
- Investment returns
- Unknown timing of future contributions if not funded in adv
- Requirement to put in extra funds if there is a shortfall=> Amount + timing unknown
- Insufficient liquid assets with which to make the contributions
- Insolvency due to excessive contributions
- Take over by a 3rd party who is unwilling to make contributions
In a DC what are the contribution risks?
- Contributions are unaffordable to the sponsor
- Insufficient liquid assets to make the contributions
- If contributions are linked to an inflation or salary index=> index may increase faster than expected
- Fixed contribution=> Benefits < E[Benefits]
What operational or external risks may lead to uncertainty in the contribution required for a benefit scheme?
7
- Loss of funds due to fraud or misappropriation of assets
- Incorrect benefit payments
- Inappropriate advice
- Admin costs=> compliances with changes in legislation
- Wrong decisions by those to whom power has been delegated
- Fines or removal of tax status resulting from non-compliance
- Changes to tax rates or status
What are the causes of inappropriate advice given in relation to the provision of benefits?
CRIMES
- Complicated products
- Rubbish adviser
- Integrity of adviser lacking
- Model or parameters unsuitable
- Errors in data relating to beneficiaries
- State-encouraged but inappropriate actions
What are the investments risks associated with a financial product?
10
- Uncertainty over the timing and level of investment returns
- Mismatching A and L
- Reinvestment risk
- Default risk
- Investment returns being lower than expected
- Lack of appreciation of benefits by recipients
- Higher than expected investment expenses
- Liquidity risk
- Lack of diversification
- Changes in the taxation of investment income and gains
What is a sponsor’s covenant?
- Ability+ willingness of Sponsor to pay benefits as they fall due
- Source of credit risk
What typical business risks are life insurance companies faced by?
- Mortality and longevity risk
- Morbidity
- Pandemic
- Expenses
- Withdrawals
- New business volumes
- New business mix
- Options take up
- Reinsurance
- Anti-selection+ moral hazard
- Loose policy wording
- Lack of data
- Poor underwriting
What business risks are typically faced by general insurance companies?
- Claim amounts
- Claim frequencies
- Accumulations+ catastrophises
- Expenses
- Renewals + lapses
- New business volumes
- New business mix
- Anti-selection and moral hazard
- Loose policy wording
- Lack of data
- Poor underwriting
- Changes in the cover provided or in the characteristics of policyholders
- Reinsurance inappropriate reinsurance chosen
How are expense, persistency and new business volume risks inter-linked?
- Expense expressed as unit costs e.g. cost per policy
- Unit costs=expenses/volume
- Lapses and new business volumes directly affect Volume
- Expenses will be fixed and not vary in line with Lapses and new business volume
- Lower than expected NB volume + higher than expected lapse rate=> greater unit cost
What are the risks of new business volume not being as expected?
- Greater than expected=> Operational issues + reputational issues
- Greater than expected new business strain
- Capital required
- Solvency issues
- Less than expected=> Company may not cover fixed overheads
What are the risks arising from the new business mix not being as expected?
- Cross subsidies=> risk of fixed expenses not being as covered+ profits not being as expected
- Larger policies may contribute more to fixed expenses and profits than smaller policies
- IF fewer larger policies and more smaller policies than expected=> fixed expenses not met
- Not all products have been priced to give the same level of profit o Risk actual policies sold are weighted more towards the lower level profit generators than that expected
