30. Risk transfer TO DO

Question 1

What is an example of a quantifiable risk appetite statement?

Answer 1

• The organization will not accept risks that would cause its available capital to fall below x% of the regulatory MCR.

Question 2

What features of the company might influence its risk appetite?

Answer 2

• Existing exposure to a particular risk
• Culture of company
• Size of company
• Period of time for which it has operated
• Level of available capital
• Existence of a parent company or other guarantors
• Level of regulatory control to which it is exposed
• Institutional structure
• Previous experience of board members
• Attitude towards risk of owners and other capital providers

Question 3

How does a market for risk arise?

Answer 3

• Different entities have different appetite for risk=> market in risk
• Enables risk to be transferred=> Entities with small risk A> large risk A • All financial transaction=> transfer of risk for payments

Question 4

What makes a market for risk transfer ‘risk efficient?

Answer 4

• Reasonable size
• Participants with excess risk
• Transfer excess risk
• Other participants with less risk
• Then they are prepared to accept

Question 5

Give an example of pairs of individuals with different appetites of risk that want to transfer risk?

Answer 5

• Policy holder ceding risk to an insurance company
• Insurance company ceding risk to a reinsurance company

Question 6

How does investment in a collective scheme result in risk transfer?

Answer 6

• Transfer risk of poor investment decisions

Question 7

How are risk and product design related?

Answer 7

• Financial products transfer risk between parties
• Price of the product cover cost of risk transferred+ profit margin
• Cost of risk= Risk covered+ business risks
• Good product design techniques=> identify all risk involved+ risk management
• Appropriate cost => perform risk classification
• Risk new product design  needs + desires of beneficiaries
• Additional options=> introduce new risks
• i. Allowed for in the costing

Question 8

What factors make a risk insurable?

Answer 8

• Policyholder must have an interest in the risk
• Risk must be financial and reasonably quantifiable
• Claim amount must bear some relationship to the financial loss incurred

Question 9

Why do insurance companies aim to pool risk?

Answer 9

• Law of large numbers=> Greater certainty in the future payments on the occurrence of the insured event.

Question 10

What additional criteria should a risk meet to be insurable?

Answer 10

• MUD PIS
• Moral hazard eliminated
• Ultimate limit on the liability undertaken
• Data exists with which to price the risk
• Pooling a large number of similar risks
• Independent risk events
• Small probability of occurrence
• Chapter 29- Risk measurement and reporting

Question 11

What is a subjective approach of assessing risk exposure?

Answer 11

• Estimate probability and severity separately
• Assign a number from the scale 1-5
• The product of probability and severity=> ranked 1-25
• Allows risks to be ranked and prioritised
• Carried out with and without possible risk controls

Question 12

How can a model be used to assess a risk event?

Answer 12

• Distribution assigned to both Frequency and severity of a risk event
• Define an event
• Use historic events to calculate a probability distribution for that event
• Alternatively – Frequency of the event defined=> determine the loss parameter
• Stochastic vs deterministic model
• Availability of data=> Influence which model is used
• Important when considering rare events

Question 13

1) What are the responses a stakeholder can choose from when faced with a risk?

Answer 13

• PI RATE
• Partially transfer=> to another party
• Ignore=> trivial or largely diversified
• Reduce=> frequency or severity
• Accept=> retain all
• Transfer=> to another party
• Evade=> avoid the risk altogether

Question 14

2) How can each risk mitigation option be evaluated?

Answer 14

• FIRM
• Feasibility + cost
• Impact on Frequency+ severity and expected costs
• Resulting secondary risks
• Mitigation required in response to secondary risks

Question 15

What factors affect whether a stakeholder retains or transfer risk?

Answer 15

• Cost of passing it on
• Willingness of another party to take it on
• Likelihood of the event occurring
• Capital with which the stakeholder has to absorb the event ❖ Stakeholders risk appetite

Question 16

What are the benefits and costs of reinsurance?

Answer 16

• Benefits
• Reduction in/ removal of risk
• Re offer competitive terns for admin, actuarial service+ advice
• Costs
• Profit passed from cedant to Re
• Re premium likely> cost of benefit in the long run
• Liability may not be fully matched by Re
• Possible liquidity issue
• Re default
• Re may not be available on the terms sought

Question 17

Why would a provider purchase Re?

Answer 17

• Reduces claims volatility
• Smooth profits
• Reduced Cap re
• Increased capacity to write more business+ achieve diversification ❖ Limitations of a large loss arising from:
• Single claim o Single event o Cumulative claims
• Geographical+ portfolio concentrations o Reduce risk of insolvency
• Increased capacity to write larger risks
• Access to expertise of the Re

Question 18

What are the two contract variations on which Re can be arranged?

Answer 18

• Facultative=> Re arranged on a case by case basis.
• Large risks usually
• Insurer NOT obliged to cede risks
• Re NOT obliged to accept risks
• Treaty=> Defined group of policies covered by Treaty
• i. Re obliged to accept risk

Question 19

What are the key features of proportional Re?

Answer 19

• Claims split between cedant and Re in predefined proportions
• Does not cap the claim payment by the cedant
• Written by treaty
• Quota share and surplus
• Quota share prop ceded= for all risks
• Surplus= prop ceded varies by risk
• Re pay insurer commission

Question 20

What is quota share Re?

Answer 20

• Prop spilt between the cedant and Re is constant for all risks in the treaty
• +useful for small, new or expanding cedants who want to diversify risk
• • Admin is simple=> treaty and all prop same
• -Inflexible
• -Share of profits transferred to Re
• -Does not cap Large claims

Question 21

What is surplus Re?

Answer 21

• Prop Re varies for each risk covered in the treaty
• Treaty=> RL and a ML
• Proportion ceded treated in the same way as quota share
• Retention level maybe specified in the treaty=> same for all risks
• i. Large volumes relatively homogenous classes of business=> Life or personal lines of GI
• Or allowed to vary at the discretion of the cedant
• i. Heterogenous classes of business=> property+ business interruption insurance
• +Cedant can fine tune exposure
• +Useful for cedants who want to diversify risk or write more business or larger risks
• -More complex and expensive to write than quota share contracts ❖ -Does not cap large claims

Question 22

What are the key features of excess of loss Re?

Answer 22

• Cedant specifies a retention level=> Pays amount up to level
• Re pays amount over level
• May be an upper limit on what Re will pay
• Different layers of XoL Re each with different Re
• Cedant required to retain a proportion of risk within layer=> maintain an insurable interest
• Retention level and upper limit may be indexed for inflation
• Re determines the Re premium
• Caps claims paid by cedant
• May or may not be written using a treaty
• What are the 4 types of XoL? ❖ Risk XoL
• Aggregate XoL
• Catastrophe XoL
• Stop loss XoL

Question 23

What the main uses of XoL Re?

Answer 23

• Opportunity to write larger risks
• Reduces risk of insolvency
• Smooths profits=> reduces claim fluctuation in return for premium

Question 24

When would Surplus and Xol Re provide the same cover?

Answer 24

• Where risk event can only result in the payment of the full SI

Question 25

What factors influence the type of Re products used?

Answer 25

• Type of business
• Size or volatility of claims

Question 26

Does the insurer have lots of free assets?

Answer 26

• Insurer mutual or proprietary

Question 27

Insurer need expertise in a new or unusual product or territory?

Question 28

Does the Insurer want diversification through the reciprocal arrangement?

Answer 28

• List 5 alternative risk transfer products (ART)
• Integrated risk covers
• Securitisation
• Post loss funding
• Insurance derivatives
• Swaps
• What are integrated risk covers? ❖ Multi-year
• Multi-line Re contracts
• Give premium savings by:
• i. Cost savings ii. Greater stability of results over time and across more diversified lines They are used to:
• o Avoid buying excessive cover o Smooth results o Lock into attractive terms

Question 29

What is securitisation?

Answer 29

• Transfer of insurance risk to banking and capital markets
• Banking and Cap markets use=> provides diversification+ capacity
• Packaged as catastrophe bond
• Repayment of both interest and capital=> depends on the Cat not occurring ❖ Yield expected to be greater than similarly rated Corporate bonds

Question 30

What is post loss funding?

Answer 30

• Insurer pays commitment fee
• Funding will be guaranteed on the occurrence of a specific loss
• Often a loan on pre-arranged terms or equity
• Commitment fee < cost of insurance
• Dependent on loss event occurring
• May appear cheaper than conventional insurance

Question 31

What are insurance derivatives?

Answer 31

• Cat and weather options
• K= certain value of Cat or weather index
• Option will be exercised depending on the value of the index at strike date

Question 32

What are swaps?

Answer 32

• Organisations with matching but negatively correlated or uncorrelated risks
• Can swap packages of risk
• Such that each organisation has a greater diversification

Question 33

What are the possible reasons for using ART?

Answer 33

• DESCARTES
• Diversification
• Exploit risk as an opportunity
• Solvency improvement
• Cheaper cover than Re
• Available when Re may not be
• Results smoothed or stabilized
• Tax advantages
• Effective risk management tool
• Security of payments improved
• Chapter 31- Other risk controls