31 - Other Risk Controls: Retained Risks

Question 1

Explain the issue with the diversification of financial services offered

Answer 1

The process could be expensive for admin staff and it removes niche firms.

Question 2

Within which areas of business operations can an insurer apply diversification?

Answer 2

1. Lines of business
2. Geographical areas of business
3. Providers of reinsurance
4. Asset classes
5. Assets held within a class of assets

Question 3

What is the main aim of underwriting?

Answer 3

The assessment of potential risks so that each risk can be charged an appropriate premium.

Question 4

How can underwriting be used to manage risks?

Answer 4

1. Protect against anti-selection
2. Classification of risks into homogenous groups for which a standard premium can be charged, thus helping to ensure all risks are rated fairly.
3. Helps to identify risks that require special terms
4. For substandard risks, the process identifies the most suitable approach and level for the special terms to be offered.
5. It helps to ensure that the claim experience does not depart too far from the assumed in the pricing basis.
6. For larger proposals, it will help to reduce the risk from over-insurance.

Question 5

Which methods of underwriting are likely to be involved in life insurance?

Answer 5

1. Medical underwriting
2. Lifestyle underwriting
3. Financial underwriting

Question 6

Give the type of special terms offered by insurers to substandard risks.

Answer 6

1. Additional premium
2. A reduction in the benefit
3. An exclusion clause
4. Declining the applicant

Question 7

What kind of risks do claims control systems guard against?

Answer 7

1. Fraudulent claims

2. Excessive claims

Question 8

Give examples of control systems used by the management of a financial provider.

Answer 8

1. Data recording - for accurate risk factors
2. Accounting and auditing - good provisioning and transparency
3. Monitoring of liabilities taken on - to manage risk portfolio and cross-subsidies.
4. Management of options and guarantees

Question 9

Give examples of techniques used to manage options and guarantees.

Answer 9

1. Liability hedging and asset-liability matching - derivatives and dynamic hedging
2. Restricting option eligibility conditions

Question 10

What is the main issue with dynamic hedging of liabilities?

Answer 10

1. It is not practical in most markets due to speed and the nature of liabilities often requiring OTC strategies and securities.
2. There may be significant transaction costs of constantly rebalancing a strategy.

Question 11

Describe how low frequency, high severity events are managed.

Answer 11

1. They can only be diversified in a limited way
2. Can be transferred to an insurer or reinsurer
3. Can be mitigated by management control procedures such as disaster recovery planning.
4. A company needs to analyse its risk tolerance to determine the capital held for such risks.

Question 12

Give the conditions on the price for accepting a risk.

Answer 12

1. The risk taker should be able to continue in business and,
2. Also provide a contribution to profit

Question 13

Give examples of how risk management can optimise the risk/return profile of an organistaion.

Answer 13

1. Supporting selective growth of the business - risk identification and capital allocation
2. Support profitability through risk-adjusted pricing - prices should reflect the cost of the risk capital in addition to funding costs and operational expenses.
3. Using limit setting to control the size and probability of potential losses - exposure limits, stop-loss limits, sensitivity limit
4. Employing techniques to manage existing risks - active portfolio management, reduce risks, transfer risks

Question 14

Give the general risks that life insurance companies face with their contracts.

Answer 14

1. Investment risk
2. Mortality risk - worse with regular premiums
3. Anti-selection and moral hazard risk
4. Persistency risk - worse with generous withdrawal benefits
5. Expense risk - not inline with expectations includes inflation
6. New business risk - too much or too low or size of contracts
7. Operational risk
8. External risks - catastrophes or competitor actions
9. Morbidity risks
10. Business mix risk
11. Reinsurance risk
12. Option take-up rate
13. Loose policy wording and legal liability
14. Underwriting risk

Question 15

Give the main purposes of risk controls

Answer 15

1. Reduce the likelihood of a risk event occurring
2. Limit the severity of the effects of a risk event that does occur
3. Limit the financial consequences of a risk
4. Reduce the wider consequences of a risk even that does occur

Question 16

Outline the risk management control cycle

Answer 16

1. Identification
2. Classification
3. Measurement
4. Control
5. Financing
6. Monitoring