A311 Flashcards
Objective of this deck is to create a level 1 thinking system for the subject A311. This is to aid memorisation in preparation for the exams.
Define anti-selection.
Anti-selection occurs when individuals have more information about their own risk levels than the insurer does.
Define underwriting.
Underwriting assesses the risk of applicants through medical exams, questionnaires, and other information to set appropriate premiums or deny coverage.
Define excess.
Excess refers to the amount the policyholder must pay out the pocket before the insurer pays for a claim.
Define new business strain.
New business strain refers to the initial financial strain a life insurance company experiences when it writes new policies, due to the upfront costs exceeding the initial premiums received.
Describe the roles which banks play within the financial services industry.
Provide liquidity to the financial system (have funds to lend)
Play a role as financial intermediaries (facilitate transfer between depositors and borrowers)
Provider of economic and business information (barometer for global financial health and business trends)
Have responsibility for monetary policy, exchange controls, printing money and as a lender of last resort
Reasons for monitoring the experience.
update method and assumptions so that they are more relevant to future experience
monitor any trends in experience, particularly adverse trends, so as to take corrective action
provide management (key-stakeholders) information
Reasons for analysing surplus. (DIVERGENCE)
Divergence of the actual verses expected (financial effect / significance of)
Information for management and for accounts
Variance of whole is equal to the sum of the variance from the individual sources
Experience monitoring to feedback into ACC
Reconcile values for successive years
Group into one-off / recurring sources of surplus
Executive remuneration schemes (data for)
New business strain (show effects of)
Check on valuation assumptions and calculations
Extra check on valuation data and processes
Why financial providers need capital. (REG CUSHION)
Regulatory requirement to demonstrate solvency
Expenses of launching a new product / starting a new operation
Guarantees can be offered
Cashflow timing management
Unexpected events cushion, e.g. adverse experience
Smooth profit
Help to demonstrate financial strength
Investment freedom to mismatch in pursuit of higher returns
Opportunities e.g. mergers and acquisitions
New business strain financing
Reasons why disclosure is important in a benefit scheme. (SIMMERS)
Sponsor is aware of the financial significance of the benefits
Informed decisions can be made
Mis-selling is avoided
Manages the expectations of members
Encourages take-up
Regulatory requirement
Security of scheme improved as sponsor / trustee made more accountable
Common aims of accounting standards (in relation to benefit scheme disclosures). (CARD)
Consistency in accounting treatment from year to year
Avoiding distortions resulting from contribution fluctuations
Recognising the realistic costs of accruing benefits
Disclosure of important information
Benefit scheme information to be disclosed in accounts. (DIM CLAIMS)
Directors’ benefit costs
Investment return over the year
Membership movements
Change in surplus / deficit over the year
Liabilities accruing over year
Assumptions
Increase in past service liabilities
Method
Surplus / deficit
When should information be disclosed to benefit scheme members? (PRICE)
Payment commencement
Request
Intervals
Combination
Entry
What information should be disclosed to benefit scheme members? (SCRIBE)
Strategy for investment
Contribution obligations
Risks involved
Insolvency entitlement
Benefit entitlements
Expense charges
What additional reports generally accompany accounts? (BRISK)
Board independence & governance
Risk appetite, exposure & management
Investment strategy & performance
Strategic objectives (progress towards)
Key objectives (performance against)
Remuneration report
Chairperson & CEO statement
What are some of the reasons for calculating provisions, for a benefit scheme? (BAD MEDICS)
Benefit improvements for a benefit scheme
Accounts and reports - published / internal
Discontinuance / surrender benefits
Mergers and acquisitions
Excess of assets over liabilities and so whether discretionary benefits can be awarded
Disclosure information for beneficiaries
Investment strategy
Contribution / premium setting
Supervisory solvency reports
Give a brief outline of the stages a monitoring investigation typically follows. (Exam Question - DIU)
Monitoring investigations typically involve the following stages:
The division of data into suitable groups that are homogeneous by risk, one needs to consider:
- the volume of data in each cell (its credibility)
- the risk factors for the investigation (age, gender)
- occurred changes that will reduce the relevance of old data
Identification of any past trends, cycles and anomalies and random variation in the past data
Using the results to revise models and assumptions used, one needs to consider:
- the purpose
- need for accuracy and margins for prudence
- allowance for future trends
- likely differences in future experience from past experience
For what reasons would a financial provider conduct an expense analysis? (DAA FUC)
Determining expense loadings and calculating provisions
Analysing sources of surplus (A/E)
Analysing areas of inefficiency within an organisation
Financial planning (expense budgeting)
Understanding the profitability of a particular product
Cashflow management (ensure liquid funds are available)
Provide a definition for capital management.
Capital management involves ensuring that a provider has sufficient solvency and liquidity to enable both its existing liabilities and future growth aspirations to be met in all reasonably foreseeable circumstances. It often involves maximising the reported profits of a provider.
Describe financial reinsurance.
Financial reinsurance involves transferring risk to a reinsurer in a way that is primarily motivated by financial management objectives, such as improving the ceding company’s financial ratios or solvency position, rather than purely for risk transfer.
Generally the main aim of financial reinsurance is to exploit some form of regulatory arbitrage in order to manage the capital, solvency or tax position of a provider more efficiently. It frequently relies on the regulatory, solvency or tax position of a reinsurer, which may be based in a overseas state, being different from that of the provider. This is done in the form of a reinsurance contract between the reinsured and the reinsurer.
Define securitisation.
Securitisation involves converting an illiquid asset into tradeable instruments. In our context the primary motivations are often to achieve regulatory or accounting (off balance sheet) treatment.
Define subordinated debt.
The main aim of subordinated debt is to generate additional capital that improves the free capital position of the provider, as the debt does not need to be included as a liability in the assessment of solvency.
Repayment of the subordinate debt can only be made if solvency capital requirements continue to be met.
Define a derivative.
Derivative is a financial instrument with a value dependent on the value of some underlying asset.
An example of when a derivative contract may be useful is when a provider may be concerned about the impact of a value in its equity portfolio. One could enter into a contract to prevent the portfolio from falling below a certain level.
What are liquidity facilities?
Liquidity facilities are typically provided by banks and can be used to provide short-term financing for companies facing rapid growth (new business strain)
What is contingent capital?
Contingent capital is generally provided by a bank, whose aim is of protecting the base of an insurance company. Under such an arrangement capital will be provided as it was required following a deterioration of experience.
What is senior unsecured financing?
Senior unsecured financing directly for an insurance company would not have capital benefits as the loan would be treated as a liability on the company’s balance sheet. Though at a group level this may be viable (capital can be moved around within a group of companies).
How could equity capital be financed for a company. (PIE)
Parent company
Issuing new shares the market
Existing shareholders via a rights issue
How could an organisation improve their capital position using internal sources of capital.
Retain capital
Change Assets
Merge funds
Weaken the valuation basis
Defer the distribution of surplus
Why do individuals need capital? (CS)
Cushion against unexpected events
Save for the future
Why do companies need capital? (FFF FS)
Financial consequences of adverse events
Financial expansion
Finance stock and work in progress
Fluctuating trade volumes
Start-up capital to hire staff, obtain premises, purchase equipment
Define economic capital
Economic capital is the amount of capital that a provider determines is appropriate to hold given its assets, its liabilities, and its business objectives.
It is an internal, rather than a regulatory capital assessment and is usually measured given a degree of confidence and over a given time horizon.
Define MCR.
Minimum Capital Requirement, which is the threshold at which a company will no longer be permitted to trade.
Define SCR.
Solvency Capital Requirement, which is target level of capital below which companies may need to discuss remedies with their regulators.
SCR is the total assets required to be held in excess of the provisions calculated on a best estimate basis.
What are the three pillars of Solvency II
Quantification of risk exposures and capital requirements
Supervisory regime
Disclosure requirements
What factors are economic capital in an ORSA assessment typically determined on (CBD R)?
Correlation of risks
Business objectives of the provider
Desired level of overall credit deterioration that it wishes to be able to withstand
Risk profile of the individual assets and liabilities in its portfolio
What is the difference between trading profit and investment profit?
Trading profit is the total of the premiums and investment income on the provisions for future liabilities, less claims, expenses, tax and the net increase in any provisions for future liabilities.
Investment profit is the investment return, less tax and investment expenses, earned on the part of the assets not required for the provisions for future liabilities.
List some of the possible sources of surplus for a life insurance company.
Mortality
Morbidity
Claim frequency
Claim amounts
Withdrawal / Lapses
Investment income
Expenses
Commission
Salary growth
Inflation
Taxation
Premium
New business levels
Strategic events (counterparty failure, business restructure)
Change in valuation method or assumption
List the factors which will affect the amount of surplus to distribute for a life insurance company.
Provision of capital
Margins for future adverse experience
Business objectives of the company
Policyholder expectations
Shareholder expectations
Stakeholder expectations
List the ways which a benefit scheme can reduce its surplus.
increase the value of the benefits and hence the value of the liabilities
Reduce future contributions for a period of time, so that the surplus decreases gradually as additional liabilities accrue
Transfer all or part of the excess assets from the scheme (to beneficiaries or the sponsor)
List the factors influencing the decision about the application of surplus or deficit for a benefit scheme. (LSD TRISS)
Legislation
Scheme rules
Discretion of the sponsor or fund managers
Tax treatment
Risk of exposure of the various parties
Industrial relations
Speed of corrective action
Source of surplus
List the factors affecting the choice of basis and valuation method chosen.
Reason for (or purpose of) the valuation
Needs of the client
Regulation and legislation
Nature of the assets
What are the differences between a going concern basis and a break-up basis
The going concern basis is based on the assumption that the insurer will continue to trade as normal for the long-term future.
The break-up basis assumes that the writing of new business ceases and cover on current policies are terminated.
What are the two definitions of fair value?
- the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm’s length transaction
- the amount that the enterprise would have to pay a third party to take over the liability
How can sensitivity analysis be used in valuing liabilities?
help to determine the extent of the margins needed in assumptions, to allow for future adverse experience
determining the extent of any global provisions required
Define global provisions and what their purpose.
Global provisions is an additional provision which looks at the provider’s liabilities in aggregate.
Purpose:
Acts as an additional protection for solvency
Cover risks, both financial and non-financial, that cannot be attributed to individual contracts
Reflect the degree of mismatching of assets and liabilities
What are some of the different methods of allowing for risk in cashflows?
Build a margin into each assumption
Apply an overall contingency loading by increasing the liability value by a certain percentage
Adjust the discount rate to reflect the risk in the project or liability
List some of the main accounting concepts commonly used when drawing up financial statements
Cost: assets are recorded at their original purchase cost and not at market value
Money Measurement: only transactions that can be measured in monetary terms are recorded in the accounting records
Going concern: assumes that the business will continue to operate for the foreseeable future and not be liquidated
Business entity: the business is treated as a seperate entity from its owners
Accrual: revenue and expenses are recorded when they are earned or incurred and not when the actual monies are recieved or paid
Prudence: assets and income should not be overstated and liabilities and expenses should not be understated
Consistency: the manner in which the accounting statements are produced should be in similar between periods
What are the benefits of a good risk management process? (SAVIOURS)
Strategic decision making improved
Avoid surprises
Volatility of profits reduced
Improved profits via capital efficiency
Opportunities exploited for profit
Understand interdependencies / aggregation
React quickly to emerging risks
Stakeholders given confidence
When is inappropriate advice given (CRIMES)
Complicated products
Rubbish adviser
Integrity of advisor lacking
Model or parameters unsuitable
Errors in data relating to beneficiaries
State encouraged but inappropriate actions
List factors which relate to the importance of risk reporting. (FRAUD CRIME)
Financing (appropriate price, reserves, capital requirements)
Rating agencies
Attractiveness to investors
Understand better (risks and their financial impact)
Determine appropriate control systems
Changes over time
Regulator
Interactions
Monitor effectiveness of controls
Emerging risk identification
List the ways which you can respond to a risk.
Transfer
Partially transfer
Retain
Reduce
Ignore
List the ways which you would evaluate risk mitigation options (FIRM)
Feasibility and cost
Impact on frequency/severity/expected value
Resulting secondary risks
Mitigation required in response to secondary risks
List the reasons for the use of reinsurance (SAD LIFE)
Smooth results
Avoid large losses
Diversification
Limit exposure to risk (single event, accumulation)
Increase capacity to take accept risk
Financial assistance
Expertise
List the reasons for using ART (Alternate risk transfer mechanisms) (DESCARTES)
Diversification
Exploits risks as an opportunity
Solvency improves / Source of capital
Cheaper cover than reinsurance
Available when reinsurance may not be
Results smoothed
Tax advantages
Efficient risk management tool
Security of payments improved
List the reasons for underwriting. (SAFAIR)
Suitable special terms
Avoids anti-selection
Financial underwriting against over-insurance
Actual experience inline with that assumed in pricing
Risk classification / rated fairly
Identify substandard risks
Define systematic risk.
This is a risk which affects an entire market or system due to its interconnectedness
Define diversifiable risk.
This is a risk which arise from an individual component of a financial market or system
Define enterprise risk management. (risks being managed at a group level)
This is a risk management function which assesses risk across all business units looking at the enterprise as a whole rather than in isolation. This approach allows for diversification, pooling of risk, economies of scale and taking advantage of risk opportunities.
Define managing risk at a business unit level.
Where the parent company determines the overall risk appetite and divides this up among the different business units. The business unit management team manages the risks of the business within the risk appetite they have been allocated. No allowance for benefits of diversification and pooling of risks, so not making the best use of its capital)
A common risk management model in financial services is to form three lines of defense, what are the three lines of defense?
First line of defense: line management staff in the business units, they are accountable for measuring and managing risk in individual business units on a daily basis.
Second line of defense: CRO, risk management team and the compliance team, they are accountable for establishing risk and compliance programs and policies, supporting and monitoring the line management and reporting to the board.
Third line of defense: the board and audit function, they are accountable for effective governance of the risk management process, setting risk management strategy, approving policies and ensuring that ERM is effective.
Define market risk
risks related to changes in investment market values / features correlated with investment market (interest, inflation, asset value changes, asset-liability matching)
Define credit risk
risk of failure of third parties to meet obligations (debtors, loanee, counterparty risk, credit rating)
Define liquidity risk
risk that the individual or company, although solvent, does not have sufficient financial resources to enable it to meet its obligations as they fall due (liquidity defined differently for providers and the market)
Define business risk
risks that are specific to the business undertaken (underwriting, insurance, exposure, financing)
Define operational risk
risk of losses arising from inadequate or failed internal processes, people and systems
Define external risk
risk arising from uncontrollable factor which are usually non-financial (climate change, pollution, technology)
Define marketability.
marketability is how easy it is to buy or sell an asset
Define liquidity.
Liquidity is a measure of how quickly an asset can be converted into cash at a predicable price.
What are the steps in conducting scenario analysis and when is usually used.
Scenario analysis is useful where it is difficult to fit full probability distributions to risk events.
It involves the following steps:
grouping of risks into broad categories
development of a plausible adverse scenario
calculation of the consequences of the risk event occurring for each scenario
total costs calculated are taken as the financial cost of all risks represented by the chosen scenario.
Define stress testing and describe the two types of stress tests.
Stress testing involves testing for weaknesses in a portfolio by subjecting it to extreme market movements ( or credit or liquidity risk events).
There are two types of stress tests:
to identify ‘weak areas’ in the portfolio and investigate the effects of localised stress situations by looking at the effect of different combinations of correlations and volatilities
to gauge the impact of major market turmoil affecting all model parameters, while ensuring consistency between correlations while they are ‘stressed’.
Define reverse stress testing.
Reverse stress testing is the construction of a severe stress scenario that just allows the firm to be able to continue to meet its business plan, e.g. having sufficient capital to meet solvency requirements or to cover its minimum risk appetite. The scenario may be extreme, but must be plausible.
Define a DB scheme.
one where the scheme rules define benefits independently of the contributions payable, and benefits are not directly linked to the investments of the scheme
Define a DC scheme.
one providing benefits where the amount of an individual member’s benefits depends on the contributions paid into the scheme in respect of that member, increased by the investment return earned on those contributions
What is the difference between a funded and an unfunded approaches to financing?
Funded - to some extent the monies needed to meet the benefit costs are set aside before the benefits fall due.
Unfunded - finding the money to pay for the benefits as the benefit falls due.
What are the several operational issues one must consider when modelling? (SCARCER FILES)
Simple but retains key features
Clear results
Adequately documented
Range of implementation methods
Communicable workings and outputs
Easy to understand
Refinable and developable
Frequency of cashflows (balance accuracy to practicality)
Independent verification of outputs
Length of run not too long
Expenses not to high
Sensible joint behavior of variables
What options do you have in sourcing a model and what considerations should you have in assessing different models(FENCED)?
Sourcing a model:
Built in-house, new model developed
Commercial model bought of the shelf
Existing model can be reused after modifications
Considerations in assessing different models:
Fit for the purpose
Expertise available in-house
Need for accuracy
Cost of the option
Expected number of times the model is to be used
Desired level of flexibility
Where can data be sourced for actuarial use? (TRAINERS)
Tables (mortality tables)
Reinsurers
Abroad (data from overseas contracts)
Industry data
National statistics
Experience investigations on existing contracts
Regulatory reports and company accounts
Similar contracts
What are the potential issues when using data? (QUERIED)
Quantity (credibility)
Up to date
Errors
Relevance (heterogeneity)
Incomplete
Exceptions
Detail and format
Factors to consider when setting assumptions (LUNCH)
Legislation or regulation
Use of the assumptions
Needs of the client
Consistency between assumptions
How financially significant the assumption is/are
Considerations when using past data to set future assumptions (BEST ARCHER)
Balance of homogeneous groups underlying the data may have changed
Economic situation may have changed
Social conditions may have changed
Trends over time (medical, demographic)
Abnormal fluctuations
Random fluctuations
Changes in regulation
Heterogeneity within the group to which the assumptions will apply
Errors in data
Recording differences (in categorization of smoker)
Mathematically define required return.
required return = required risk-free real rate of return + expected inflation + risk premium
the return which investors, as a whole require on any asset class
Mathematically define expected return.
expected return = initial income yield + income growth + impact of change in yield
the return the investors expects to achieve on the asset
What are some of the regulatory influences on assets held (TECH SCAM)
Types of assets which the provider can invest in
Extent to which mismatching is allowed
Currency matching requirement
Hold certain assets (government bonds)
Single counterparty maximum exposure
Custodianship of assets
Amount of any one asset used to demonstrate solvency may be restricted
Mismatching reserve
List the factors which influence an institutions investment strategy.
existing liability 5
institution 3
asset
3
external environment 6
nature of the existing liabilities
currency of the existing liabilities
term of the existing liabilities
level of uncertainty of existing liabilities
future accrual of liabilities
institutions risk appetite
institutions objectives
institutions need for diversification
size of assets relative to liabilities in absolute terms
expected long-term return from various asset classes
the existing asset portfolio
strategy followed by other funds
statutory, legal, voluntary restrictions
statutory regulation, solvency requirements
accounting rules
taxes and expenses
ESG
What are the types of actuarial advice? (FIR)
Factual advice - based on research of facts
Indicative advice - an opinion
Recommendations - involving research, modelling and consideration of alternatives
What are the aims of a regulator? (GRIP) & functions of a regulator (RISIP)?
Give confidence to the financial system
Reduce financial crime
Inefficiencies in the market corrected and orderly markets promoted
Protect customers of financial product
Influencing and reviewing government policy
registering and vetting firms and individuals
supervising prudential management of financial organizations
imposing regulation upon suspected breaches/imposing sanctions
providing information to government and the public
List the external environment factors. (CREATE GRAND LISTS)
Corporate structure
Regulation and legislation
Environmental issues and climate change
Accounting standards
Tax
Economic outlook (interest rates, inflation, exchange rates)
Governance
Risk management requirements
Adequacy of capital and solvency
New business environment
Demographic trends
Lifestyle considerations
International practice
State benefits
Technology
Social and cultural trends
Define the strategic benchmark
The strategic benchmark is an appropriate asset mix established for the fund
Define the strategic risk of a fund
The strategic risk of a fund is the risk of poor performance of the strategic benchmark relative to the value of the liabilities
Define active risk
Active risk refers to risk that an investor does not meet their particular benchmark
Define structural risk
Structural risk arises from mismatches between the aggregate of the portfolio benchmarks and the total fund benchmark
Define overall risk
Overall risk is the sum of the active, strategic and structural risks
What are the principles of investment for a provider?
A provider should select investments that are appropriate to the nature, term, currency and uncertainty of the liabilities, and the providers appetite for risk. Subject to the above, investments should also be selected to maximize the overall return on the assets.
Define active investment management.
where the investment manager has fewer restrictions on investment choice within a broad remit. It is expected to produce greater returns despite extra dealing costs and risks of poor judgement
Define passive investment management.
involves holding assets closely reflecting those underlying an index or specific benchmark. The investment manager has little freedom of choice. There remains the risk of tracking errors and the index performing poorly
What is a tactical asset allocation switch, and what should you consider before making the switch.
Tactical asset allocation switch involves a short term departure from the benchmark position in pursuit of higher returns.
Before making the switch consider:
The expected extra returns compared with the additional risk
Any constraints on changing the portfolio
The expenses of making the switch
Any problems of switching a large amount of assets
List the key steps in developing and running a model
specify the purpose and key features of the model
obtain and adjust the data
set the parameters / assumptions, including any dynamic links
construct the model cashflows
check the accuracy and fit of the model
run the model as many times as required
output and summarise the results.
What is the Actuarial Quality Framework?
The Actuarial Quality Framework aims to promote actuarial quality through four main drivers: methods, communication, actuaries and the environment. It is designed by the FRC and aims to complement professional and other regulation affecting actuaries and their clients.
List properties which make a risk insurable
A risk is insurable if:
the policyholder has an interest in the risk
the risk is of a financial and reasonably quantifiable nature
the claim amount payable bears some relationship to the financial loss.
The following criteria are also desirable for a risk to be insurable:
individual risks should be independent
the probability of the event occurring should be relatively small
large numbers of similar risks should be pooled to reduce variance
there should be a limit on ultimate liability undertaken
moral hazard should be eliminated as far as possible
there should be sufficient existing data / information in order to quantify risk.
Three possible relationships between the CRO’s office and individual business units.
Offence vs defense: set up in oppositions (CRO minimizing risk, line management maximising returns)
Policy and policing: CRO sets policy which line management abide by (feel restrictive, policy may become out of date)
Partnership: CRO staff integrated into business unit, client consultant relationships, beneficial over long term, lack of independence
What are the direct and indirect costs of regulation
Direct
Administering regulation
Ensuring compliance for regulated firms
Indirect
Alteration in consumer behaviour
Undermining the sense of professional responsibility of advisor/intermediaries
reduced consumer protection mechanisms developed by the market
reduced product innovation
reduced competition
