Brehm #1 Flashcards
ERM definition
process of systematically and comprehensively identifying critical risks, quantifying their impacts, and implementing integrated strategies to maximize enterprise value
Risks included in ERM analysis (2)
- enterprise-wide risks
2. focuses only on material risks
Main categories of risk facing insurers (4)
- insurance hazard risk
- financial (asset) risk
- operational risk
- strategic risk
Sub-categories of insurance hazard risk and associated exposures (3)
- UW - risk of non-cat losses from current exposures
- accumulation/cat - risk of cat losses from current exposures
- reserve deterioration - risk of losses from past exposures
Insurance hazard risk
risk assumed by insurer in exchange for premium
Financial (asset) risk (5 sources)
risk in asset portfolio due to volatility in:
- interest rates
- foreign exchange rates
- equity prices
- credit quality
- liquidity
Operational risk and examples
risk associated w/execution of company’s business
- IT systems
- policy service systems
- people
- processes
Strategic risk
risk of making the right or wrong strategic choices, refusing to choose, OR failing to recognize that choices need to be made
Stages of ERM process (4)
- diagnose - initial risk assessment
- analyze - quantify critical risks using probability distributions of potential outcomes
- implement - avoidance, reduction, mitigation, or exploitation strategies
- monitor - actual vs. expected results
Essential elements of an enterprise risk model (4)
- UW risk
- reserving risk
- asset risk
- dependencies (correlations)
Components of UW risk in an enterprise risk model (5)
- loss frequency
- loss severity
- pricing risk
- parameter risk
- cat modeling uncertainty
Pricing risk definition (UW risk - enterprise risk model)
instability in UW results arising from variation in premium or losses (can come from mis-estimating projected losses or market pressures)
Components of parameter risk (UW risk in enterprise risk model - 4)
- estimation risk
- projection risk
- event risk
- systematic risk - *all parameter risk is systematic
Definition of parameter risk (UW risk)
risk of misestimation of parameters, imperfect form, and risk not modeled
Definition of parameter projection risk in enterprise risk models and examples (3)
changes over time and uncertainty in projection of those changes
ex:
1. frequency trend
2. severity trend
3. loss development
Definition of event risk in enterprise risk models and examples (5)
uncertainty due to events outside of company control which impact loss frequency or severity
ex:
1. class-action lawsuits
2. latent exposures
3. legal decisions on policy wording
4. new cause of loss discovered that was previously uncovered
5. new market entrant reduces rates to grab market share
Definition of cat modeling uncertainty in enterprise risk models
uncertainty in probability of event and amount of insured damage
Definition of reserving risk in enterprise risk models and impacts (2)
risk of reserves developing other than as anticipated
impacts:
1. amount of required capital
2. length of time capital must be held
Capital should be sufficient to… (5)
- sustain current UW
- provide for adverse reserve changes
- provide for declines in assets
- support growth
- satisfy regulators, rating agencies, and shareholders
Common capital requirements (5)
- default avoidance - hold enough capital that probability of default is remote
- maintain financial ratings
- continue to service renewals (which are more profitable)
- not only survive a major cat event, but thrive in aftermath
- maximize insurer’s franchise value
Traditional risk management techniques (4)
- risk avoidance
- risk mitigation
- risk transfer
- risk retention
Uses for enterprise risk modeling (5)
- Determine capital needed to support risk, maintain ratings, etc.
- Set reinsurance strategies
- Plan growth
- Manage asset mix
- Value companies for M&A
Most important elements for an effective enterprise risk model (4)
- Model reflects relative importance of risks to business decisions
- Modelers have deep knowledge of fundamentals of those risks
- Model includes mathematical techniques to reflect the relationships among risks (dependencies)
- Modelers have a trusted relationship with sr management.
Definition of parameter estimation risk in enterprise risk models (UW risk)
Specifying incorrect form or model parameters
Reduced with more or better quality data but never eliminated
