Brehm CH 4 Flashcards
What is operational risk?
risk of loss resulting from inadequate or failed internal processes, people or systems or from external events (includes legal risk, but excludes strategic and reputational)
What are 7 examples of operational risk? (category level 1)
(1) Internal fraud: intentionally misreporting positions, employee theft, insider trading
(2) External fraud: robbery, forgery, cheque kiting
(3) Employment practices and workplace safety: customer slip and fall
(4) Clients, products, and business practices: fiduciary breaches, misuse of confidential customer info, money laundering, sale of unauthorized products
(5) Damage to physical assets: terrorism, vandalism, EQs, fires, and floods
(6) Business disruption and system failures: hard/software failures, telecommunication problems and utility outages
(7) Execution, delivery, and process management: data entry errors, collateral management failures, incomplete legal documentation, vendor disputes
What are the principal causes of US insurer insolvency according to a 2004 A.M Best study?
(1) Deficient loss reserves
(2) Rapid Growth
(3) Alledged fraud
(4) Overstated assets
(5) Cats
(6) Reinsurance failure
What is cycle management?
prudent management of UW capacity as market pricing fluctuates through the UW cycle
can achieve success by focusing on intellectual property, underwriter incentives, market overreaction, and owner education
What is intellectual property and how can it improve cycle management?
includes experts in uw, claims, actuarial; proprietary databases, forecasting systems, market relationships and reputation
prudent managers need to focus on maintaining these assets through the cycle (retain top-talent and develop their skils, maintain a presence in core market channels, consistently invest in systems, models, and databases)
What are underwriter incentives and how can it improve cycle management?
hard-coded bonus formulas for doing well
What is Market Overreaction and how can it improve cycle management?
insurance industry has a proven track record of overreaction in both directions
can prudently manage capacity so that they have most available capacity in the price-improvement phase and stockpile for the small UW loss years
What is owner education and how can it improve cycle management?
owners need to understand that in a soft market their premiums may drop relative to their peers but thats probably a good thing
What is the agency theory perspective?
management are the agents of owners, but agents with potentially divergent interests
goal: understand impacts of divergence and learn how to align incentives
managers can gamble with owners money
paying management with stock options is seen as a solution but has issues: shareholders become more diversified than management, which then becomes more risk averse
big risk when tying compensation to growth metrics.
What are 5 general operational risks?
pension funding issues combine financial and HR: models that incorporate financial risk with firm demographics are needed
IT failure risk: quantified to some degree; monitoring and contingency planning is needed, but quantification and funding of risk is also possible
Other HR risks: loss of important staff (possible misdesign of benefits and comp programs, employee fraud, inade training, incompetence) possibly can purchase insurance for this
reputational risk: product tampering, bad press coverage: need to ID and manage these risks not quantify and fund them
Lawsuits against the firm: monitor behaviors; company culture could maybe make a difference here
What is control self-assessment?
process through which internal control effectiveness is self-examined and assessed
to provide reasonable assurance all business objectives will be met
Primary objectives:
1) reliability and integrity of info
2) compliance with policies, plans, procedures, laws
3) safeguarding of assets
4) economical and efficient use of resources
5) accomplishment of established objectives and goals for operations
What are key risk indicators (KRIs)?
broad category of measures used to monitor the activities and status of the control environment of a business area for a given operational risk
forward-looking, leading indicators of risk
some KRIs:
Production: hit ratios, retention ratios, item count, pricing levels
Internal controls: audit results and frequency
Staffing: employee turnover, training budget, premium per employee
Claims: freq, sev, new classes of loss
What is six sigma?
management framework born out of the manufacturing world
name means customer-specified tolerances are +- 3 SDs from the mean
can help firms identify and eliminate chronic process issues: errors, inefficiencies, gaps in communication
goal is to reduce operational risk
insurer processes that could benefit:
UW: exposure data verification, price component monitoring
Claims: coverage verification, ALAE, use of outside counsel
Reinsurance: treaty claim reporting, coverage verification, reinsurance recoverables, disputes, LOCs and collateralization
What are some necessary steps for operational risk portfolio management?
(1) Identify exposure bases for each key risk source: payroll, head count, policy count
(2) measure exposure level for each BU for each risk source
(3) estimate the loss potential per unit of exposure for each risk
(4) combine (2) and (3) to produce modeled BU loss freq / sev distributions
(5) estimate the impact of mitigation, process improvements, or risk transfer on the BU distributions (significant expert opinion required likely)
What is the proposed unified definition of strategy?
A science and art of planning,
Using political, economic, psychological and organizational resources,
To achieve major organizational goals.
