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exam 7 > Brehm ch.1 > Flashcards

Brehm ch.1 Flashcards

1
Q

how is enterprise risk management defined?

Brehm ch.1

A

the process of systematically and comprehensively identifying critical risks, quantifying their impacts and implementing integrated strategies to maximize enterprise value

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2
Q

what 6 aspects does the definition of enterprise risk management consist of?

(Brehm ch.1)

A
  • effective ERM should be a regular process, not just a one-time event
  • risks should be considered on an enterprise basis (consider risks other than insurance risk)
  • ERM focuses on risks that have a significant impact to the value of the firm
  • risk must be quantified as best as possible, calculated on an overall, portfolio basis, and considering correlations with other risks
  • strategies must be implemented to avoid, mitigate, or exploit risks
  • to maximize firm value, risk management strategies are evaluated for trade-off between risk and return
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3
Q

what are four general types of risk that insurers face?

Brehm ch.1

A
  • insurance hazard
  • financial (asset)
  • operational
  • strategic
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4
Q

what is insurance hazard risk?

Brehm ch.1

A

risk assumed by insurer in exchange for a premium

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5
Q

what three subcategories does insurance hazard risk consist of?

(Brehm ch.1)

A
  • accumulation/[C]at
  • [U]nderwriting
  • [R]eserve deterioration
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6
Q

what is the underwriting risk subcategory of insurance hazard risk?

(Brehm ch.1)

A

risk due to non-cat losses from current exposures

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7
Q

what is the accumulation/cat risk category of insurance hazard risk?

(Brehm ch.1)

A

risk due to cat losses from current exposures

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8
Q

what is the reserve deterioration risk category of insurance hazard risk?

(Brehm ch.1)

A

risk due to losses from past exposures

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9
Q

what is financial (asset) risk?

Brehm ch.1

A

risk in the insurer’s asset portfolio related to volatility in interest rates, foreign exchange rates, equity prices, credit quality and liquidity

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10
Q

what is operational risk?

Brehm ch.1

A

risk associated with the execution of the company’s business

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11
Q

what are two examples of operational risk?

Brehm ch.1

A
  • execution of IT systems

- policy service systems

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12
Q

what is strategic risk?

Brehm ch.1

A

risk associated with making the wrong or right strategic choices -> risk of choosing the wrong plan, given the current and expected market conditions

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13
Q

what four steps describe the ERM process?

Brehm ch.1

A
  • diagnose
  • analyze
  • implement
  • monitor
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14
Q

what occurs in the diagnose step of the ERM process?

Brehm ch.1

A

company conducts a risk assessment to determine material risks that exceed a company-defined threshold

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15
Q

what are three examples of types of risks found in the diagnose step of the ERM process?

(Brehm ch.1)

A
  • general environment
  • industry
  • firm specific
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16
Q

what are four examples of general environment risks found in the diagnose step of the ERM process?

(Brehm ch.1)

A
  • political uncertainties
  • government policy
  • macroeconomic changes
  • catastrophes
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17
Q

what are two examples of industry risks found in the diagnose step of the ERM process?

(Brehm ch.1)

A
  • supply and demand changes

- competitive uncertainties

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18
Q

what are three examples of firm-specific risks found in the diagnose step of the ERM process?

(Brehm ch.1)

A
  • labor changes
  • liability (products, pollution)
  • R+D
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19
Q

what occurs in the analyze step of the ERM process?

Brehm ch.1

A

risks that exceed a company threshold are modeled as best as possible

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20
Q

how would a company model risks that exceed a company threshold?

(Brehm ch.1)

A
  • quantify risks by creating probability distr. of potential outcomes
  • correlations among risk factors must be recognized and distributions must be integrated across individual risks
  • risk metrics are calculated using the combined distribution of outcomes
  • risk factors that contribute the most to the risk metrics must be prioritized
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21
Q

what occurs in the implement step of the ERM process?

Brehm ch.1

A

implement various activities to manage the risks

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22
Q

what are five traditional examples of activities that occur during the implement step of the ERM process?

(Brehm ch.1)

A
  • risk avoidance
  • reduce risk occurrence
  • risk mitigation
  • risk transfer
  • retain the risk
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23
Q

what occurs in the monitor step of the ERM process?

Brehm ch.1

A

monitor the actual outcomes of the plans implemented in the previous steps against expectations

24
Q

what six firm functions do enterprise risk models help with?

Brehm ch.1

A
  • [V]aluing companies for mergers and acquisitions
  • managing [A]sset mix
  • planning [G]rowth
  • setting [R]einsurance strategies
  • [I]dentifying the sources of significant risk and the cost of capital to support them
  • [D]etermining capital needed to support risk, maintain ratings, etc.
25
what are seven characteristics of a good enterprise risk model? (Brehm ch.1)
- model includes [M]athematical techniques to reflect relationships among risks (dependencies/correlations) - recognizes and reflects its own [I]mperfections - modelers have [D]eep knowledge of the fundamentals of those risks - reflects relative [I]mportance of various risks to business decisions - modelers have [T]rusted relationship with senior management of the company - model reflects the [U]ncertainty of the output of other models being incorporated (e.g. cat models, macroeconomic models) - shows [B]alance between risk and reward from different strategies
26
what might happen if a model does not contain the seven desirable characteristics? (Brehm ch.1)
- models w/o desirable characteristics often exaggerate certain aspects of risk while underestimating others - lead to overly aggressive or overly cautious corporate decisions
27
what are two types of risk that do not lend themselves to quantification? (Brehm ch.1)
- operational risk | - strategic risk
28
what are the four essential elements of a mathematical enterprise model? (Brehm ch.1)
-[R]eserving risk -[A]sset risk -[U]nderwriting risk -[D]ependencies/correlations [y]
29
what does underwriting risk consist of? | Brehm ch.1
- loss frequency - loss severity - pricing risk - parameter risk - cat modeling uncertainty
30
what should be considered about pricing risk? | Brehm ch.1
- instability in underwriting results arises from variations in premiums as well as losses - u/w cycle contributes heavily to pricing risk and needs to be modeled over multiple periods
31
what are four facets of parameter risk? | Brehm ch.1
- estimation risk - projection risk - event risk - systematic risk
32
what is estimation risk (as part of parameter risk)? | Brehm ch.1
misestimation of model parameters due to imperfect data
33
what is projection risk (as part of parameter risk)? | Brehm ch.1
refers to changes over time and the uncertainty in the projection of these changes
34
what are examples of projections that contribute to projection risk? (Brehm ch.1)
- trending F and S to future periods | - loss development
35
what are examples of changes that lead to projection risk? | Brehm ch.1
unexpected changes in risk conditions: - increase in driving due to cheaper fuel - criminals attack security vehicles because banks are more secure
36
what is event risk (as part of parameter risk)? | Brehm ch.1
situations in which there is a causal link between a large unpredicted event (outside of the company's control) and losses to the insurer
37
what are examples of event risk (as part of parameter risk)? | Brehm ch.1
- class-action lawsuits - latent exposures (asbestos) - legal decisions on policy wording (court decides to ban a policy exclusion)
38
what is systematic risk (as part of parameter risk)? | Brehm ch.1
risks that operate simultaneously on a large number of individual policies -> non-diversifying and do not improve with added volume
39
what are examples of systematic risk? | Brehm ch.1
- inflation | - all other types of parameter risk (event risk, estimation risk, projection risk)
40
how is cat exposure incorporated into enterprise risk models? (Brehm ch.1)
by incorporating proprietary cat models
41
what does cat modeling uncertainty consist of? | Brehm ch.1
- cat models often differ from each other and change over time as the modeling firms release model updates - each model includes considerable uncertainty relating to the probabilities of various events and relating to the amount of insured damage - data quality and assumptions also contribute to uncertainty
42
what is reserving risk? | Brehm ch.1
- risk of reserves developing other than as anticipated | - affects both amount of required capital and time for which that capital must be held
43
what are four important asset classes to model? | Brehm ch.1
- bonds - equities - real estate - exchange rates
44
what is a key aspect of asset modeling? | Brehm ch.1
- modeling scenarios consistent with historical patterns | - more probable scenarios should be given more weight
45
how can a good enterprise risk model help balance asset and underwriting risk? (Brehm ch.1)
-risk profiles on liability and asset sides of balance sheet are often different in duration -> optimize use of capital by offsetting insurance risks with investment risk (i.e. duration matching)
46
what are correlated sources of dependency? | Brehm ch.1
- inflation rates, interest rates, equity values -> macroeconomic model - u/w cycles, insurance loss trends, reserve developments -> correlated across LOB and with each other - cats and other kinds of event risk -> often correlated across LOB
47
what is an example of tail dependency in extreme events? | Brehm ch.1
large EQ creates simultaneous large losses for property, workers compensation, and auto LOBs
48
how is tail dependency often modeled? | Brehm ch.1
using copulas
49
what five things must capital be sufficient for? | Brehm ch.1
- support [G]rowth - provide for [A]dverse reserve changes - [S]ustain current u/w - [S]atisfy regulators, rating agencies, and shareholders - provide for [D]eclines in assets
50
what is one of the key uses for the enterprise risk model? | Brehm ch.1
-help insurer find the optimal level of capital that balances efficiency and prudence
51
what are four common approaches for setting capital requirements? (Brehm ch.1)
holding enough capital: - to continue to service [R]enewals - so that probability of [D]efault is remote - so that insurer survives a major cat AND [T]hrives in its aftermath - to maximize insurer's [F]ranchise value
52
what is a downside of holding enough capital so that the probability of default is remote? (Brehm ch.1)
- very conservative | - mainly protects just the policyholder
53
what is a benefit to holding enough capital to maximize franchise value? (Brehm ch.1)
protects both policyholder AND shareholder
54
what are four examples of things included in franchise value? (Brehm ch.1)
- balance sheet - customer base - agency relationships - reputation
55
why is it important to remember that an ERM is least reliable in extremes? (Brehm ch.1)
- extreme reference points (such as holding enough capital to avoid default) are difficult to model accurately - better to focus on more manageable probability levels
56
what is a positive consequence of risk modeling? | Brehm ch.1
-ability to measure the risk-adjusted performance of various business segment

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