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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
Q

what are seven characteristics of a good enterprise risk model?

(Brehm ch.1)

A
  • 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
Q

what might happen if a model does not contain the seven desirable characteristics?

(Brehm ch.1)

A
  • models w/o desirable characteristics often exaggerate certain aspects of risk while underestimating others
  • lead to overly aggressive or overly cautious corporate decisions
27
Q

what are two types of risk that do not lend themselves to quantification?

(Brehm ch.1)

A
  • operational risk

- strategic risk

28
Q

what are the four essential elements of a mathematical enterprise model?

(Brehm ch.1)

A

-[R]eserving risk
-[A]sset risk
-[U]nderwriting risk
-[D]ependencies/correlations
[y]

29
Q

what does underwriting risk consist of?

Brehm ch.1

A
  • loss frequency
  • loss severity
  • pricing risk
  • parameter risk
  • cat modeling uncertainty
30
Q

what should be considered about pricing risk?

Brehm ch.1

A
  • 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
Q

what are four facets of parameter risk?

Brehm ch.1

A
  • estimation risk
  • projection risk
  • event risk
  • systematic risk
32
Q

what is estimation risk (as part of parameter risk)?

Brehm ch.1

A

misestimation of model parameters due to imperfect data

33
Q

what is projection risk (as part of parameter risk)?

Brehm ch.1

A

refers to changes over time and the uncertainty in the projection of these changes

34
Q

what are examples of projections that contribute to projection risk?

(Brehm ch.1)

A
  • trending F and S to future periods

- loss development

35
Q

what are examples of changes that lead to projection risk?

Brehm ch.1

A

unexpected changes in risk conditions:

  • increase in driving due to cheaper fuel
  • criminals attack security vehicles because banks are more secure
36
Q

what is event risk (as part of parameter risk)?

Brehm ch.1

A

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
Q

what are examples of event risk (as part of parameter risk)?

Brehm ch.1

A
  • class-action lawsuits
  • latent exposures (asbestos)
  • legal decisions on policy wording (court decides to ban a policy exclusion)
38
Q

what is systematic risk (as part of parameter risk)?

Brehm ch.1

A

risks that operate simultaneously on a large number of individual policies -> non-diversifying and do not improve with added volume

39
Q

what are examples of systematic risk?

Brehm ch.1

A
  • inflation

- all other types of parameter risk (event risk, estimation risk, projection risk)

40
Q

how is cat exposure incorporated into enterprise risk models?

(Brehm ch.1)

A

by incorporating proprietary cat models

41
Q

what does cat modeling uncertainty consist of?

Brehm ch.1

A
  • 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
Q

what is reserving risk?

Brehm ch.1

A
  • risk of reserves developing other than as anticipated

- affects both amount of required capital and time for which that capital must be held

43
Q

what are four important asset classes to model?

Brehm ch.1

A
  • bonds
  • equities
  • real estate
  • exchange rates
44
Q

what is a key aspect of asset modeling?

Brehm ch.1

A
  • modeling scenarios consistent with historical patterns

- more probable scenarios should be given more weight

45
Q

how can a good enterprise risk model help balance asset and underwriting risk?

(Brehm ch.1)

A

-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
Q

what are correlated sources of dependency?

Brehm ch.1

A
  • 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
Q

what is an example of tail dependency in extreme events?

Brehm ch.1

A

large EQ creates simultaneous large losses for property, workers compensation, and auto LOBs

48
Q

how is tail dependency often modeled?

Brehm ch.1

A

using copulas

49
Q

what five things must capital be sufficient for?

Brehm ch.1

A
  • 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
Q

what is one of the key uses for the enterprise risk model?

Brehm ch.1

A

-help insurer find the optimal level of capital that balances efficiency and prudence

51
Q

what are four common approaches for setting capital requirements?

(Brehm ch.1)

A

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
Q

what is a downside of holding enough capital so that the probability of default is remote?

(Brehm ch.1)

A
  • very conservative

- mainly protects just the policyholder

53
Q

what is a benefit to holding enough capital to maximize franchise value?

(Brehm ch.1)

A

protects both policyholder AND shareholder

54
Q

what are four examples of things included in franchise value?

(Brehm ch.1)

A
  • balance sheet
  • customer base
  • agency relationships
  • reputation
55
Q

why is it important to remember that an ERM is least reliable in extremes?

(Brehm ch.1)

A
  • 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
Q

what is a positive consequence of risk modeling?

Brehm ch.1

A

-ability to measure the risk-adjusted performance of various business segment

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