Brehm ch.4 Flashcards
1
Q
what is operational risk?
Brehm ch.4
A
risk of loss resulting from inadequate or failed internal processes, people and systems or from external systems
2
Q
what is one thing that operational risk includes, and two that it excludes?
(Brehm ch.4)
A
- includes legal risk
- excludes strategic and reputational risk
3
Q
what are seven types of operational risk loss events?
Brehm ch.4
A
- internal fraud
- external fraud
- employment practices and workplace safety
- clients, products, and business practices
- damage to physical assets
- business disruption and system failures
- execution, delivery, and process management
4
Q
what is internal fraud?
Brehm ch.4
A
acts by an internal party that defraud, misappropriate property (i.e. unfairly take) or circumvent the regulations (law or company policy)
5
Q
what is an insurer-specific example of internal fraud?
Brehm ch.4
A
claim falsification
6
Q
what is external fraud?
Brehm ch.4
A
acts by a third party that defraud, misappropriate property or circumvent the law
7
Q
what are three general examples of external fraud?
Brehm ch.4
A
- robbery
- forgery
- computer hacking
8
Q
what are two insurer-specific examples of external fraud?
Brehm ch.4
A
- claims fraud
- falsifying application information
9
Q
what are employment practices and workplace safety events that can lead to operational risk loss?
(Brehm ch.4)
A
acts that are inconsistent with employment, health, or safety laws
10
Q
what are four general examples of employment practices and workplace safety loss events?
(Brehm ch.4)
A
- workers compensation claims
- violation of employee health and safety rules
- discrimination claims
- organized labor activities
11
Q
what is an insurer-specific example of an employment practice/workplace safety loss event?
(Brehm ch.4)
A
repetitive stress
12
Q
what are clients, products, and business practices operational risk loss events?
(Brehm ch.4)
A
- unintentional or negligent failure to meet a professional obligation to specific clients
- nature/design of a product also poses operational risk
13
Q
what are four general examples of clients, products, and business practices loss events?
(Brehm ch.4)
A
- fiduciary breaches
- misuse or confidential customer information
- money laundering
- sale of unauthorized products
14
Q
what are three insurer-specific examples of clients, products, and business practices loss events?
(Brehm ch.4)
A
- client privacy
- bad faith
- red-lining
15
Q
what is a damage to physical assets operational risk loss event?
(Brehm ch.4)
A
loss or damage to physical assets from natural disasters
16
Q
what are four examples of damage to physical assets operational risk loss events?
(Brehm ch.4)
A
- terrorism
- vandalism
- earthquakes
- floods
17
Q
what are insurer-specific examples of damage to physical assets loss events?
(Brehm ch.4)
A
-physical damage to its own office building and its own automobile fleets
18
Q
what are general examples of business disruption and system failures operational risk loss events?
(Brehm ch.4)
A
- hardware and software failures
- telecommunication problems
- utility outages
19
Q
what are two insurer-specific examples of business disruption and system failures operational risk loss events?
(Brehm ch.4)
A
- processing center downtime
- system interruptions
20
Q
what are execution, delivery, and process management operational risk loss events?
(Brehm ch.4)
A
failed transaction processing or process management and relationships with vendors
21
Q
what are four general examples of execution, delivery and process management operational risk loss events?
(Brehm ch.4)
A
- data entry errors
- incomplete legal documentation
- unapproved access given to client accounts
- vendor disputes
22
Q
what are two insurer-specific examples of execution, delivery and process management operational risk loss events?
(Brehm ch.4)
A
-policy processing and claim payment errors
23
Q
what are eight primary causes of P&C company impairments?
(Brehm ch.4)
A
- deficient loss reserves
- underpricing
- rapid growth
- alleged fraud
- overstated assets
- catastrophes
- reinsurance failures
- reckless management
24
Q
how are significant sources of operational risk accounted for?
(Brehm ch.4)
A
-implicitly accounted for in the capital charges for premium, reserves and growth
25
what is the root reason for insurer failure?
| Brehm ch.4
-accumulation of too much exposure for the supporting asset base
26
what are two things that deficient carried reserves may indicate?
(Brehm ch.4)
- deficient initial reserving (optimistic plan loss ratios)
| - premature reserve releases
27
what is a "bridging model" for setting plan loss ratios?
| Brehm ch.4
-more mature prior-year ultimate loss ratios are bridged forward using estimates of year-over-year loss cost and price level changes
28
what is an operational problem with a bridging process?
| Brehm ch.4
-produces a high degree of interdependence between prior-year ultimate loss ratios -> optimistic older prior-year LRs roll forward, leads to optimistic plan LR -> unrealistic forecasted prior years
29
what is reserve conflagration?
| Brehm ch.4
-BF ELRs for newer prior years increase via bridging when older prior years begin to deteriorate
30
what are three possible explanations for deficient reserving?
(Brehm ch.4)
- plan loss ratio (reserving review) model(s) could not accurately forecast the loss ratio (reserves)
- plan loss ratio (reserving review) model(s) could have accurately forecasted the loss ratio (reserves), but was (were) not properly used
- plan loss ratio (reserving review) model (models) did accurately forecast the loss ratio (reserves) but the indications were ignored
31
what is cycle management?
| Brehm ch.4
management of underwriting capacity as market prices change with the u/w cycle
32
what are four things that system performance assessments focus on?
(Brehm ch.4)
- stability
- availability
- reliability
- affordability
33
why type of problem is being downgraded?
| Brehm ch.4
-stability and availability
34
what type of problem is becoming insolvent?
| Brehm ch.4
reliability and affordability
35
what are four focus areas to achieve process improvements re: effective cycle management?
(Brehm ch.4)
- intellectual property
- underwriter incentives
- market overreaction
- owner education
36
what is an insurer's franchise value driven by?
| Brehm ch.4
intangible assets (ex: intellectual property)
37
what are five examples of intellectual property?
| Brehm ch.4
- expertise of an insurer's staff
- proprietary database of policyholder information
- forecasting systems (pricing and reserving)
- market relationships
- reputation
38
how can managers help maintain intellectual property?
| Brehm ch.4
- focus on retaining top talent during periods of capacity retraction & continue developing their skills
- maintain a presence in core market channels
- continue to invest in systems, models, and databases
39
how should underwriter incentives be managed?
| Brehm ch.4
- based on ow well u/w support portfolio goals throughout year
- ->goals should be fluid and based on market condition
40
what is an example of why portfolio goals should be fluid and change based on market condition?
(Brehm ch.4)
if prices drop to unacceptable level, u/w should be able to stop writing NB without fearing that their bonuses will be in jeopardy
41
what is an example of market overreaction to the underwriting cycle?
(Brehm ch.4)
-market prices and coverage tend to soften below reasonable levels -> eventually, prices and restrictions overcorrect to other extreme
42
what is an example of how financial figures may look "out of line" under effective cycle management?
(Brehm ch.4)
-premium volumes will drop under cycle management -> fine if soft market, do NOT want increased market share
43
how does the overhead expense ratio change under effective cycle managemnet?
(Brehm ch.4)
- most firms: higher -> operational inefficiency
| - effective cycle management -> expected to rise as premium volume decreases
44
what does agency theory consider?
| Brehm ch.4
management agents of a firm's owners -> interests not always aligned -> operational risk
45
what are the two goals of agency theory studies?
| Brehm ch.4
- aligning management and owner interests
| - understanding impacts of potential divergence
46
what is an example of divergent interests of owners and management based on management incentive?
(Brehm ch.4)
-management gets paid %age of increase in market cap -> management may be more willing to take on risky investments (end up with higher or same pay)
47
what is another example of divergent interests of owners and management based on management incentive?
(Brehm ch.4)
-management paid in stock grants/options -> management may be less willing to take on risk (compensation less diversified than owners of firm)
48
what are five additional operational risks?
| Brehm ch.4
- pension funding risk
- IT failure risk
- other HR risks
- reputational risks
- lawsuits
49
what is pension funding risk?
| Brehm ch.4
combines financial and HR components
50
how is pension funding risk handled?
| Brehm ch.4
-models that incorporate financial risk with firm demographics are needed to quantify
51
what does IT failure risk include?
| Brehm ch.4
- traditional hardware and software failure
| - viruses and internet attacks
52
how is IT failure risk handled?
| Brehm ch.4
-monitoring and contingency planning
53
what are six examples of "other" HR risks?
| Brehm ch.4
- loss of important staff
- employee fraud
- inadequate training
- errors
- rule breaking
- incompetence
54
what does reputational risk result from?
| Brehm ch.4
- product tampering
- bad press coverage
- off-hours behavior of key employees
55
how is reputational risk handled?
| Brehm ch.4
-monitoring and controlling is more important than quantifying/funding
56
how are "other" HR risks handled?
| Brehm ch.4
-monitoring and controlling rather than quantifying/funding
57
what might lawsuits result from?
| Brehm ch.4
- making too much money
- making too little money
- improper business practices
58
how are lawsuit risks handled?
| Brehm ch.4
- monitoring behavior is key
- funding may provide value too
- manage corporate culture to reduce risk
59
what is a control self-assessment? (CSA)
| Brehm ch.4
-process through which internal control effectiveness is examined and assessed
60
what is the objective of control self-assessment (CSA)?
| Brehm ch.4
provide reasonable assurance that all business objectives will be met
61
what are the five primary objectives of internal controls?
| Brehm ch.4
ensure:
- reliability and integrity of information
- compliance with policies, plans, procedures, laws, regulations and contracts
- safeguarding of assets
- economical and efficient use of resources
- accomplishment of established objectives and goals for operations or programs
62
what are risk indicators?
| Brehm ch.4
measures used to monitor activities and status of the control environment of a particular business area for a given operational risk category
63
how do key risk indicators (KRIs) differ from historical losses?
(Brehm ch.4)
- KRIs are forward-looking indicators of risk
| - historical losses are backward-looking
64
what are four categories of insurer KRIs?
| Brehm ch.4
- production
- internal controls
- staffing
- claims
65
what are four examples of production KRIs?
| Brehm ch.4
- hit ratios
- retention ratios
- pricing levels
- rate per unit of exposure
66
what are two examples of internal controls KRIs?
| Brehm ch.4
- audit results
| - audit frequency
67
what are four examples of staffing KRIs?
| Brehm ch.4
- employee turnover
- training budget
- premium per employee
- policies per employee
68
what are three examples of claims KRIs?
| Brehm ch.4
- frequency
- severity
- new classes of loss
69
how do risk indicators function?
| Brehm ch.4
- risk measures can be assessed daily
- must have frame of reference (escalation criteria/trigger levels)
- when trigger level is reached, management must take action
70
what is six sigma?
| Brehm ch.4
- management framework
| - customer-specified tolerances for product defects are plus/minus three SDs from the mean
71
what seven things does six sigma focus on?
| Brehm ch.4
- process redesign
- project management
- customer feedback
- internal communication
- design tradeoffs
- documentation
- control plans
72
what two settings is six sigma applied in?
| Brehm ch.4
- existing process improvement
| - predictive design
73
what benefit can six sigma provide the financial services industry?
(Brehm ch.4)
-identify and eliminate inefficiencies, errors, overlaps, and gaps in communication and coordination
74
what are three types of insurer processes that might benefit from process improvements?
(Brehm ch.4)
- underwriting
- claims
- reinsurance
75
what are five underwriting processes that might benefit from process improvements?
(Brehm ch.4)
- exposure data verification
- exposure data capture
- price component monitoring
- classification
- hazard selection
76
what are four claims processes that might benefit from process improvements?
(Brehm ch.4)
- coverage verification
- ALAE
- use of outside counsel
- case reserve setting
77
what are five reinsurance processes that might benefit from process improvements?
(Brehm ch.4)
- treaty claim reporting
- coverage verification
- reinsurance recoverables
- disputes
- letters of credit
- collaterization
78
what does an operational risk portfolio consist of?
| Brehm ch.4
-all operational risk exposures that are either transferred (i.e. insured or transferred to capital markets) or retained
79
what are the five steps needed for operational risk portfolio management?
(Brehm ch.4)
- identify exposure bases for each key operational risk source
- measure exposure level for each BU
- estimate loss potential (F&S) per exposure for each risk
- combine 2 & 3 to the BU level
- estimate impact of mitigation, process improvements or risk transfer on BU F & S distr
80
what are four examples of exposure bases for operational risk sources?
(Brehm ch.4)
- payroll
- policy count
- claim count
- premium volume
81
what should the loss potential (F&S) per unit of exposure for each operational risk reflect?
(Brehm ch.4)
existing levels of controls and process effectiveness
82
how is strategy defined?
| Brehm ch.4
- a long-term series of actions designed to take a company from its current state to its desired future state
- aims to provide a competitive advantage over other companies in the same market
83
what ISN'T strategy?
| Brehm ch.4
- pure business planning
| - tactics
84
how does strategy go beyond pure business planning?
| Brehm ch.4
strategy ensures that companies understand markets in which they are competing, where they sit relative to their competitors, and how they will compete and outperform their rivals
85
how does strategy differ from tactics?
| Brehm ch.4
- tactics are short-term and detailed
| - strategy is long-term and broad in scope
86
what is strategic risk-taking?
| Brehm ch.4
intentional risk-taking as an essential part of a company's strategic execution
87
what is strategic risk?
| Brehm ch.4
unintentional risks that occur as a result of strategy planning or execution
88
how do Slywotzsky and Drzik describe strategic risk management?
(Brehm ch.4)
means to devise and deploy a systematic approach for managing strategic risk
89
how do Slywotzsky and Drzik categorize strategic risk? (7)
| Brehm ch.4
- industry
- technology
- brand
- competitor
- customer
- project
- stagnation
90
what falls into the "industry" category of strategic risk? (5)
(Brehm ch.4)
- capital intensiveness
- overcapacity
- commoditization
- deregulation
- cycle volatility
91
what falls into the technology category of strategic risk? (3)
(Brehm ch.4)
- shifts
- patents
- obsolescence
92
what falls into the brand category of strategic risk? (2)
| Brehm ch.4
- erosion
| - collapse
93
what falls into the competitor category of strategic risk? (#)
(Brehm ch.4)
- global rivals
- gainers
- unique competitors
94
what falls into the customer category of strategic risk? (3)
| Brehm ch.4
- priority shift
- power
- concentration
95
what falls into the project category of strategic risk? (4)
| Brehm ch.4
- failure of R&D
- IT
- business development
- mergers and acquisitions
96
what falls into the stagnation category of strategic risk? (3)
(Brehm ch.4)
- flat or declining volume
- price decline
- weak pipeline
97
how do Hertz and Thomas use strategic risk analysis?
| Brehm ch.4
-use as an input for strategy development process, aiding strategy formulation, choice and implementation
98
what is the magnitude of industry strategic risk for insurers?
(Brehm ch.4)
very high
99
what is the magnitude of technology strategic risk for insurers?
(Brehm ch.4)
low
100
what types of technology strategic risk might insurers experience?
(Brehm ch.4)
technological advancement in:
- internet distribution (issuing policies over internet, adjusting claims over internet)
- data management
101
what is the magnitude of brand strategic risk for insurers?
| Brehm ch.4
moderate
102
how might brand strategic risk apply to insurers?
| Brehm ch.4
- insurance products are fairly homogeneous, primary feature: ability to pay claim
- differentiate on price and service
- reputation for fair claims handling, low prices
103
what is the magnitude of competitor strategic risk for insurers?
(Brehm ch.4)
moderate
104
what are three ways competitor strategic risk can manifest for insurers?
(Brehm ch.4)
- rival pricing below the market to grab market share
- entering new market with inadequate u/w expertise, pricing systems, policy serving capabilities
- multiple competitors targeting same market segment
105
what is the magnitude of customer strategic risk for insurers?
(Brehm ch.4)
moderate, worse for large commercial insurance companies
106
what is the magnitude of project strategic risk for insurers?
(Brehm ch.4)
-high
107
what are two examples of how project strategic risk can manifest for insurers?
(Brehm ch.4)
- mergers and acquisitions can destroy value of company if not appropriately assessed
- insurers often under-invest in R&D and IT
108
what is the magnitude of stagnation strategic risk for insurers?
(Brehm ch.4)
high
109
how might stagnation strategic risk manifest for insurers?
| Brehm ch.4
- hard to redeploy assets
- extensive reporting lags, mismatched revenue/expenses
- tendency to respond poorly to market price cycles
110
why do insurers have a hard time redeploying assets?
| Brehm ch.4
most insurer assets are intellectual with a large degree of task specificity
111
what is scenario planning?
| Brehm ch.4
- range of future outcomes is limited to a fixed number of scenarios
- scenarios describe how various elements might interact under certain conditions
112
what are scenarios used for?
| Brehm ch.4
- explore joint impact of various uncertainties
| - scenarios change several variables at one time, trying to capture the impacts of major shocks in key variables
113
what are ten steps in the scenario planning process?
| Brehm ch.4
```
1-define scope
2-identify major stakeholders
3-identify basic trends
4-identify key uncertainties
5-construct initial scenario themes
6-check for consistency and plausibility
7-develop learning scenarios
8-identify research needs
9-develop quantitative models
10-evolve toward decisions scenarios
```
114
what elements of scenario planning scope need to be defined?
| Brehm ch.4
-time frame and level of analysis (geographic, product segments)
115
what are six potential major stakeholders for scenario planning?
(Brehm ch.4)
- customers
- suppliers
- competitors
- employees
- shareowners
- regulators
116
what are three questions to evaluate consistency and plausibility of scenario planning?
(Brehm ch.4)
- are trends compatible with chosen timeframe?
- are major stakeholders placed in realistic positions?
- do outcomes fit together?
117
what are key plan components within a traditional insurer planning exercise?
(Brehm ch.4)
- base loss ratio
- cost trend
- price change
- target premium volume
- plan loss ratio
118
what are drawbacks to using "plan estimates" in the traditional planning approach?
(Brehm ch.4)
- they are often overly optimistic due to need to meet overall corporate profit or premium volume targets
- reluctance to deviate from plan numbers -> booked numbers are unrealistic
119
what are two advantages of scenario planning?
| Brehm ch.4
- company thinks through responses beforehand -> prescreen and agree on best response, save time during crises
- organizational inertia is reduced (plan is more flexible)
120
what is necessary when expanding scenario planning to a combined scenario set for multiple lines of business?
(Brehm ch.4)
- LOB perspectives must be realist/consistent and correlations must be considered
- u/w capacity must be taken into account
121
what does agent-based modeling capture?
| Brehm ch.4
captures the dynamics of simultaneous action by multiple competing companies strategy-testing at once
122
what is agent-based modeling (ABM)?
| Brehm ch.4
a method for studying systems of interacting "agents"
123
what are "agents" in ABM?
| Brehm ch.4
independent entities capable of assessing the environment, selecting courses of action and using those selections to effect change on the environment
124
what are emergent properties (in ABM)?
| Brehm ch.4
new qualities created in the environment when one agent's changes interact with another agent's changes
