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exam 7 > Brehm ch.4 > Flashcards

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

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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

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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
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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)

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5
Q

what is an insurer-specific example of internal fraud?

Brehm ch.4

A

claim falsification

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6
Q

what is external fraud?

Brehm ch.4

A

acts by a third party that defraud, misappropriate property or circumvent the law

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7
Q

what are three general examples of external fraud?

Brehm ch.4

A
  • robbery
  • forgery
  • computer hacking
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8
Q

what are two insurer-specific examples of external fraud?

Brehm ch.4

A
  • claims fraud

- falsifying application information

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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

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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
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11
Q

what is an insurer-specific example of an employment practice/workplace safety loss event?

(Brehm ch.4)

A

repetitive stress

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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
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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
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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
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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

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16
Q

what are four examples of damage to physical assets operational risk loss events?

(Brehm ch.4)

A
  • terrorism
  • vandalism
  • earthquakes
  • floods
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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

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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
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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

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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

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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
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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

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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
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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

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25
Q

what is the root reason for insurer failure?

Brehm ch.4

A

-accumulation of too much exposure for the supporting asset base

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26
Q

what are two things that deficient carried reserves may indicate?

(Brehm ch.4)

A
  • deficient initial reserving (optimistic plan loss ratios)

- premature reserve releases

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27
Q

what is a “bridging model” for setting plan loss ratios?

Brehm ch.4

A

-more mature prior-year ultimate loss ratios are bridged forward using estimates of year-over-year loss cost and price level changes

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28
Q

what is an operational problem with a bridging process?

Brehm ch.4

A

-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

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29
Q

what is reserve conflagration?

Brehm ch.4

A

-BF ELRs for newer prior years increase via bridging when older prior years begin to deteriorate

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30
Q

what are three possible explanations for deficient reserving?

(Brehm ch.4)

A
  • 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
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31
Q

what is cycle management?

Brehm ch.4

A

management of underwriting capacity as market prices change with the u/w cycle

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32
Q

what are four things that system performance assessments focus on?

(Brehm ch.4)

A
  • stability
  • availability
  • reliability
  • affordability
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33
Q

why type of problem is being downgraded?

Brehm ch.4

A

-stability and availability

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34
Q

what type of problem is becoming insolvent?

Brehm ch.4

A

reliability and affordability

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35
Q

what are four focus areas to achieve process improvements re: effective cycle management?

(Brehm ch.4)

A
  • intellectual property
  • underwriter incentives
  • market overreaction
  • owner education
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36
Q

what is an insurer’s franchise value driven by?

Brehm ch.4

A

intangible assets (ex: intellectual property)

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37
Q

what are five examples of intellectual property?

Brehm ch.4

A
  • expertise of an insurer’s staff
  • proprietary database of policyholder information
  • forecasting systems (pricing and reserving)
  • market relationships
  • reputation
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38
Q

how can managers help maintain intellectual property?

Brehm ch.4

A
  • 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
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39
Q

how should underwriter incentives be managed?

Brehm ch.4

A
  • based on ow well u/w support portfolio goals throughout year
  • ->goals should be fluid and based on market condition
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40
Q

what is an example of why portfolio goals should be fluid and change based on market condition?

(Brehm ch.4)

A

if prices drop to unacceptable level, u/w should be able to stop writing NB without fearing that their bonuses will be in jeopardy

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41
Q

what is an example of market overreaction to the underwriting cycle?

(Brehm ch.4)

A

-market prices and coverage tend to soften below reasonable levels -> eventually, prices and restrictions overcorrect to other extreme

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42
Q

what is an example of how financial figures may look “out of line” under effective cycle management?

(Brehm ch.4)

A

-premium volumes will drop under cycle management -> fine if soft market, do NOT want increased market share

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43
Q

how does the overhead expense ratio change under effective cycle managemnet?

(Brehm ch.4)

A
  • most firms: higher -> operational inefficiency

- effective cycle management -> expected to rise as premium volume decreases

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44
Q

what does agency theory consider?

Brehm ch.4

A

management agents of a firm’s owners -> interests not always aligned -> operational risk

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45
Q

what are the two goals of agency theory studies?

Brehm ch.4

A
  • aligning management and owner interests

- understanding impacts of potential divergence

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46
Q

what is an example of divergent interests of owners and management based on management incentive?

(Brehm ch.4)

A

-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)

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47
Q

what is another example of divergent interests of owners and management based on management incentive?

(Brehm ch.4)

A

-management paid in stock grants/options -> management may be less willing to take on risk (compensation less diversified than owners of firm)

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48
Q

what are five additional operational risks?

Brehm ch.4

A
  • pension funding risk
  • IT failure risk
  • other HR risks
  • reputational risks
  • lawsuits
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49
Q

what is pension funding risk?

Brehm ch.4

A

combines financial and HR components

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50
Q

how is pension funding risk handled?

Brehm ch.4

A

-models that incorporate financial risk with firm demographics are needed to quantify

51
Q

what does IT failure risk include?

Brehm ch.4

A
  • traditional hardware and software failure

- viruses and internet attacks

52
Q

how is IT failure risk handled?

Brehm ch.4

A

-monitoring and contingency planning

53
Q

what are six examples of “other” HR risks?

Brehm ch.4

A
  • loss of important staff
  • employee fraud
  • inadequate training
  • errors
  • rule breaking
  • incompetence
54
Q

what does reputational risk result from?

Brehm ch.4

A
  • product tampering
  • bad press coverage
  • off-hours behavior of key employees
55
Q

how is reputational risk handled?

Brehm ch.4

A

-monitoring and controlling is more important than quantifying/funding

56
Q

how are “other” HR risks handled?

Brehm ch.4

A

-monitoring and controlling rather than quantifying/funding

57
Q

what might lawsuits result from?

Brehm ch.4

A
  • making too much money
  • making too little money
  • improper business practices
58
Q

how are lawsuit risks handled?

Brehm ch.4

A
  • monitoring behavior is key
  • funding may provide value too
  • manage corporate culture to reduce risk
59
Q

what is a control self-assessment? (CSA)

Brehm ch.4

A

-process through which internal control effectiveness is examined and assessed

60
Q

what is the objective of control self-assessment (CSA)?

Brehm ch.4

A

provide reasonable assurance that all business objectives will be met

61
Q

what are the five primary objectives of internal controls?

Brehm ch.4

A

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
Q

what are risk indicators?

Brehm ch.4

A

measures used to monitor activities and status of the control environment of a particular business area for a given operational risk category

63
Q

how do key risk indicators (KRIs) differ from historical losses?

(Brehm ch.4)

A
  • KRIs are forward-looking indicators of risk

- historical losses are backward-looking

64
Q

what are four categories of insurer KRIs?

Brehm ch.4

A
  • production
  • internal controls
  • staffing
  • claims
65
Q

what are four examples of production KRIs?

Brehm ch.4

A
  • hit ratios
  • retention ratios
  • pricing levels
  • rate per unit of exposure
66
Q

what are two examples of internal controls KRIs?

Brehm ch.4

A
  • audit results

- audit frequency

67
Q

what are four examples of staffing KRIs?

Brehm ch.4

A
  • employee turnover
  • training budget
  • premium per employee
  • policies per employee
68
Q

what are three examples of claims KRIs?

Brehm ch.4

A
  • frequency
  • severity
  • new classes of loss
69
Q

how do risk indicators function?

Brehm ch.4

A
  • 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
Q

what is six sigma?

Brehm ch.4

A
  • management framework

- customer-specified tolerances for product defects are plus/minus three SDs from the mean

71
Q

what seven things does six sigma focus on?

Brehm ch.4

A
  • process redesign
  • project management
  • customer feedback
  • internal communication
  • design tradeoffs
  • documentation
  • control plans
72
Q

what two settings is six sigma applied in?

Brehm ch.4

A
  • existing process improvement

- predictive design

73
Q

what benefit can six sigma provide the financial services industry?

(Brehm ch.4)

A

-identify and eliminate inefficiencies, errors, overlaps, and gaps in communication and coordination

74
Q

what are three types of insurer processes that might benefit from process improvements?

(Brehm ch.4)

A
  • underwriting
  • claims
  • reinsurance
75
Q

what are five underwriting processes that might benefit from process improvements?

(Brehm ch.4)

A
  • exposure data verification
  • exposure data capture
  • price component monitoring
  • classification
  • hazard selection
76
Q

what are four claims processes that might benefit from process improvements?

(Brehm ch.4)

A
  • coverage verification
  • ALAE
  • use of outside counsel
  • case reserve setting
77
Q

what are five reinsurance processes that might benefit from process improvements?

(Brehm ch.4)

A
  • treaty claim reporting
  • coverage verification
  • reinsurance recoverables
  • disputes
  • letters of credit
  • collaterization
78
Q

what does an operational risk portfolio consist of?

Brehm ch.4

A

-all operational risk exposures that are either transferred (i.e. insured or transferred to capital markets) or retained

79
Q

what are the five steps needed for operational risk portfolio management?

(Brehm ch.4)

A
  • 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
Q

what are four examples of exposure bases for operational risk sources?

(Brehm ch.4)

A
  • payroll
  • policy count
  • claim count
  • premium volume
81
Q

what should the loss potential (F&S) per unit of exposure for each operational risk reflect?

(Brehm ch.4)

A

existing levels of controls and process effectiveness

82
Q

how is strategy defined?

Brehm ch.4

A
  • 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
Q

what ISN’T strategy?

Brehm ch.4

A
  • pure business planning

- tactics

84
Q

how does strategy go beyond pure business planning?

Brehm ch.4

A

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
Q

how does strategy differ from tactics?

Brehm ch.4

A
  • tactics are short-term and detailed

- strategy is long-term and broad in scope

86
Q

what is strategic risk-taking?

Brehm ch.4

A

intentional risk-taking as an essential part of a company’s strategic execution

87
Q

what is strategic risk?

Brehm ch.4

A

unintentional risks that occur as a result of strategy planning or execution

88
Q

how do Slywotzsky and Drzik describe strategic risk management?

(Brehm ch.4)

A

means to devise and deploy a systematic approach for managing strategic risk

89
Q

how do Slywotzsky and Drzik categorize strategic risk? (7)

Brehm ch.4

A
  • industry
  • technology
  • brand
  • competitor
  • customer
  • project
  • stagnation
90
Q

what falls into the “industry” category of strategic risk? (5)

(Brehm ch.4)

A
  • capital intensiveness
  • overcapacity
  • commoditization
  • deregulation
  • cycle volatility
91
Q

what falls into the technology category of strategic risk? (3)

(Brehm ch.4)

A
  • shifts
  • patents
  • obsolescence
92
Q

what falls into the brand category of strategic risk? (2)

Brehm ch.4

A
  • erosion

- collapse

93
Q

what falls into the competitor category of strategic risk? (#)

(Brehm ch.4)

A
  • global rivals
  • gainers
  • unique competitors
94
Q

what falls into the customer category of strategic risk? (3)

Brehm ch.4

A
  • priority shift
  • power
  • concentration
95
Q

what falls into the project category of strategic risk? (4)

Brehm ch.4

A
  • failure of R&D
  • IT
  • business development
  • mergers and acquisitions
96
Q

what falls into the stagnation category of strategic risk? (3)

(Brehm ch.4)

A
  • flat or declining volume
  • price decline
  • weak pipeline
97
Q

how do Hertz and Thomas use strategic risk analysis?

Brehm ch.4

A

-use as an input for strategy development process, aiding strategy formulation, choice and implementation

98
Q

what is the magnitude of industry strategic risk for insurers?

(Brehm ch.4)

A

very high

99
Q

what is the magnitude of technology strategic risk for insurers?

(Brehm ch.4)

A

low

100
Q

what types of technology strategic risk might insurers experience?

(Brehm ch.4)

A

technological advancement in:

  • internet distribution (issuing policies over internet, adjusting claims over internet)
  • data management
101
Q

what is the magnitude of brand strategic risk for insurers?

Brehm ch.4

A

moderate

102
Q

how might brand strategic risk apply to insurers?

Brehm ch.4

A
  • insurance products are fairly homogeneous, primary feature: ability to pay claim
  • differentiate on price and service
  • reputation for fair claims handling, low prices
103
Q

what is the magnitude of competitor strategic risk for insurers?

(Brehm ch.4)

A

moderate

104
Q

what are three ways competitor strategic risk can manifest for insurers?

(Brehm ch.4)

A
  • 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
Q

what is the magnitude of customer strategic risk for insurers?

(Brehm ch.4)

A

moderate, worse for large commercial insurance companies

106
Q

what is the magnitude of project strategic risk for insurers?

(Brehm ch.4)

A

-high

107
Q

what are two examples of how project strategic risk can manifest for insurers?

(Brehm ch.4)

A
  • mergers and acquisitions can destroy value of company if not appropriately assessed
  • insurers often under-invest in R&D and IT
108
Q

what is the magnitude of stagnation strategic risk for insurers?

(Brehm ch.4)

A

high

109
Q

how might stagnation strategic risk manifest for insurers?

Brehm ch.4

A
  • hard to redeploy assets
  • extensive reporting lags, mismatched revenue/expenses
  • tendency to respond poorly to market price cycles
110
Q

why do insurers have a hard time redeploying assets?

Brehm ch.4

A

most insurer assets are intellectual with a large degree of task specificity

111
Q

what is scenario planning?

Brehm ch.4

A
  • range of future outcomes is limited to a fixed number of scenarios
  • scenarios describe how various elements might interact under certain conditions
112
Q

what are scenarios used for?

Brehm ch.4

A
  • 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
Q

what are ten steps in the scenario planning process?

Brehm ch.4

A 
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
Q

what elements of scenario planning scope need to be defined?

Brehm ch.4

A

-time frame and level of analysis (geographic, product segments)

115
Q

what are six potential major stakeholders for scenario planning?

(Brehm ch.4)

A
  • customers
  • suppliers
  • competitors
  • employees
  • shareowners
  • regulators
116
Q

what are three questions to evaluate consistency and plausibility of scenario planning?

(Brehm ch.4)

A
  • are trends compatible with chosen timeframe?
  • are major stakeholders placed in realistic positions?
  • do outcomes fit together?
117
Q

what are key plan components within a traditional insurer planning exercise?

(Brehm ch.4)

A
  • base loss ratio
  • cost trend
  • price change
  • target premium volume
  • plan loss ratio
118
Q

what are drawbacks to using “plan estimates” in the traditional planning approach?

(Brehm ch.4)

A
  • 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
Q

what are two advantages of scenario planning?

Brehm ch.4

A
  • company thinks through responses beforehand -> prescreen and agree on best response, save time during crises
  • organizational inertia is reduced (plan is more flexible)
120
Q

what is necessary when expanding scenario planning to a combined scenario set for multiple lines of business?

(Brehm ch.4)

A
  • LOB perspectives must be realist/consistent and correlations must be considered
  • u/w capacity must be taken into account
121
Q

what does agent-based modeling capture?

Brehm ch.4

A

captures the dynamics of simultaneous action by multiple competing companies strategy-testing at once

122
Q

what is agent-based modeling (ABM)?

Brehm ch.4

A

a method for studying systems of interacting “agents”

123
Q

what are “agents” in ABM?

Brehm ch.4

A

independent entities capable of assessing the environment, selecting courses of action and using those selections to effect change on the environment

124
Q

what are emergent properties (in ABM)?

Brehm ch.4

A

new qualities created in the environment when one agent’s changes interact with another agent’s changes

exam 7 (21 decks)

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