CH 13 - 15 (Risks)

Question 1

3 Classes of Assumption Risk

Answer 1

• Model Risk
  (inappropriate/erroneous probability distribution chosen for underlying model)
• Parameter Risk
  (correct model but parameters inadequate)
• Random Fluctuation Risk
  (model and parameters may be adequate, but actual experience has inherent volatility)

Question 2

Qualities of Good Data
(Risk if not met)

Answer 2

–Complete
–Accessible
–Consistent
(format, comparable across systems - unambiguous inputs)
–Credible
–Relevant
(up-to-date, detail)
–Accurate
–Quantity of data

Question 3

Data checks

Answer 3

–Cross-check
(against other sources)
–Consistency
(ave, min, max)
–Recon
–Spot checks

Question 4

Business Risk

Answer 4

1. Decrement Risk
   > Morbidity, Mortality, Longevity
   > Affected by medical advances and new diseases
   > Aggregation and concentration risk
2. Expense Risk
   > Inflation risk
   > Charge mismatch risk
   (incl. investment risk if charges are fund-based)
   > New business mix
   (cross-subsidies)
   > Persistency risk
   (recouping)
   > Volume risk
   (fixed cost loading)
3. Withdrawal Risk
   > Effect on decrement:
   Selective Withdrawals
   > Effect on Expenses:
   Persistency
   > Greatest risk when asset share is negative or low
   (esp. when mismatch on initial expenses vs charges)
4. Investment Risk

Special elements affecting above:
a. New business risk
> Volumes + Mix
> Capital strain
b. Guarantees and Options

Question 5

Other Risks

Answer 5

-Business
(DEWI)

-Liquidity

-Operational
> Management risk
> Systemic risk
> Fraud

-Credit

-Market

-External
> Competition
> Counterparty risk
(outsourcing, reinsurers, distribution channels)
> Legal, Regulatory and Fiscal (DERPFLEP)

Question 6

Drivers of management risk

Answer 6

• Poor controls
• Conflicting aims

Question 7

Consequences of System/Management Failure

Answer 7

• Regulator Intervention
• Reputational Damage
• Financial Loss

Question 8

Risks induced by Competitor Pressures

Answer 8

P(EN) GOB C

• Premium/charge reduction on New business
• maintaining low charges on Existing reviewable contracts (no growth of charges)
• additional Guarantees/Options
• increased Bonuses under existing contracts
• increase salaries/commissions of distribution Channels

Question 9

Credit Risk Failure Consequences

Answer 9

• Adverse publicity
  –> Marketing issues
• Difficulty in raising capital
  –> Greater cost
  OR
  –> Unable to pursue capital intensive projects

Question 10

Risk Management Core Principle

Answer 10

1. Balance need for risk control against achievement of profit aims
2. Context of…
   > Impact on capital and other resources
   > Impact on supervisory solvency
   > Cost of failing to meet any other legislative requirements

Question 11

Risk Impact of Mix and Volume Changes

Answer 11

Mix of the book’s Nature:
1. Class (e.g. pensions sold)
2. Type (e.g. term ass vs endowment)
3. Contract design (e.g. with profits vs unit linked)
4. Premium frequency (singular vs regular)

Mix of book’s Size
1. Change in risk profile or capital needs:
If smaller on average than assumed, expense loadings may fail to cover company’s overheads

Mix by source (distribution channel)
…if same premium across channels
1. Demographic experience (mortality, withdrawals)
2. Cost of channel

Small Volume
1. Fixed expense risk charges
2. Recovering development costs
3. Damages to long term profitability, competitiveness and viability

High Volume:
1. Insufficient capital for financing requirements
2. Insufficient admin resources to process new policies

Question 12

How to Assess Overall Risk

Answer 12

1. Stochastic projections of financial impact
2. Incorporate distributions of key risks
3. Allow for correlation between the parameters
4. Multiple runs
   (to test sensitivities and scenarios)
5. Consider
   > Capital and resources
   (controls risk appetite and desire for return)
   > Cost of failing to meet public interest need for company avoiding insolvency
   > Cost of failing to meet requirements of any applicable legislation

Question 13

Creditor Rating

Answer 13

Def:
> External assessment of the insurer’s risk profile

Insurer behaviour:
> Insurer will change business practice to minimise chances of downgrade

Significance of downgrade:
1. Adverse publicity
> Policyholders may be less likely to maintain/purchase policies
2. Greater difficulty + cost of raising additional capital
> Profitable activities may be constrained

Question 14

Risks Mitigated by Matching Investments

Answer 14

1. Investment risk
   (return required to meet liabilities for future payouts)
2. Inflation risk
3. Marketing risk
   (ability to satisfy p/holders in relation to any investment-linked/discretionary benefits)

Question 15

Managing Parameter Risk

Answer 15

• Risk margins
• Reinsurance
• issuing products with Reviewable premiums/charges
• Risk element of the RDR