Ch 13: Risk 1

Question 1

Summary Card

Answer 1

• Sources of risk
• Data risk
• Mortality risk
• Expense risk
• Persistency risk

Question 2

Give an overview of the broad catergories of risk faced by insurers.

(CA1/ARM recap; not in ST2/F102 notes)

Answer 2

1. Business risk
   
   • Risk specific to business undertaken [UIFE]
   • Underwriting: Accept risk @ inadequate price
   • Insurance: Claim freq and severity higher than expected
   • Financing: Failure to generate returns for providers of finance
   • Exposure: Concentration risk
2. External risk
   
   • Losses due to external events
   • natural disasters, regulation changes
3. Liquidity risk
   
   • Solvent insurer does not have suff capital to meet obligations
   • Inability to convert assets to cash w/o significant cost
4. Credit risk
   
   • Failure of 3rd parties to meet obligations
   • Default,Downgrade,Spread, Counterparty
5. Operational risk
   
   • Losses resulting from failed internal processes, people, systems
   • Inadequate internal processes
   • Conduct Risk
   • Dominance Risk
   • 3rd Party risk, carry out essential function
6. Market risk
   
   • Risk from change in MV of assets relative ot liabilities(mismatch risk)
   • No perf match due to no assets available
   • High cost of matching
   • Uncertain Liabilities
7. Climate change
   
   • Physical:
     
     • 1st order risk , global warming, disasters,Ops disruptions
     • Incr Claims, expenses, decr inv ret
   • Transition:
     
     • Change in econ,markets,polictics
     • Incr Demand for greener companies products
     • change in investment strat
   • Liability
     
     • IBNR claims due to changes in environment
     • eg air pollution

BELCOM C

Question 3

List 16 possible sources of risk to a life insurer

Answer 3

• Business
  
  1. Mortality rates
  2. Expenses (including inflation)
  3. Persistency
  4. Policy and other data
  5. New business mix
  6. New business volumes
  7. Guarantee and options
  8. Competition
  9. Aggregation and concentration of risk
  10. Legal, regulatory and tax developments (not strictly business risk, but just putting it here as it doesn’t make sense in other category)
• Market
  
  1. Investment performance
     
     • Market fluctuations
     • How assets change vs liabilities
• Credit
  
  1. Counterparties
     
     • Others: credit downgrading
• Operational
  
  1. Fraud
  2. Actions of board members
  3. Actions of distributors
  4. Failure of management systems and control

ARM

Question 4

DATA RISKS

Policy data? (2)

What kind of ‘other data’ might insurer use (5)

Answer 4

1. Policy data
   
   1. eg age at entry, policy term, duration in force, sum assured
   2. records maintained by insurer, main reason is to carry out valuation
   3. Risk data is inaccuarate, incomplete, not maintained:
      
      • Inaccurate valuation results (MP != underlying polices)
      • Investigations give inacc results
2. Other data
   
   1. Data req to det assump
   2. Can be from multiple sources (TRAINERS)
      
      1. Internal experience data
      2. Industry data
      3. National stats
      4. Overseas markets
3. Data risks
   
   • Inacc: not reliable
   • Insuff Vol: not Credible
   • Diff pop in data vs act pop: not suitable/relevant

Question 5

what would an insurer use this data for?

(Remember a useful acronym from CA1/ARM)

Answer 5

Uses of data: MAFIA PEPRS acronym from CA1/ARM :)

1. Marketing
2. Administration
3. Financial planning and management
4. Investments
5. Accounting
6. Provisioning/reserving
7. Experience statistics and analysis/investigations
   
   1. done to give appropriate advice
   2. inaccurate data => inaccurate advice
   3. model points:
      
      1. not always practical/cost effective to do investigation on whole book.
      2. can use model points, then scale up results
      3. the fewer the model points, less accurate
8. Premium rating or product costing
9. Risk management
10. Statutory returns

Question 6

Risk due to data:

Explain how policy and other data can be a source of risk to a life insurer in terms of

• maintenance of policyholder data
• internal data from other prods
• external data
• model points

Answer 6

1. Poor maintenance
   
   • Company may not maintain adequate, accurate and complete records requred by actuary and so
     
     • results of supervisory valuation may be innacurate
     • other investigations may be inaccurate and so advice innapropriate
2. Internal data
   
   • future experience inadequate: due to inaccuracy/low volumes
   • population differences: adequate, but inappropriately used
   • missing data
3. External data
   
   • ​may also be inadequate and/or inappropriate
   • unreliable
4. In modelling whole company, there may be model point risk

Question 7

Risk due to data

Discuss main issues for health and care products compared to life insurance products (3)

Answer 7

For health and care contracts specifically, the following issues are experienced (more so than for life insurance:

1. Limited credibility
   
   • smaller policy volumes e.g CI and LTCI
   • lower incidence rates e.g. IP and CI
2. Limited applicability of past data
   
   • Changes to products/market over time
   • Limited relevance of past data due to sensitvity to
     
     • socio economic conditions (IP)
     • medical advances (CI)
     • longevity/health at older ages (LTCI)
3. Limited applicability of industry data
   
   • ​Due to heterogeneity of products and markets

Question 8

Risks in investigations: MORTALITY

Define 3 risks which normally arise in investigations

e.g. when setting mortality assumptions for pricing

Answer 8

1. Model risk:
   
   • Inappropriate/erroneous probability distribution chosen for underyling model e.g. future mortality.
2. Parameter risk:
   
   • Underlying model correct, but parameters inadequate (don’t reflect future experience of lives insured/to be insured)
3. Random fluctuation risk:
   
   • Actual future experience may not correspond with model/parameters adopted (even though these adequately reflect lives insured/ to be insured)

• All these risks always exist (impossible to predict future with complete certainty).
• 1&2 depend on quality of data
• Extent of 3rd depends on numbers exposed to risk: smaller number = greater risk.

These risks are also associated with other major assumptions e.g. investment, expenses

Question 9

Expense and other risk

2.1.3

Answer 9

• Assump made on future expenses
  
  • Incl inflation assump => param risk due to LT nature
  • Incl loadings to cover expenses: withdrawla risk if no recoup
• The risk that actual expenses are higher than expected or allowed for e.g. due to inflation is called expense risk.
• The risk that charges received are lower than expected or allowed for is more typically classified as other types of risk. Give 3 examples of what these other risks might be.
  
  • Investment performance risk (e.g. if charges are fund-based)
  • Persistency risk (e.g if charges required to recoup initial expenses are not received due to high withdrawal)
  • New business mix or volume risk (e.g. if charges are linked to average size or volume of new business)

Question 10

Investment Performance risks

Answer 10

• Assump made for return => param +model risk
• Deterministic assump tested useing Sens analysis
• Stoch assump: model inv ret as RV, monte-carlo sims, incr risk

Question 11

Withdrawal/Persistency risk (4)

Answer 11

Also known as withdrawal risk
* Assumption made=> param
* Model withdrawals=> model risk.
* Financial risk:

• Asset share: risk if less than surrender value greater at time of withdrawal…
• …made worse by mismatching initial expenses vs charges to recoup expenses
• Selective withdrawals negatively influencing mortality experience
• Reduce business volumes means risk of increasing per-policy expenses