Ch 13: Risk 1

Question 1

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

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

Answer 1

• Financial risks
  
  1. Business risk
  2. Liquidity risk
  3. Market risk
  4. Credit risk
• Non-financial risks
  
  1. Operational risk
  2. External risk

Question 2

List 16 possible sources of risk to a life insurer

Answer 2

• 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

Question 3

Risk due to data: types of data

What type of data might an insurer work with? (2)

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

Answer 3

1. Policy data
   
   1. eg age at entry, policy term, duration in force, sum assured
   2. maintained by insurer
   • 2. Other data
   • Data used in the formulation of actuarial assumptions
     1. ​Internal data from other products
     2. External data
     
     1. Insurance industry data
     2. National stats
     3. Overseas markets

Question 4

Risk due to data: types of data

We’ve covered the various data an insurer might use and what its potential sources of data might be; what would an insurer use this data for?

(Remember a useful acronym from CA1/ARM)

Answer 4

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 5

Risk due to data:

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

Answer 5

1. Poor maintenance
   
   • Company may not maintain adequate, accurate and complete records required by the actuary and so
     
     • results of supervisory valuation may be inaccurate
     • other investigations may be inaccurate and so advice inappropriate
     • incorrect decisions
2. Internal and External data
   
   • future experience inadequate: due to inaccuracy/low volumes
   • population differences: adequate, but inappropriately used
   • missing data
3. In modelling whole company, there may be model point risk - risk that all the model points will not accurately represent the underlying policy data
   - the fewer the model points, the less accurate the the representation of in-force business

Question 6

Risk due to data

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

Answer 6

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 7

Risks in investigations:

Define 3 risks which normally arise in investigations

e.g. when setting mortality assumptions for pricing

Answer 7

1. Model risk: the risk that the underlying model is not accurate
   * Inappropriate/erroneous probability distribution chosen for underyling model e.g. future mortality.
2. Parameter risk: the risk that the parameters assumed for the underlying model are incorrect
   * (don’t reflect future experience of lives insured/to be insured)
3. Random fluctuation risk: the risk of unpredictable fluctuations arising from sample error. The greater the sample, the smaller the error
   * Actual future experience may not correspond with model/parameters adopted (even though these adequately reflect lives insured/ to be insured)

First 2 risks always exist (impossible to predict future with complete certainty).

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 8

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.

Answer 8

• 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 9

Explain how persistency may be a source of risk to a life insurer (4)

Answer 9

Also known as withdrawal 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