Ch 31: Other risk controls Flashcards
List 4 risk management tools available to a financial product provider, other that reinsurance and ART.
- Diversification
- Underwriting at the proposal stage
- Claims control processes / procedures
- Management control systems
Give 5 examples of how an insurer can diversify its business
5
- Different lines of business
- Different geographical areas
- Different reinsurers
- Different asset classes
- Different assets held within a class
Why might an insurance company use reciprocal QS reinsurance to diversify its risks in preference to selling a wider range of insurance contracts itself?
2
Marketing and selling a wide range of contracts is expensive. It also gives the insurance company the reputation of being a ‘generalist’ rather than a specialist player, which might not be the company’s desired strategy.
Reciprocal quota share reinsurance, where one company reinsures a part of another company’s business and vice versa, enables the insurance compnay to concentrate its marketing, sales and administrative effort on its chosen segment of the market (whilst still achieving a diversified portfolio). This should be more efficient.
What is underwriting?
3
- Underwriting is the assessment of potential risks so that each can be charged an appropriate premium
3 Main types:
* Medical: Obtain medical info of applicant. Factor in dishonesty, health improvements eg impaired lives annuity rates- anti-selection
* Financial: Risk of over insurance- check financial health of applicants 1st
* Lifestyle: To cover lifestyle risks
Usually special terms maybe imposed by specialist underwriters in each type. These can be reduced benefits, increased premiums, exclusions etc
Why do insurers underwrite business?
SAFARI
- Suitable special terms - identification of the most suitable approach and level for special terms to be offered to substandard risks.
- Avoid anti-selection
- Financial underwriting to reduce the risk of over-insurance on large policies
- Actual claims experience being in line with that expected in the pricing basis
- Risk classification to ensure that all risks are rated fairly (premium commensurate with the risk)
- Identify substandard risks, for which special terms will need to be quoted - while aiming to accept as many risks as possible on standard premium rates.
What is the purpose of performing financial underwriting for a life insurance contract, and what information on the applicant may be obtained in order to carry it out?
The purpose of financial underwriting is to assess whether the proposed SA is reasonable relative to the financial loss that the applicant would suffer if the insured event occurs. The aim is to reduce the risk of over-insurance.
Information obtained may include:
- The applicant’s occupation and salary
- The proposed SA selected by the applicant
- Details of other insurance policies held by the same applicant
- Whether the applicant has an insurable interest in the insured life
List 6 possible decisions that can be made following underwriting
6
- Accept on standard terms
- Reject / decline
- Deferral of cover
- Addition to premium, commensurate with the degree of extra risk.
- Reduction in benefit, commensurate with the degree of extra risk
- Exclusion clause(s)
What are claims control systems?
2
Claims control systems mitigate the consequences of a financial risk that has occurred.
They guard against fraudulent or excessive claims.
Give 4 examples of claims control systems
- Requiring claimants to submit a claim form
- Requiring evidence of eligibility to claim, e.g. death certificate
- Requiring continued evidence of eligibility to claim, e.g. for LTCI
- Requiring estimates of the extent of a loss, e.g. by the policyholder, or a company approved by the insurer, or by a loss adjuster
Explain why insurers may encourage income protection insurance benefit claimants to make a partial return to work, with a continued benefit.
This will benefit the insurer in terms of paying a lower claim amount, plus the longer-term health of the policyholders may be improved by entering active employment again. This can reduce the time to recovery from the current claim and reduce the likelihood of future claims.
Describe the 5 types of management control systems used to reduce risk.
- Data recording - the company should hold good quality data on all risks insured and on the risk factors identified during underwriting, to ensure that adequate provisions are established and to reduce operational risks.
- Accounting and auditing - effective procedures enable adequate provisions to be established, regular premiums to be collected and finance providers to be reassured.
- Monitoring liabilities - this protects against aggregation of risks to an unacceptable level. Also, by monitoring new business volumes, it helps ensure the provider is not exceeding the resources available; new business mix to monitor the risk to profitability due to cross-subsidies.
- Options and guarantees - in particular, monitoring will determine whether the options and guarantees are likely to bite.
- Due diligence performed before agreement with counterparty
Outline how the investment risks associated with options and guarantees can be managed
3,2
Main risks asociated with options and guarantees:
* Market risk: min benefit guarantees can bite
* Business risk: high take up of more valuable options
* Match Risk: due to uncertain CF’s
- Liability hedging can be used, i.e. choosing assets which match the liabilities so that they move consistently with each other.
- The hedging can be dynamic, i.e. rebalancing the underlying hedging portfolio as market conditions change.
For example:
- where the benefit is linked to an external index, the liabilities can be hedged using derivatives linked to the same index.
- put options can be used to hedge guaranteed minimum benefits under UL or WP products.
How should low likelihood, high impact risks be dealt with?
1,3,1
It is important to manage these risks in a measured way. Whilst they are very important and credit rating agencies and regulatory authorities are very interested in them, it is important not to concentrate unduly on these risks at the expense of other types of risk.
Low likelihood, high impact risks can be:
- diversified away to a limited extent
- passed to an insurer or reinsurer
- mitigated using management control procedures such as disaster recovery planning.
Some such risks have to be accepted, and the organisation then has to assess an appropriate amount of capital to hold against the risk event (e.g. by stress testing) - if the event lies within the company’s risk tolerance.
List 5 components of the total cost of risk
- Expected loss costs
- Disruption of business
- Insurance premiums (and other risk mitigation costs)
- Risk managers’ salaries
- Cost of capital held against the risks
Capital Adequacy for retained risks
3
- Capital needs to be held for all accepted/retained risks.
- The amount of capital depends on the ruin probability over a certain period of time
- Hold sufficient capital so the probability of ruin is less than 1/200 over a year
