Chapter 10,11,12 - Risk

Question 1

List 16 possible sources of risk to a life insurer

Answer 1

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

Question 2

Risks in investigations:

Define 3 risks which normally arise in investigations

Answer 2

Model risk:
* Inappropriate/erroneous probability distribution chosen for underyling model e.g. future mortality.

Parameter risk:
* Underlying model correct, but parameters inadequate (don’t reflect future experience of lives insured/to be insured)

Random fluctuation risk:
* Actual future experience may not correspond with model/parameters adopted (even though these adequately reflect lives insured/ to be insured)

Question 3

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

Answer 3

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

Question 4

Risk due to new business mix:

Explain how the mix of new business (M.O.B) may be a source of risk to a life insurer in terms of

Mix by nature/size of contract (3)

Mix by source (3)

Answer 4

Mix by nature/size of contract
change in M.O.B by
nature
class of business (eg proportion of pensions sold)
type of contract (eg term ass vs endowment)
contract design (eg with profits vs unit linked)
premium frequency (single vs regular)
size of contract
mix
could cause significant change in risk profile/capital needs of company
in particular, if contracts are on average smaller than assumed, expense loadings may fail to cover company’s overheads
Mix by source (distribution channels)
Pricing assumptions (e.g. mortality, withdrawals) based on expected M.O.B by source,
If same premium charged across channels, effectively causes some average weighting in assumptions.
Change in M.O.B by source may invalidate assumptions

Question 5

Risk due to new business volumes:

Explain risks may arise for the insurer if new business is

too much and ( 2 )
too little ( 3 )

Answer 5

Too much: risk of insufficient
capital to cover financing requirements
admin resources to process new policies
Too little
expense risk:
​overheads spread over too few policies (expense loadings in premiums/charges insufficient)
mismatching of charges and expenses
new products’ (fixed) development costs:
risk of not recovering fixed development costs already incurred
fall in new business
damages profitability, competitiveness, long term viability

Question 6

Credit rating

What do we mean by an insurer’s credit rating? (1)
Why is downgrading of credit rating a risk to the insurer? (4)

Answer 6

An insurer’s credit rating is an external, objective measure/assessment of the insurer’s risk profile…hence its aggregation of risks
Life office will want to ensure it arranges its business practices/overall risk profile to minimyse chances of downgrade

Downgrading of company’s credit rating is a risk because it would lead to:
adverse publicity
greater difficulty + cost of raising additional capital in market
…and as a consquence

profitable activities available to do may be constrained
policyholders may be less likely to maintain/purchase policies=> less business