Chapter 11: Risk and Uncertainty Flashcards
Uncertainty
The inability to predict the future with confidence.
6 Categories of risks and uncertainties MR DAMPP
Model Error
Random Error
Data errors from systems and procedures
Adjustment factors
Market conditions
Portfolio movements- business mix uncertainty
Parameter error
4 Main headings of elements of risk and uncertainty
- those affecting CLAIMS EXPERIENCE
- those affecting EXPENSES
- those relating to the INVESTMENTS
- BUSINESS RISKS, including new business or lapse risks
3 Main types of legislative changes
FISCAL CHANGES,
such as increases in tax on:
- insurers,
- insured items or their repair
CHANGES IN THE LAW:
- which increase the amount of cover being provided, eg removal of a legal limit on compensation levels
- restrict using certain factors in underwriting
Reinsurance risks (6)
Risks with reinsurance decisions
Problems with reinsurance decisions
- not purchasing the right type of reinsurance, or enough of it
- doubts as to the AVAILABILITY AND COST of the desired reinsurance
- difficulty assessing reinsurance value for money
- whether catastrophe reinsurance will prove satisfactory with regard to such features as the size of the retention, the reinstatement provisions and the upper limit of cover
- the ABILITY to make reinsurance RECOVERIES. There is the potential for reinsurers to default, especially following catastrophes or poor claims experience for the industry as a whole
- failure to comprehend the true coverage/limits of a reinsurance arrangement and therefore being exposed to risk in areas that were thought to be reinsured.
How do radically new types of policy and cover contribute to uncertainty?
If a radically new type of policy is to be introduced, there may be considerable uncertainty regarding the INFORMATION on which the premiums are to be based.
How do
Characteristics of policyholders
contribute to uncertainty?
Policyholders with different characteristics means the resulting claims experience may differ from the past, in ways that are hard to determine.
4 Sources of uncertainty regarding other expenses include:
Refer another card
examples - broker mergers, aggregator power, offshoring costs, increase in legal expenses, economic factors such as inflation, wage inflation, etc. accounting changes and costs associated thereof, changes in taxes, levies.
Uncertainty regarding investments (4)
- market conditions may worsen
- claims may have to be paid sooner than expected.
- assets may need to be realised in unfavourable conditions.
- poor investment management.
- a larger than expected portion of the assets may not be available for investment. There is usually some delay between the broker receiving the premium and passing it on to the insurer. Similarly, the insurer usually pays a claim in full and then has to wait for recoveries from reinsurance or salvage.
Debtors may, in total, form quite a large portion of the insurer’s total assets. If the average delay increases, a lower proportion of the insurer’s assets will be earning investment return, so the average rate of investment income will fall.
Risks regarding competition (business) (5)
Our (insurer’s) products MAY NOT APPEAL to their potential customers
the prices they need to charge for their products in order to achieve a satisfactory financial result may be TOO HIGH TO BE COMPETITIVE
as a consequence of losing business to competitors, their UNIT COSTS RISE so that they find it even harder to price their products competitively
if they deliberately under-price in response to competition, the prices they actually charge may be insufficient to produce a satisfactory financial result.
ADMINISTRATIVE STRUCTURES and channels for obtaining business may BECOME OBSOLETE, for example because of technological developments exploited by their competitors, resulting in additional costs to update.
Writing “loss leaders”
the process of
… winning new business
… by charging less than economic premiums
… to increase business volumes,
… with the hopes of recovering costs later when premiums are increased to sound levels
(sufficient to cover costs).
4 implications of a low solvency margin
An insurer with a low solvency margin may be subject to intervention from the supervisory authority
- A loss of confidence in the market leading to a loss of business (may also extend to the stock market, with falls in the share price).
- A need to restrict business to prevent intervention by the supervisory authority. This will result in possible loss of profitable business.
- need to purchase more reinsurance to increase protection against fluctuations.
Process uncertainty effect on claims
Process error refers to the inherent randomness underlying a book of business.
An insurer’s specific process uncertainties stem from:
1. general claims uncertainty relating to the specific business written
2. internal influences, eg changes in reserving philosophy or mix of business.
Process uncertainty - External sources of claims uncertainty (10)
- claim frequency
- claim amounts
- claim payment patterns.
- Development pattern changes
- Legislation or laws
- Economic factors
- Demand surge
- Climate change
- Bodily injury claims - stuctured settlement and not lumpsum
- Third party behaviour eg. law firms
Process Uncertainty - External - Claim Frequency
- Random fluctuation
- Change in pH propensity to claim
- Increasing litigousnous
- Intrepretation of wordings - adverse to insurer
Process Uncertainty - External - Claim Amounts
- Accumulations of risk - may occur due to the insurer’s business acquisition strategy (eg it might target policyholders of a particular type) or they may arise inadvertently (eg there may be a large concentration of policies taken out by individuals living close to the insurer’s head office). Accumulations may also arise as a result of a catastrophe event.
- Random variation - Due to the variability in the size of claims, there may be uncertainty as to whether changes in claim costs from year to year are due to changes in underlying risks or are simply the result of random variation.
The level of random variation will be higher, the smaller the portfolio of business. This problem is therefore greater for small companies (or small classes of business) where we would expect a larger variation from year to year