Chapter 18- Risk Management and Control Flashcards

1
Q

Outline the requirements of Insurance Act to demonstrate sound risk management? (5)

A

o Good corporate governance

o Sound risk management procedures

o Adequate control functions

o Independent audit and monitoring functions

o Adequate disclosure and reporting to stakeholders

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2
Q

Outline the provision in the Insurance Act regarding adopting, implementing and documenting of a governance framework? (5)

A

• Protects the interest of the policyholders

• Proportionate to the nature, scale and complexity of the insurance business and risks

• Include an effective system of corporate governance, internal control and risk management

• The insurer also requires monitoring system to ensure compliance

• The prudential authority may require independent review at the insurers costs if not satisfied

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3
Q

outline the functions of a risk committee established? (8)

A

• Assist the board of directors in developing risk management strategy

• Assist the board of directors in evaluating the adequacy and effectiveness of a risk management system

• Identify the build-up of a concentration of risk

• Assist in identifying and monitoring any material risk

• Facilitate communication between the board of directors and senior management

• Ensure segregation between risk management and operation duties

• Introduce measure to enhance risk management

• Oversee the monitoring of risk management at an individual business unit and enterprise level

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4
Q

the requirements for a risk managment system is as follows? (5)

A

• Effective risk management is critical to honouring its promise to policyholders

• Insurer must have a board approved, enterprise wide risk management system consisting of a strategies, polices, procedures and tools for assessing, monitoring, reporting and mitigating material risks

• The risk appetite of the system must be aligned with business objectives and strategies

• An insurer must establish, maintain and operate within a system of effective internal control

• To provide appropriate governance the following control functions would be required:
o Risk management
o Compliance
o Internal audit
o Actuarial function

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5
Q

outline the roles and responsibilities regarding risk management? (4)

A

• The board of directors hold the ultimate responsibility to ensure compliance with the prudential standards

• The head of the control functions are responsible to provide an opinion on the effectiveness of risk management and internal controls

• The internal auditors will conduct a review to provide assurance to the board of directors of effective risk management

• The insurer’s external auditors will provide assurance to the PA as well as the board regarding the compliance with prudential standards

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6
Q

outline the duties of a risk managment function? (5)

A

• Assists the board of directors and senior management to develop and maintain a risk management system

• The risk management function provides reasonable assurance that there are adequate mechanisms to
o Identify individual and aggregated risks
o Assess, monitoring and manage risk identified
o Gain and maintain an aggregate view of the insurers risk profile
o Forward looking assessment of the insurers profile

• Provides written reports to the board, senior management, other control functions regarding risk profile, risk exposures and appropriate mitigation actions

• Document and report material changes to the risk management system

• Have access to the board of directors

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7
Q

Outlined what would be documented in a risk management strategy as a minimum? (6)

A

• Identify objectives of the strategy

• Describe each current material risks and emerging risks

• List the policies and procedures for dealing with risk management

• Summaries the roles and responsibilities of risk management functions, board, senior management and board committees

• Included documented process for board approval for changes or deviations

• Outline process for creating awareness of risk management system

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8
Q

An insurers risk appetite statment clearly include? (4)

A

• Overall risk that they are willing to accept in strategic objectives and business plan

• For each type of material risk that maximum levels to which they are willing to operate within

• Monitor and report compliance with limits

• Regular review appropriateness of limits

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9
Q

List the board approved polcies in the risk management system? (14)

A

• Asset-liability management
• Capital management
• Concentration
• Credit
• Fitness and proprietary
• Information technology
• Insurance fraud
• Investment
• Liquid management
• Operational
• Outsourcing
• Reinsurance and risk transfer
• Remuneration
• Underwriting

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10
Q

outline the requirements in the ALM policy? (4)

A

• Clearly specify the nature, role and extent of ALM as well as integration with product design, pricing and investment management

• Co-ordinate the management of asset and liability risk

• Recognise the interdependence between assets and liabilities (correlation between asset classes and business line)

• Take into account off-balance sheet risk and the contingency that they may revert to the insurer

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11
Q

outline the requirements in the capital management policy? (6)

A

• Internal capital planning process

• Strategy for ensuring that adequate capital is maintained

• Provide identification and measurement of risk that may result in capital shortfalls

• Establish procedures to monitor compliance with internal and regulatory capital targets

• Set out actions that will occur in the event of a capital shortfall

• Provide for appropriate management and regular review

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12
Q

outline the requirements in the concentration risk policy? (2)

A

• Identify sources of concentration risk and strategies to ensure risks remains in established limits

• Analyses possible correlation between risk of concentrated exposure

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13
Q

outline the requirements in the credit risk policy? (6)

A

• Set out approach in assessment, monitoring, managing and reporting on credit risk

• Proportional to complexity, scale of insurers operations

• Identify the full range of credit exposures including direct (credit facilities and debt instruments)and indirect (financial instruments)

• Identify range of exposure that they would want to retain

• Provide a quantification for credit risk

• Identification of risk mitigation such that credit exposure is kept within the desired limits

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14
Q

outline the requirements in the insurance fraud policy? (4)

A

• Outline appropriate strategies and procedures to deter, prevent, detect, report and remedy insurance fraud

• Outline appropriate strategies for managing fraud risk

• Consider the effectiveness of fraud risk management may be enhanced by contributing to industry wide initiatives

• Provide a prompt for reporting to regulatory bodies

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15
Q

outline the requirements in the investment policy? (9)

A

• Ensuring compliance with asset requirements prescribed under the financial soundness standards

• Set out strategy for investing including asset allocation and how they are related to ALM

• Explicit risk management to more complex and less transparent classes

• Take into account factors the will influence long-term sustainability example environment, government and social

• Investments would need to be made such that it ensures security, quality, liquidity and profitability of insurance portfolio

• Investments that do not trade on regulated financial markets are kept within prudent levels

• Ensures appropriate diversification

• Ensures that conflicts of interest are avoided or managed such that benefits are made in the best interests of the policyholders

• Ensure appropriate matching with respect to unit-linked, index-linked and guaranteed liabilities

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16
Q

outline the requirements in the liquidity managment policy? (5)

A

• Sets out identification, assessment, monitoring, management and reporting of liquidity risk such that obligations can be met as they fall due

• The approach should be proportional and should include triggers to detect breaches and action plans to respond to liquidity stresses

• Include modelling of the insurers liquidity from a range of scenarios e.g. catastrophes, downgrades and defaults

• Take into account the liquidity consequences of financial difficulties or reinsurance default

• Impact of adverse scenarios of the liquidity given investments

17
Q

outline the requirements in the operating risk policy? (2)

A

• Sets out identification, assessment, monitoring, management and reporting of operational risk

• To the extent that quantitative data is available it should be used quantify operational risks

18
Q

outline the requirements in the underwriting policy? (7)

A

• Identify that nature of insurance risk including the class of insurance as well as the risk to be underwritten

• Describe the formal risk assessment process for underwriting
o Criteria used for assessment
o Methods for monitoring the emerging experience
o Methods by which the emerging experience is taken into consideration in the underwriting process

• Establish decision making process and controls where non-mandated intermediaries and underwriting managers perform binder functions

• Set out actions of insurer to assess and manage the risk of loss from inadequate pricing

• Establish the insurers process with respect to assumption setting with reference to risk appetite

• Set out the relevant data to be considered in the underwriting process

• Review the adequacy of the claims management process

19
Q

outline the requirements in the reinsurance policy? (7)

A

• Outline the strategies and procedures for selecting appropriate reinsurance programmes

• Ensure that transparent reinsurance and risk transfer arrangements allow PA to understand economic implications

• Provide process and procedures to ensure compliance with selection strategy

• Identify the level of risk transfer that is appropriate given the insurers risk appetite

• Establish principles of assessing the appropriateness, creditworthiness and diversification from instruments

• Establish procedures for assessing the effectiveness of risk transfer

• Provide for liquidity management due to mismatch between claims payments and recoverables

20
Q

In monitoring the credit risk to which the insurer is exposed the internal controls will take into account the following? (6)

A

• Counterpart exposure is the amount the a firm would lose if a counterparty were to fail to meets its obligations

• Assets exposure is the amount a firm will lose if an assets or assets class where to yield less than expected

• Adequacy of diversification in spreading credit risk

• Likelihood of defaults

• Expected loss in the event of defaults

• Exposure period

21
Q

Market risk controls will include the following? (3)

A

o Defining governance arrangements and authorisation levels around investment management decisions

o Understanding the sensitivity of liability calculations to movements in the market

o Outline likely management actions in the event of certain movements in key market indicator levels

22
Q

Define liquidity risk? (1)

A

• Liquidity risk is the risk arising from short-term cashflows where a mismatch occurs and assets will have to be realised at a loss to meet the outgo

23
Q

Provide examples of opperational risk? (5)

A

o Internal and external fraud

o Failure to comply with employment law

o Damage to physical assets

o Business disruption and system failures

o Transactional processing failures

24
Q

outine insurance risk management? (2)

A

• Insurance risk refers to the fluctuations in timing, frequency and severity of insured event relative to the that expected at the time of underwriting

• Information that may be monitored include
o A statement of profit and loss for each class of business it writes
o Amount and detail of new business written and the amount of business that has been cancelled
o Emerging trends in persistency and expenses levels

25
Q

outline group risk? (2)

A

• Group risk arise where one firm in a company can impact on the reputation and financial soundness of different firms within the group

• Group risk can also arise from internal loans and internal reinsurance agreements

26
Q

Define Reinsurance? (5)

A

• Reinsurance is an agreement where one party (the reinsurer)
• In consideration for a premium
• Partially or fully indemnifies another party (the cedant)
• From the liabilities associated with one or more polices
• In one or more reinsurance contracts

27
Q

Outline the reasons for reinsurance? (4)

A

• Reduce claim fluctuations

• Reduce new business strain

• Technical expertise

• Improve solvency position through increased capital

28
Q

Outline the Types of reinsurance? (4)

A

• Original terms

• Risk premium

• Catastrophe loss

• Financial reinsurance

29
Q

Outline the factors that will infleucen the choice of reinsurance? (7)

A

• The purpose and requirement for reinsurance
• The cost of reinsurance
• Risk appetite of the insurer as well as technical expertise
• Variety of reinsurance offered
• Type of business
• Maturity of business
• Legal and tax implications

30
Q

Outline the elegibility criteria that needs to be met such that the reinsurance can be taken into account in financial soundness calculations? (5)

A

• The assessment of the risk transfer must be carried out in context of commercial environment, judge with reference to a range of outcomes (reasonably to occur in practice)

• A reassessment must be done if there is a material change to the risk transfer instrument

• Reasonable probability of significant loss without the instrument

• Where risk mitigation (transfer of significant risk) is not self-evident this should then be verified

• Furthermore documentation regarding the economic intent and risk analysis (cash flow projection for various scenarios) must be held by both parties

31
Q

State the limit on premiums that a direct insurer can reinsure? (1)

A

There is a limit of 75% of premiums that a direct insurer can reinsure (this is increased to 85% is the reinsurer is part of the same insurance group)

32
Q

outline factors that should be considered when setting the retention limit? (9)

A

• Free capital
• Cost of reinsurance
• Impact of capital requirements
• Average benefit amounts and distribution of benefits amounts
• Increase in benefit amounts in the future
• The retention limits on other products
• Risk appetite
• Experience underwriting (technical expertise)
• Profit sharing agreements

33
Q

Outline the various factors that should be considered when determining the level of underwriting? (9)

A

• Expenses associated with underwriting
• Reduction in anti-selection
• Level of underwriting of competitors
• The impact on reinsurance terms
• The impact on marketing as well as sales volumes
• The effectiveness of underwriting
• The uncertainty created by claims management underwriting
• The degree of homogenous group desired
• Regulation regarding the constitution and employment equity

34
Q

Outline the modelling and considerations regarding logevity risk and mortality projections? (5)

A

• A large part of longevity risk is the impact of future mortality improvements

• Process based projections aim to model trends in mortality from a biomedical perspective (which is only effective if the process causing death can be mathematically modelled)

• Extrapolative trends are based on projecting historical trends in the future however there is a degree of subjectivity regarding the selection of historic period

• Actuaries now have the option of stochastic projection of future mortality

• Assumptions at old ages are significantly uncertain due to the lack of data (a common approach is to use a limiting age)

35
Q

outline longevity hedging using a longevity swap? (7)

A

• Longevity swaps are a tool by such companies to hedge risk although the use in South Africa to date has been limited

• The purpose of the swap is to remove the uncertainty around the cost of providing immediate annuities by fixing this cost

• The swap has two counterparties:
o Counterparty A (the insurance company)
o Counterparty B (a reinsurer or bank)

• Counterparty A pays a fixed series of payments agreed at the outset of the swap (“fixed leg”)

• Counterparty B pays a floating series of payments linked to the actual annuity amounts paid

• The insurer has fixed its outgo but has also increased its counterparty risk therefore collateral is an important mechanism

• In order to value the swap they need to agree on a discount rate as well as mechanism to determine assumed life expectancy to determine the value of the floating leg

36
Q

outline the underwriting and risk managment regarding HIV/AIDS? (3)

A

• There are some products that are specifically defined for HIV positive lives which takes into account reduced life expectancy which is reflected in the cost of the product

• On the other hand underwriting for HIV is essential until underwriting makes it illegal

• A binding ASISA code of practice lays down the procedures that must be followed:
o Confidentiality
o Action against the alarming rate of substitution of blood samples
o Provision of appropriate counselling for those that test positive
o The long-term insurance industry agreed to remove exclusions for HIV/AIDS since 2005

37
Q

Outline the sources of unit pricing risk? (7)

A

Inequitable Treatment among generations of policyholders
o Errors in the calculation of the prices at which units are allocated and redeemed
o Errors in the calculation of prices at which units are created or cancelled
o The way that compensation for errors or inequity is determined

Operational Risk
• More generally systems are being changed for whatever reason may carry out of date or inaccurate information

Basis Risk
• The basis to calculate unit prices will depend on whether the company is a net allocator or redeemer of units in the internal unit fund (therefore there is a risk that the basis is not changed)

Income and dividends tax
• A risk arises if during the period of deduction from the unit fund and calculation of tax the tax rates where to change

Capital Gains Tax
• The actual capital gains will unlikely be precisely the same as the allowance as there is usually a long period between the change in market value (where the deduction is made from the unit fund) and when the assets is realised and capital gains is crystallised

Anti-selection risk
• There may be some form of anti-selection if surrenders/ portfolio switches are permitted at a price the does not reflect the underlying assets of the fund

Liquidity and related risks
• Additional risks can arise if the underlying assets are relatively illiquid for example large property investments
• If there are significant withdrawals then it will take some time to dispose of these assets