Chapter 25 Nature of risks (2)

Question 1

Guarantee and options

Answer 1

• To calculate the cost of guarantees and options, an insurance company will use a model.
• Model, parameter and random fluctuations risk therefore occur.
• Stochastic models are usually used to model these.
• Because there would be bias in scenarios chosen under a deterministic model and probabilities assigned to them.
• health and care event are less easy to predict than their life insurance counterparts and greater care has to be taken in policy wording of options and guarantees.

Question 2

Competitions

Answer 2

• The need to compete may lead to management to take unacceptable risks. This might involve decisions to:
• reduce premium rates or charges under new business contracts
• offer additional guarantees and options under new business contracts
• increase the coverage under existing contracts
• increase salaries or commissions for distribution channels.
• arrest/constrain the future growth of charges

Question 3

Actions of management

Answer 3

• The company’s management may choose to ignore the actuary’s advice concerning what the actuary views as unacceptable risk. Possible reasons for this are:
• to be competitive
• to increase the size of the business
• to maximise shareholder earnings
• to achieve personal goals of the executive

Question 4

Counterparties under reinsurance arrangements

Answer 4

• When an insurer gets into an agreement it expects the 3rd party to meet its obligations.
• There is a risk the entity will not be able to do this.
• default on reinsurance recoveries.

Question 5

Counterparties in distribution

Answer 5

• the risks are that the distributor may:
• commit the insurer to new conditions that were not part of the original purpose of the contract.
• delay premium or claim payments or become bankrupt
• bring the insurer into disrepute

Question 6

Counterparties in provision of medical services

Answer 6

• There may be some loss of claims cost control and quality of service to 3rd parties.
• Under medical expenses covers and some long-term care insurance the benefit itself is provided by 3rd parties on an indemnity basis.
• This of ultimate claims cost then lies, at least to some extent, in the hands of these 3rd parties.

Question 7

Counterparties in investments

Answer 7

• There is a counterparty risk associated with some investments that the insurer may be holding to back its business.
• This particularly relates to corporate bonds and deposits.
• The issuer of a bond may default on its obligations to pay coupons.

Question 8

Other sources of risks

Answer 8

• Legal, regulatory and tax developments
• reputation
• Internal audit failures
• physical risks
• aggregation and concentration risks
• catastrophes
• Non-disclosure and anti-selection

Question 9

Regulatory and fiscal developments

Answer 9

• Development might relate to tax, policy conditions, exclusions and premium rating for example.
• new legislation and regulation may apply to policies already in force changing the nature of contract between insurer and policyholder.
• some exclusions may be deemed unacceptable.

Question 10

reputational risks

Answer 10

• quality of customer service is very important in market when product is not differentiated in terms of benefits or price.
• Where there is a higher degree of consumer market awareness or culture of consumer protection, the insurer runs a risk of losing existing client base and potential new business as a result of obtaining a reputation for poor customer service.
• this may arise through press comments or legally through courts.

Question 11

Internal audit failures/fraud

Answer 11

• Examples of internal audit failures are leaking of information and embezzlement of funds.
• appropriate training , governance and internal audit procedures are vital.

Question 12

Physical risks

Answer 12

• Examples of physical risks are fire, fire, flood, impact, loss of key staff.
• suffering IT outages due to a computer virus
• it is imperative to have business continuation procedures in hand to manage the smooth flow of business in these circumstances, including back-ups and alternative premises.
• business interruption cover but intervening damage makes proper processes and drills essential.

Question 13

Aggregation and concentration of risk

Answer 13

• An example of aggregations/concentration of risk is the outbreaks of local illnesses.
• part of an insurer’s assessment of portfolio risk will be the extent to which the insurer is over-exposed to a particular risk as a result of specialisation of a product.
• these risks are mitigated through more widespread marketing, reinsurance and through reciprocation.

Question 14

Catastrophe

Answer 14

• a health and care insurer is at risk from a catastrophe ie an event that gives rise to the introduction of widespread illness or injury.
• by their very nature, these are difficult to predict.
• resolution lies mainly in reinsurance or possible global expansion to spread risks.

Question 15

Non-disclosure and anti-selection

Answer 15

• non-disclosure makes premium rating more difficult.
• the extent of this risk depends in part on whether a moratorium approach is used.
• There is also a risk that anti-selection is greater than anticipated in the pricing basis.

Question 16

Anti-selection/non-disclosure: Resolution or mitigation can be achieved through?

Answer 16

• clearly explained sales literature
• effective sales intermediary processes
• clearly worded proposal forms
• more frequently use of doctors’ reports at new business stage
• more checking of information provided
• thorough audits on sample cases
• closer dialogue between underwriting, sales and claims management.

Question 17

Advancing information and genetic test come with some potential problems.

Answer 17

• genetic testing exposes an insurer to anti-selection if the insured has information that is not available to the insurer.
• there is the potential for illnesses to be diagnosed at afar earlier stage through such tests, leading to potential windfall payments
• increased diagnosis of early stage illnesses increase the risk of future non-disclosure for insurers.
• through genetic testing, “personalised medicine” is being developed. like to be more expensive although effective.

Question 18

Product specific risks: PMI

Answer 18

• Main risk to insurer is that it may have limited control over the benefit payments.
• although the insurer may also impose constraints through the use of agreed fee schedule.
• 3rd party control over claims
• anti-selection if underwriting and risk rating are not used, moral hazard and selective withdrawals.
• in regions where the state provides an alternative free healthcare service, the insurer is under constant pressure to remind policyholders the insurance package is preferable to the free-alternative.
• single large claims and accumulations due to no policy limits.
• capital strain even lower than CI, unless high commission. This is due to the short-term nature of the contracts.

Question 19

Product specific risks: CI insurance

Answer 19

• for both stand-alone and rider benefits diagnosis rates, of CI specified in the contract including anti-selection.
• limited information in most markets with which to assess the likely rates of diagnosis.
• selective and normal withdrawals
• stand-alone contracts give rise to expense risk and to a lesser extent investment
• A financial risk from lapses will also arise at times when the asset share is negative.
• capital requirements will normally be low, depend on the relationship between pricing and supervisory reserving bases.

Question 20

Product specific risks: Long-term care insurance

Answer 20

• claim inception and transition probabilities between multiple states, including anti-selection.
• there will be investment and expenses because the reserves are significant & may build up in advance of a claim starting.
• where the asset share is negative there is a financial risk from selective and normal withdrawals
• There are additional risks where the policy pays directly to the care provider and where the policy indemnifies the cost of care. Costs may be higher than expected.
• marketing & reputational risk due to policyholder expecting benefits to be enough to cover the eventual costs of care.
• capital requirements could be extensive especially where any guarantees are given.