Chapter 25 Nature of risks (2)

Question 1

Overview of the broad categories of insurer risks

Give an overview of the broad catergories of risk faced by insurers (8)

(CA1/ARM recap; not in ST1/F101 notes)

Answer 1

• Financial risks
  
  1. Business risk
  2. Liquidity risk
  3. Market risk
  4. Credit risk
• Non-financial risks
  
  1. Operational risk
  2. External risk

Question 2

Various possible sources of health insurer risk:

List the various possible sources of risk to a health insurer

Answer 2

Financial risks

• Business risk
  
  1. Risks in investigations (model, parameter, random flactuation)
  2. Policy data and other data
  3. Morbidity: claim incidence rates, claim inception rates, sickness duration, claim amount
  4. Mortality
  5. Early screening diagnosis
  6. Expenses (including inflation)
  7. Persistency/withdrawals
  8. New business mix
  9. New business volumes
  10. Anti-selection and non-disclosure
  11. Guarantee and options
  12. Competition
  13. Aggregation and concentration of risk
  14. Management of company
  15. Legal, regulatory and tax developments (makes more sense in this catergory than any other other category)
• Market risk
  
  1. Investment performance
     
     • Market fluctuations
     • How assets change vs liabilities
• Credit risk
  
  1. Counterparties
     
     • distribution
     • provision of medical services
     • reinsurance
  2. Others: credit downgrading

Non-financial risks

• Operational risk
  
  1. Fraud
  2. Actions of board members
  3. Actions of distributors
  4. Failure of management systems and control
• External risk
  
  1. Catastrophes

Question 3

Risks due to guarantees and options

Describe the risks an health insurer faces in relation to guarantees and options (4)

How does predicability of health related events compare to that of life events, and what additional caution on the part of the insurer does this necessitate? (4)

Answer 3

• To calculate cost of guarantees and options, insurer will use a model…
  
  • …introduces model, parameter and random fluctuations risk
• Stochastic models are usually used to model guarantees and options because
  
  • there would be bias in scenarios chosen under a deterministic model and probabilities assigned to them
• Health and care events are less easy to predict than their life insurance counterparts, hence greater care is needed for
  
  • policy wording of options and guarantees
  • pricing
  • reserving

Question 4

Risk due to competition

Why is competition risk a factor (2)

Give 5 examples of decisions, which may be taken as a result of competition, that may increase a company’s risk profile (5)

Answer 4

Why is competition a risk factor?

• The need to compete, especially in a free market, may lead management to take decisions which increase risk profile beyond that supported by available resources

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 ie add new illnesses
• increase salaries or commissions for distribution channels.
• arrest/constrain the future growth of charges on business with reviewable charges

Question 5

Risks due to actions of management

Describe risks arising for health insurers due to actions of management

Answer 5

• 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
  • achieve strategic objectives eg maximise new business
  • to maximise shareholder earnings or mutual fund benefits
  • to achieve personal goals of the executive (which is a conflict of interest btw)

Question 6

Risk due to counterparties: intro

What do we mean by counterparty risk?

Answer 6

• When an insurer gets into an agreement it expects the 3rd party to meet its obligations.
• There is a risk that these counterparty/entity in question will not be able to meet its obligations as per the terms of their agreement.

Question 7

Risk due to counterparties: reinsurance arrangements

What kind of counterparty risks arise for the insurer due to reinsurance? (5)

Answer 7

• There is a risk that the reinsurer does not meet its obligations ie pay claim recovery amounts even though…
• ….insurer is is still lible to pay policyholder claims
• this may lead to
  
  • greater claim costs than expected
  • insolvency risk
  • liquidity risk

Question 8

Risk due to counterparties: distribution

Describe the risks that arise for the insurer due to counterparties in distribution (5)

Answer 8

Risks arise because the distributor may

• commit the insurer to policy conditions that were not part of the original purpose of the contract/make promises that were not priced for eg
  
  • can manually change contract wording to satisfy policyholder
• delay premium or claim payments or become bankrupt
• bring the insurer into disrepute

Nature of practical and legal relationship affects extent of these risks and mitigation

Question 9

Risk due to counterparties: counterparties provision of medical services

Describe risks arising to the insurer due to counterparties in the provision of medical services (7)

Answer 9

• There may be some loss of claims cost control and quality of service due to use of 3rd parties eg
  
  • underwriters
  • claims assessors
  • managed care
  • counsellors
• Under medical expenses covers and some long-term care insurance the benefit itself is provided by 3rd parties on an indemnity basis
  
  • hence, risk/amount of ultimate claims cost then lies, at least to some extent, in the hands of these 3rd parties

Question 10

Risk due to counterparties: investments

Describe some risks arising for the insurer due to counterparties in investment (4)

Answer 10

• 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.
• Similarly, if the insurer outsources some of its investment administration responsibilities to a 3rd party, this introduces risks as well
  
  • errors
  • reputational risk

Question 11

Risks due to regulatory and fiscal developments

Describe how regulatory and fiscal developments might lead to risks for a health insurer (6)

Decsribe how these developments pose additional risk in the context of existing policyholders (2)

Answer 11

• Local law and supervisory requirements often transcend explicit conditions in the policy
• Changes in these lead to risks for the health insurer; changes/developments 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.
  
  • eg some exclusions may be deemed unacceptable.

Question 12

Risks in respect of customer service and reputational risk

In what way is customer service and the insurer’s reputation a risk which must be considered? (5)

Through what forums/mediums may a health insurer’s bad reputation be propagated amongst customers? (2)

Answer 12

• Quality of customer service is very important in a 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
  • losing 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 13

Risks due to internal audit failures/fraud

List 3 examples of these that lead to risk for a health insurer (2)

Give examles of important things an insurer can do to reduce this risk (3)

Answer 13

Examples of internal audit failures are

• leaking of information/data and
• embezzlement of funds.

To reduce this risk the following items are vitally important, appropriate:

• training ,
• governance and
• internal audit procedures

Question 14

Risks due to physical risks

Give examples of this risk and why it is important for health insurers to understand the physical risks they may face doing their jobs (3)

For these specific risks, what kind of protective/pre-emptive measures are quite important for the insurer to take? (5)

Answer 14

Examples of physical risks are

• natural disasters
• fire, flood,
• loss of key staff
• suffering IT outages due to a computer virus

In regards to physical risks, 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 15

Risks due to aggregation and concentration of risk

What do we mean by aggregation/concentration of risk? (3)

Give examples of how risks due to aggregation/contraction might lead to isues for the isurer (1)

What is a great way to address/mitigate risks due to aggregation and concentraction of risk within a health insurer’s portfolio (4)

Answer 15

Aggregation/exposure risk relates to

• having overexposure to a particular region/risk
• 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

An example of aggregations/concentration of risk is

• the outbreaks of local illnesses
• overexposure to risk, region and distribution channel

These risks are mitigated through

• more widespread marketing,
• reinsurance,
• co-insurance with through reciprocation - sharing risks with another insurer of a complementary nature
• diversification

Question 16

Risks due to catastrophe

What do we mean by ‘catastrophe’? (3)

In what way are catrasophes a risk to the health insurer? (2)

Answer 16

Catasrophe

• an event that gives rise to the introduction of widespread illness or injury
• e.g. epidemic, pandemic, war, terrorism

Risks due to catastrophe

• a health and care insurer is at risk from a catastrophe, and by their very nature, these are difficult to predict.
• resolution lies mainly in
  
  • reinsurance, or
  • possible global expansion to spread risks (diversification)

Question 17

Risks due to non-disclosure and anti-selection

What do we mean by non-discloure, and describe risks to the insurer arising form non-dscosure ? (5)

Comment on anti-selection risk (1)

Answer 17

Non-disclosure

• policyholder may not share key risk information, and this non-disclosure makes premium rating more difficult.
• the extent of this risk depends in part on whether a moratorium approach is used for underwriting1
• it is especially problematic if moratorium underwriting is used (ie only at claims stage)
• difficult to prove policyholder had knowledge of non-disclosed condition prior to purchasing health insurance
  
  • and can also cause player unrest

Anti-selection

• there is also a risk that anti-selection is greater than anticipated in the pricing basis.

Question 18

Risks due to non-disclosure and anti-selection: resolution/solutions

How might risks due to non-disclosure and anti-selection be mitigated by the insurer? (7)

Answer 18

Measures to mitigate risks that arise due to non-disclosure and anti-selection

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

Question 19

Risks due to advancing information, genetic testing and early screening diagnosis

Describe risks to the health insurer arising from advancing information, genetic testing and early screening diagnosis (8)

Answer 19

Advances in medical science allow diseases to be picked up earlier through genetic testing and early screening

• genetic testing/early screening exposes an insurer to anti-selection if the insured has information that is not available to the insurer.
• increased diagnosis of early stage illnesses increase the risk of future non-disclosure for insurers
• there is the potential for illnesses to be diagnosed at a far earlier stage through such tests leading to
  
  • more claims being paid out earlier than expected
  • benefits being paid to policyholders that would’ve otherwise died undetected
  • otential windfall payments
  • prolonged livelihood, which also leads to higher pay outs overall
• through genetic testing, “personalised medicine” is being developed; and although this might be more effective, it is likely to be more expensive

Question 20

Product specific risks: PMI

What is the key PMI specific risk to the insurer? (3)

What other PMI specific risks face the insurer? (6)

Comment on the capital strain an insurer will experience when writing PMI business (3)

Answer 20

PMI main risk to insurer is

• limited control over the benefit pmts/claim costs (3rd party payer problem)
  
  • original trigger may even be effected by GP referring patient to specialist
• in spite of this, insurer may also impose constraints through the use of agreed fee schedule

Other key risks/important points

• in regions where the state provides an alternative free healthcare service, insurer must constantly remind policyholders that insurance is preferable to the free-alternative, else risk of
  
  • losing new business and
  • insolvency
• anti-selection risk if underwriting or risk rating are used minimally/not at all
• also risk of selective withdrawal and moral hazard
• risk of single large claims or single event leading to large accumulation of claims (especially where there are no policy limits)

Capital strain

• capital strain lower than other health insurance products due to the short-term nature
• however, significant new bsuiness costs can arise due to
  
  • commission, and
  • recruitement of sales team

Question 21

Product specific risks: CI insurance

What are the key risks specific to CI insurance that are faced by the insurer? (5)

What other CI insurance specific risks are face by the insurer? (4)

Comment on the capital strain an insurer will experience when writing CI insurance business (2)

Answer 21

Main CI insurance specific risks faced by insurer

• main risk is diagnosis rates of CI specified in the contract…
• …worsened by the fact that data required to assess likley diagnosis rates is highly limited, given how new most of these contracts are
• this risk applies both for standalone contracts and ride contracts
• significant risk of anti-selection, especially for individual contracts

Additional risks/factors

• 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
• withdrawal risk where asset share is negative

Capital requirements

• capital requirements will normally be low…
• …depending on the relationship between pricing and supervisory reserving bases

Question 22

Product specific risks: LTCI

What are the key risks specific to LTCI that are faced by the insurer? (5)

What other LTCI insurance specific risks are face by the insurer? (5)

Comment on the capital strain an insurer will experience when writing LTCI business (5)

Answer 22

LTCI main risks

• claim inception and transition (transfer) probabilities between multiple states underlying the multiple state model
  
  • this risk is worsened given the low data available for modelling
• investment risk is a big factor because the reserves are significant and may build up in advance of a claim starting
• significant marketing and reputational risk due to policyholder expecting benefits to be enough to cover the eventual costs of care

Additional risks

• anti-selection and selective withdrawals are an important risk as well
• moral hazard may be a risk as well, however, ADLs help mitigate this
• 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

Capital requirements

• capital requirements could be extensive given
  
  • the long term nature of the contract
  • the need to build up large reserves
• capital requirements are made even worse where any guarantees are given
• similar capital requirements to an endowment assurance, but depends on nature of contract and its guarantees…and unlike with endowment, benefit is not certain to be paid