Chapter 27 - Financial product and benefit scheme risks Flashcards
What are the two key risks to a beneficiary?
The two key risks are:
1. The benefits may be less valuable than required (or expected), or
- They may not be received at the required time
What is the key risks to the Provider in relation to benefit provision?
- The benefit payment will be greater than expected
- The benefit payments will be required at inopportune time
What is the key risk to the State in relation to benefit provision?
The risk is that the State is expected to put right any losses that the public incurs, especially if the State provides means-tested benefits such as a minimum income level in retirement.
(For example, if the public does not make adequate retirement provision but instead spends money on their immediate lifestyle, there may be more pensioners eligible for the means-tested benefits than expected)
What are the 4 key areas of benefit risk when the benefits are known in advance?
I BIN
- Inadequate funds to provide the benefits (especially if they are pre-defined)
Which may be a result of underfunding, the insolvency of a sponsor, mismatched assets and liabilities - Benefit changes
- Illiquid assets
( To overcome this is to hold cash. Companies can get sufficient cash from premiums and investment income to provide sufficient liquidity for claims outgo. However, there is the risk that new business volumes may fall and therefore there may be insufficient liquidity to meet outgo) - Not meeting beneficiaries’ needs
This may be a result of a failure to recognise this when the benefit was promised, inflation eroding the value of the benefits, beneficiaries circumstances changing
What are the four key areas of benefit risk when the benefits are not known in advance?
I AIR
- Investment and expense risk
due to lower than expected investment returns or higher than expected expense charges - Annuity risk
lower than expected benefits due to worse than expected purchase terms for any investment vehicles - Inflation risk
there is an inflation risk for the beneficiary and provider (e.g. if investment returns are below inflation; if cost of new drugs is higher than expected) - Risk of inadequate benefits
due to inflation, or poor planning
Whether benefits are defined or not, how might sponsor / provider actions contribute to the uncertainty surrounding the benefits?
GIFT DD
- General economic mismanagement of assets and liabilities by the sponsor
- Inadequate communication by the provider with beneficiaries
- Failure by the provider to pay in a timely manner
- Takeover of the provider
-Default by the provider
-Decision by the provider that benefits will be reduced
In a DC scheme, what are the 4 contribution risks?
- Contributions are unaffordable to the sponsor (because of poor financial circumstances)
- Insufficient liquid assets with which to make the contributions
- If contributions are linked to inflation or a salary index, that index may increase faster than expected.
- If contributions are fixed, benefits may be less than expected / unable to provide for an expected standard of living.
In a defined benefit scheme, what are the 6 key contribution risks?
CUTLER
- Cost of guarantees
- Uncertain level of future contributions
- Takeover risk
new party is not willing to make contributions - Liquidity risk
- Excessive contributions required
excessive contributions may make the provider insolvent - Risk of insufficient assets
The requirement to put in extra funds if there is a shortfall in the scheme - the amount and timing of which is unknown
General contribution risks in a benefit scheme
BF ADMIT
- Incorrect Benefit payments
- Fines or removal of tax status resulting form non-compliance with legislative requirements
- Administration costs
- Decisons by parties to whom power has been delegated
- loss of funds due to fraud or Misappropriation
- Inappropriate advice
- changes in Tax rates
List possible causes of inappropriate advice in relation to the provision of benefits
CRIMES
- Complicated products
- Rubbish (incompetent) adviser
- Integrity of adviser lacking
- Model of parameters unsuitable
- Errors in data relating to beneficiaries
- State-encourages but inappropriate actions, e.g. encouraging people to save for retirement when this might reduce the level of State benefits they are entitled to and reduce their overall standard of living in retirement.
List 9 investment risks associated with a financial product
CHILL DRUM
Changes in taxation of investment income and gains
Higher than expected investment expenses
Investment returns being lower than expected, increasing provider cost
Lack of diversification
Liquidity risk
Default risk
Reinvestment risk
Uncertainty over the level and timing of investment returns (both income and capital)
Mismatching of assets and liabilities
List the typical business risks faced by life insurance companies
PLOWMEN RAMP N
- Pandemics
- Loose policy wording
- Option take-up
- Withdrawals
- Mortality and longevity
- Expenses
- New business volumes
- Reinsurance
- Anti-selection and moral hazard
- Morbidity
- Poor underwriting
- New business mix
What are the risks arising from new business volumes not being as expected?
Greater than expected:
- Writing new business requires capital to support the additional risks taken on. If too much new business is written, the company will incur greater than expected new business strain and might face solvency issues.
- Also, the administration department might struggle to deal with very high new business volumes, leading to potential operational and reputational issues.
Less than expected:
- The company may not cover its fixed overhead expenses.
What are the key risks arising from the new business mix not being as expected?
If there are cross-subsidies in the pricing basis, there is a risk that fixed expenses will not be covered and/or that profits will not be as expected if the mix of business differs from that expected.
For example, larger policies may contribute more to fixed expenses and profits than smaller policies. There is a risk that fixed expenses are not met and/or profits are lower than expected if fewer larger policies and more small policies are written than expected.
Not all products or policies may have been priced to generate the same level if profit. There is therefore a risk that the actual mix of new business sold is weighted more towards those products or rating factors with lower profit margins than had originally been expected.
