Chapter 3 - Types of Risk

Question 1

Why place risks in types & categories?

Answer 1

Helps to cope with the complexity – helps in the understanding and finding solutions

Question 2

Briefly explain corporate risk

Answer 2

= risks associated with large commercial companies, general businesses and commercial organisations driven by a profit motive and shareholders/owners to satisfy

Question 3

What is business risk?

Answer 3

Business risk is the probability of loss inherent in an organisation’s operations and environment e.g. adverse economic conditions & competition within the market

Question 4

Explain strategic risk

Answer 4

Strategic risks are closely related to business risks & are Associated With Vision, Mission & Long-Term Objectives Or An organisation: e.g. decisions the organisation makes about direction, product mix and the target markets. Objective is the plan and operations and tactics is how to achieve the plan

Strategic failings could include sale of poor or unsuitable products/services or the failure of partnerships and alliances (M&A)

Question 5

What is a financial risk?

Answer 5

‘Financial risk’ covers a group of risks associated with the financing of business activities and transactions e.g. borrowing, lending, m&a. Includes areas such as accuracy of financial reporting, valuation(s) within the business, market, liquidity and credit risks?

Question 6

What is a market risk, where does this term fit in?

Answer 6

Within the financial risks umbrella and is concerned with the risk of losses in trading positions arising from movements in market prices (also called systematic risk). Driven by economic factors and influenced by events such as natural disasters, risks include:
- Equity risk – relating to organisation wide investments
- Property price risk
- Solvency risk

Question 7

Explain what is meant by a credit risk? Which umbrella does this fit into?

Answer 7

Financial risks & is the risk a counterparty (a party to a contract) will suffer a financial loss or be unable to pay amounts in full when due e.g mortgage loans of property. The risk factors include type of business, industry, profiles and geographic, economic standing of the counterparty.
Includes default risk, concentration risk & country risk

Question 8

What is a default risk?

Answer 8

The probability of a debtor being unable to repay its loan obligations

Question 9

What is a concentration risk?

Answer 9

Risk of a bank loaning too much money to a single industry or multinational company

Question 10

What is a country risk? What umbrella does that risk fit under?

Answer 10

Where the sovereign state (country) is a credit risk and if there is a crisis, can freeze foreign currency leaving the country, or like Greece in 2012, can default on the loan repayment

Question 11

Explain what is meant by a liquidity risk
Describe some of the risk factors?

Answer 11

= The risk of running out of cash when financial obligations need to be met
Liquidity is fundamental to any organisation, as without it the company will fail
Liquid funds can be cash or liquid assets (asset liquidity is the ease with which can asset can be turned into cash should the investor need)
Illiquid = buildings & land
Middle liquid = bonds & securities
Liquid = Shares in public companies

Question 12

What umbrella of risk does legal, regulatory and compliance risk come under:
a) corporate risk
b) operational risk

Answer 12

a) corporate risk

Question 13

What is a legal risk?

Answer 13

Associated with alleged or actual BREACH OF CONTRACT between an organisation or counterparty, with a counterparty being a business party, third-party or customer. e.g. litigation from financial transactions, financial reporting or misappropriation of funds

Question 14

Explain a regulatory risk

Answer 14

Associated with factors an organisation needs to consider because of the regulatory environment in which it operates

Question 15

Explain a compliance risk

Answer 15

A failure to comply with laws and regulations which may incur large financial penalties or fines. = Very important as sends out bad signals to the market and can result in criminal charges for directors or senior officials

Question 16

Define operation risk

Answer 16

The risk of loss resulting from inadequate or failed internal processes, people or systems, or from external events.

Question 17

How is staff resourcing an operation risk?

Answer 17

Organisations required skilled workers to operate, if they do not have sufficient number of workers with knowledge and experience, this is a risk

Question 18

Explain fraud in relation to operation risk with some examples

Answer 18

Fraud and dishonesty of staff is a risk to all organisations. For financial institutions e.g. insurance companies the main risk is LARGE MOVEMENTS OF CASH e.g. could be a fabricated claim or embezzlement. The sources may lie with external contacts

Question 19

Explain why health and safety is an operational risk

Answer 19

Apply to all businesses and organisations and is the employers duty to protect employees and public from workplace dangers

Question 20

What are some examples of health & safety office-based risks?

Answer 20

• Work related stress
• Slips, trips & falls
• Back injury, headaches from poorly set up work stations

Question 21

What is outsourcing? What are the two types?

Answer 21

The purchasing of goods & services from third-parties in order to support business activities
1. Non-core functions - e.g. rental of property, supply of electricity & auditing/accounting
2. Core functions & business activities (seeks to obtain commercial advantage) - back office processing, premium collection & accounting, claims processing and IT

Question 22

What are some risks associated with outsourcing?

Answer 22

= LOSS OF CONTROL of the operation of the service, less appreciation of the risk which reduces inability to monitor client service
- Concentration risk, too much outsourced to one provider and e.g. business goes bankrupt of if geographical concentration, natural disaster or political which could strikes

Question 23

What is in-sourcing and why is there a noticeable trend?

Answer 23

= Bringing core and non-core business functions back in house. Cost of labour geographically have reduced between western europe and asia, e.g. flexible labour such as zero-hours contracts

Question 24

What is the operation risk: damage to physical assets and how does it arise?

Answer 24

Losses arising from loss or damage relating to physical assets from natural disasters (storm, flood) or other events (fire, theft, vandalism, terrorism)

Question 25

Explain the threat to protection of intellectual assets

Answer 25

Now more complex and expensive than ever before - threats include unethical competitors illegally obtaining information, countries nationalising intellectual property by exercising power if eminent domain (government taking property to turn to public use), employees stealing and counterfeiting by organised crime groups.

Question 26

What are the 4 categories of intellectual property, with a brief explanation:

Answer 26

1. Trademark - word, name of symbol destinctive to brand owener to identify and distinguish goods from alt. manufacturer
2. Copyright - exclusive rights given to creator of original work
3. Trade secret - Information such as formula, pattern or device which a business has taken reasonable steps to keep secret
4. Patent - Right granted by government to an inventor to exclude others from making, using and selling devices that embody their invention

Question 27

How is Business Interruption an operational risk?

Answer 27

= Serious fire or explosion at a premises could destroy building, computer systems, data and records -> disrupting organisation’s ability to function leading to loss of income and potentially putting out of business

Question 28

What is a system failure risk and what does it include?

Answer 28

Risk of any financial loss, disruption or damage to reputation resulting from failure of IT systems, process breakdown and potential damage caused by e.g. fire, arson, terrorist meaning businesses may need continuity or related recovery plans

Question 29

What is a data protection risk?

Answer 29

Wide risk to organisations and keeping data secure is fundamental to good risk management. e.g. UK GDPR - larger risk to life and health insurers as handle sensitive information

Question 30

What are the 4 key components of UK GDPR? Came into force January 2021

Answer 30

1. Right of individuals to have personal data erased and transfered
2. Mandatory requirement to report data breaches within 72 ours of it becoming known
3. Introduction of a data protection officer
4. Tougher penalties for non-compliance

Question 31

What is the Data Protection Act & when did it come into force?

Answer 31

May 2018, key components:
1. Ensuring sensitive data can be continue to be processed to ensure confidentiality in health and safeguarding situations
2. Restricting rights to access and delete data where there are rights to do so (national security)
3. Setting age of which parental consent required
4. increased powers of penalties e.g. serious data breaches can levy up to £17.5 million or 4% of annual global turnover

Question 32

What is a boundary risk?

Answer 32

= Where it is not clear if a risk is operational or belongs to another category so organisation must decide which it fits

Question 33

What is a reputational risk?

Answer 33

= Possible loss of an organisation’s reputation, closely linked with brand management and concerns level of public confidence & trust. -> can lead to loss of revenue, litigation and loss of customers/consumer confidence in the business
e.g. bad behaviour of employees, or the organisations actions

Question 34

Explain a communication risk

Answer 34

Risk associated with the new technologies influencing creation and speed of communication and documents - e.g. disaffected employees leaking confidential information, resulting in significant reputational damage

Question 35

What is the difference between a speculative and pure risk?

Answer 35

Speculative = Aims to make a gain but carries possibility of break-even or failure
Pure = Possibility of loss, but not of gain and best scenario is break-even

Question 36

What is the difference between a fundamental & particular risk?

Answer 36

Fundamental risk occur on vast scale arising from social, economic and environmental causes and are wide-spread in their effect (often uninsurable as too large)
Particular = localised or even personal in cause and effect. Cause can be widespread but effect is localised and are insurable

Question 37

Explain upside & downside risk

Answer 37

Upside risk = gain
downside risk = potential of loss

= Good risk management principles can result in upside risk

Question 38

What risks do insurance organisations face?

Answer 38

Same as majority of other organisations (damage to property, legal liabilities) but also face risks such as underwriting risk, pricing risk, accumulation risk & e&o risks

Question 39

What are other examples of risks unique to insurance companies?

Answer 39

Volatility
Pricing
Economic factors
Accumulation risk
Preserving risk

Question 40

Explain an underwriting risk

Answer 40

Risk that the underwriting: designing policy wording & terms, appropriate calculation of premium and choosing when to accept risks can go wrong e.g. wordings giving wider coverage than intended

Question 41

What is meant by volatility risk?

Answer 41

= The unpredictability in terms of the outcome of the insurance risks taken on - cannot predict the total amount of claims and timing of occurrence

Question 42

Explain at pricing risk?

Answer 42

Insurers miscalculating the correct premiums due to changing risk factors, so use both historical outcomes & predicted future environments which would influence frequency and severity of claims

Question 43

Explain the economic factors influencing risk to insurance organisations

Answer 43

Economic downturn can affect insurance companies claims & solvency/claims reserves

In economic downturn, often higher claims due to periods of financial stress where businesses and individuals seek to take advantage of the insurance.
Also, when market confidence reduces the value of an insurer’s assets are influenced and often reduced hence the requirement of the insurer to strengthen the reserve, resulting in higher premiums.

Question 44

Explain what is meant by an accumulation risk to insurers

Answer 44

Risk of accumulation of exposures to the insurers to a single risk event or source - e.g take on exposure management

Question 45

Explain what a reserving risk is:

Answer 45

The insurance risk associated in a contract is two-fold: firstly the uncertainity the event will occur and secondly the severity of it. Insurers must ensure have sufficient funds to pay all legitimate claims. so a risk there is not enough money in this event - even harder for ‘long-tail’ risk exposures which show up later such as lung diseases from asbestos

Question 46

How do homogeneous exposures aid risk forecasting?

Answer 46

Sufficient exposure to similar risks, historical patterns and trends enable insurers to forecasted expected extent of future losses. Call this ‘objective risks’ meaning they are calculated by using similar risk events that have taken place and working out averages.

Question 47

What are the risks faced by insurance brokers?

Answer 47

1. Errors & Omissions - Potential legal action against broker for incorrect advice
2. Insurer security - Risk the insurer will go out of business and nobody to pay the claims so brokers consider the financial strength of the insurers