Chapter 31 - Other risk controls Flashcards
List 4 risk management tools available to a financial product provider, other that reinsurance and ART.
- Diversification
- Underwriting at the proposal stage ( ensures a fair price is paid for the risk )
- Claims control processes / procedures ( these mitigate the consequence of a risk event that has occurred )
- Management control systems ( these reduce the exposure to risk)
Give examples of how an insurer can diversify its business
GIRL
- GEOGRAPHICAL areas of business
- INVESTMENTS; asset classes and assets held within a class
- providers of REINSURANCE
- LINES of business
What is underwriting?
Underwriting is the process of consideration of an insurance risk.
This includes assessing whether the risk is acceptable and, if so, the appropriate premium, together with terms and conditions of the cover.
It may also include assessing the risk in the context of the other risks in the portfolio.
Why do insurers underwrite business?
ASS HOE
- protects the provider against ANTI-SELECTION
- enables the provider to identify risks for which SPECIAL terms must be quoted
- for SUBSTANDARD risks, the UW process will identify the most suitable approach and level for the special terms to be enforced
- enables provider to classify risks into HOMOGENEOUS groups for which a standard premium is charged
- for larger proposals, the financial underwriting procedures will help to reduce the risk of OVER-INSURANCE
- help ensure claim EXPERIENCE doesn’t depart too far from that assumed in the pricing of the contracts
What is financial underwriting?
it is an assessment of whether the proposed benefits are reasonable relative to the financial loss the insured will suffer if the insured event occur
What are the 3 main types of underwriting for a life insurer?
- Medial
- Financial
- Lifestyle
List 3 factors that lifestyle underwriters may investigate.
- Applicant’s occupation
- Applicant’s leisure pursuits
- Applicant’s normal country of residence
What are claims control systems?
Claims control systems mitigate the consequences of a financial risk that has occurred.
They guard against fraudulent or excessive claims.
Give 4 examples of claims control systems
- Requiring claimants to submit a claim form
- Requiring evidence of eligibility to claim, e.g. death certificate
- Requiring continued evidence of eligibility to claim, e.g. for LTCI
- Requiring estimates of the extent of a loss, e.g. by the policyholder, or a company approved by the insurer, or by a loss adjuster
Describe the 4 types of management control systems used to reduce risk.
DAMO
- Data recording - the company should hold good quality data on all risks insured and on the risk factors identified during underwriting, to ensure that adequate provisions are established and to reduce operational risks.
- Accounting and auditing - effective procedures enable adequate provisions to be established, regular premiums to be collected and finance providers to be reassured.
- Monitoring liabilities - this protects against aggregation of risks to an unacceptable level. Also, by monitoring new business volumes, it helps ensure the provider is not exceeding the resources available; new business mix to monitor the risk to profitability due to cross-subsidies.
- Options and guarantees - in particular, monitoring will determine whether the options and guarantees are likely to bite.
Outline how the investment risks associated with options and guarantees can be managed
Liability hedging can be used, i.e. choosing assets which match the liabilities so that they move consistently with each other.
For example:
- where the benefit is linked to an external index, the liabilities can be hedged using derivatives linked to the same index.
- put options can be used to hedge guaranteed minimum benefits under UL or WP products.
The hedging can be dynamic, i.e. rebalancing the underlying hedging portfolio as market conditions change.
How should low likelihood, high impact risks be dealt with?
It is important to manage these risks in a measured way. Whilst they are very important and credit rating agencies and regulatory authorities are very interested in them, it is important not to concentrate unduly on these risks at the expense of other types of risk.
Low likelihood, high impact risks can be:
- diversified away to a limited extent
- passed to an insurer or reinsurer
- mitigated using management control procedures such as disaster recovery planning.
Some such risks have to be accepted, and the organisation then has to assess an appropriate amount of capital to hold against the risk event (e.g. by stress testing) - if the event lies within the company’s risk tolerance.
How can risk management optimise the risk/return profile of the organisation?
SPiCE
- support SELECTIVE growth of the business
– establish a process for assessing new business opportunities
– allocate capital and resources to activities with high risk-adjusted return - support PROFITABILITY through risk-adjusted pricing
– prices should reflect the cost of capital in addition to funding costs and operational expenses - CONTROL size and probability of potential losses
– set exposure limits
– set stop loss limits, which if reached trigger management action - EMPLOY techniques to manage existing risks
– active portfolio management
– reduce risk by asset-liability matching
– transfer risk to third party
List 5 components of the total cost of risk
CIDER
Cost of capital held against the risks
Insurance premiums (and other risk mitigation costs)
Disruption of business
Expected loss costs
Risk managers’ salaries
List possible decisions that can be made following underwriting
AR DARE
- Accept on standard terms
- Reject / decline
- Deferral of cover
- Addition to premium, commensurate with the degree of extra risk.
- Reduction in benefit, commensurate with the degree of extra risk
- Exclusion clause(s)
