Chapter 45: Risk Management tools (2)

Question 1

Risks can be managed through diversification within… (5)

Answer 1

• lines of business
• geographical areas of business
• providers of reinsurance
• investments - asset classes
• investments - assets held within a class

Question 2

Underwriting

Answer 2

the assessment of potential risks

… so that each can be charged an appropriate premium

Question 3

6 Ways in which underwriting can be used to manage risk.

Answer 3

• PREVENTS ANTI-SELECTION
• helps RATE risks fairly
• helps ensure that claim experience doesn’t depart too far from that assumed in pricing
• financial underwriting prevents over-insurance

SPECIAL TERMS:

• – identifies risks for which special terms need to be quoted
• – identifies a suitable approach / level for the special terms

Question 4

3 Parts of life insurance initial underwriting

Answer 4

• medical underwriting (assessing the applicant’s health)
• lifestyle underwriting (assessing the impact of lifestyle on the level of risk)
• financial underwriting (to reduce the risk of overinsurance)

Question 5

Special terms that can be offered to applicants

Answer 5

• PREMIUM ADDITION
• BENEFIT REDUCTION
• an EXCLUSION clause
• DECLINING the applicant (either on temporary or permanent basis)

Question 6

Claims control systems

Answer 6

Mitigate the consequences of a financial risk that has occurred by guarding against fraudulent or excessive claims.

Question 7

4 Management control systems

Answer 7

• data recording
• accounting and auditing
• monitoring of liabilities taken on
• options and guarantees

Question 8

4 Techniques for managing options and guarantees

Answer 8

• liability hedging
• immunisation
• derivatives purchased over-the-counter
• option pricing methods.

Question 9

How can diversification of business lines be achieved

Answer 9

By marketing a wide range of contracts insuring a wide range of risks.

Question 10

How do insurance companies deal with the disadvantages associated with diversifying over business lines (using a wide range of contracts)?

Answer 10

RECIPROCAL QUOTA SHARE reinsurance.

Each company can concentrate its marketing, sales and administrative effort on its chosen segment, while still writing a wide spread of risks.

Question 11

Reciprocal quota share reinsurance

Answer 11

One company reinsures part of its business to another in exchange for accepting part of its reinsurer’s business.

Question 12

2 potential types of risk when setting an appropriate premium rate

Answer 12

the premium rates

• are NOT APPROPRIATE to the risks concerned
• permit SELECTION against the provider

Question 13

An insurer will assess the longevity and health risks of a prospective policyholder by (4)

Answer 13

• asking questions on the PROPOSAL FORM
• obtaining reports from a policyholder’s DOCTOR(s)
• carrying out a MEDICAL EXAMINATION
• performing SPECIALIST TESTS on the applicant

Question 14

Lifestyle underwriting

Answer 14

Risks associated with the applicant’s:

• occupation
• leisure pursuits
• normal country of residence

Question 15

Financial underwriting

Answer 15

To counter the risk of over-insurance, details of the financial health of the applicant may be obtained.

Question 16

Management control systems:

- data recording

Answer 16

It is important that the company holds good quality data on all the risks it insures, with particular emphasis on the risk factors identified when the product was designed or when the risk was written.

While this cannot change the provider’s exposure to the business risks underwritten, it can assist in ensuring that adequate provisions are established for those risks, and reduce the operational risks from having poor data.

Question 17

Management control systems:

- accounting and auditing

Answer 17

Good accounting and audit procedures enable

• proper provisions to be established,
• regular premiums to be collected
• and the providers of finance to the provider to be reassured as to its financial position.

Question 18

Management control systems:

- Monitoring of liabilities taken on

Answer 18

It is important to monitor the liabilities taken on by a company to protect against aggregation of risks of a specific type to an unacceptable level.

Where the acceptance of risks involves the provider in new business strain, it is important to quantify the amount of new business to ensure that it is wihtin the provider's resources.
In addition, premium rating may involve cross-subsidies from one type or class of business to another.

Question 19

Management control systems:

- Options and guarantees

Answer 19

Care needs to be taken when offering options and guarantees, particularly those which appear to have limited value when granted but which could become valuable if market or other conditions change.

Question 20

Liability hedging

Answer 20

Involves choosing assets in such a way as to perform in the same way as the liabilities.
A specific example of this is immunisation, where assets are matched to liabilities by term in order to hedge against interest rate risk

Question 21

4 tools aiding the management of risk for a financial product provider

Answer 21

• diversification
• underwriting at the proposal stage - this ensures a fair price is paid for the risk
• claims control procedures - these mitigate the consequences of a risk event that has occurred
• management control systems

Question 22

Why will a provider aim to accept a large proportion of the business it accepts at standard rate of premium?

Answer 22

Accepting a large proportion of the business at standard rates makes all aspects of the administration easier.

Is may also be easier to present to customers, who are likely to dislike being classed as substandard risks.

Question 23

What characteristics of a class of insurance would make underwriting important for that class?

Answer 23

Underwriting is important for those products where the potential risk to the provider is large. This is the case when:

• the size of the policy is large
• the gains to be made from anti-selection are large
• cover is optional rather than compulsory.

Question 24

What are the risks of offering preferential annuity rates to smokers?

Answer 24

The risk is that the policyholders deemed to be unhealthy improve in health (ie give up smoking).

There is also a risk of non-smokers declaring themselves as heavy smokers when applying.

It might not be considered ETHICAL.

Question 25

What questions would be asked on a typical life insurance proposal form?

Answer 25

questions about:

• age and sex
• height and weight
• smoking and drinking habits
• current health and details of any current treatment being received
• personal medical history
• family medical history
• occupation and salary
• sum assured
• address (country of residence)
• potentially dangerous leisure pursuits.

Question 26

How big of a risk to the insurer is applicant dishonesty?

Answer 26

Dishonesty is not in any event a major problem if premiums charged allow for it correctly.
This happens automatically since premiums are based on mortality experience for past policyholders who might have displayed the same degree of dishonesty in answering their original proposal form questions.

So dishonesty is only a problem if:

• it is increasing, or
• the insurer’s premiums are based on some other group of lives and underwriting procedures were stricter for these lives.

Question 27

What factors, relating to the applicant’s normal country of residence, influence mortality risk?

Answer 27

• standard of living
• diet and lifestyle
• climate
• prevalent diseases
• access to medical care and the quality of care
• levels of violent crime
• terrorism / war risk