Chapters 42 and 43: Risk Management Process Flashcards
5 Stages in the risk control cycle
- risk identification
- risk measurement
- risk control
- risk financing
- risk monitoring
Risk control
The implementation of systems that aim to
- reduce the probability of a risk occurring, or
- reduce the severity of a risk that does occur, or
- reduce the consequences of a risk that does occur
Under Risk financing, you would look at the TOTAL COST of a risk.
What is this?
Total cost is equal to:
the cost of loss control measures
plus insurance
plus self insurance
What are the choices available to the provider in deciding how to control risk?
- reject the need to over the risk
- retain the risk
- transfer the risk to a 3rd party through insurance
- share the risk
- take action to reduce the risk
What factors affect whether a provider retains or transfers risk?
- the cost of passing it on
- the willingness of another party to take it on
- the likelihood of the risk occurring
- the capital the provider has with which to absorb the risk
What are the potential benefits of risks management?
- Avoiding surprises
- Improving the stability of results
- Exploiting risk opportunities
- Using capital more effectively
- Giving shareholders more confidence
- Being able to price products to reflect the inherent risk
- Improve job security for employees
- Being able to detect risks early
- Determine efficient means of risk transfer
What is a risk portfolio?
A means of categorising the various risks to the company or individual.
Against each risk, the likely impact and probability of occurrence are recorded. The risk portfolio can be extended to indicate how each risk has been dealt with.
A large multinational company might comprise of several business units, carrying out completely unrelated activities.
Associated risks can be managed at the business unit, or enterprise level.
What do we mean by managing risks at the business unit level?
The parent company would determine its overall risk appetite and then divide it amongst the business unit.
Each business unit would then manage its risk within the allocated risk appetite.
What does the approach of managing risks at the business unit level not allow for?
The benefits of diversification, or pooling of risk.
What is meant by risk management at the enterprise level?
This is the preferred approach.
Risk management is carried out at the group level. This gives an insight into areas with undiversified risk exposure, where risk needs to be transferred, or capital allocated.
An entity will need to decide how much capital to hold to back retained risks.
How might this be expressed?
As the capital needed so that the ruin probability over a specified period (or the entire runoff of the existing portfolio) does not exceed a certain level.
How might risks linked to assets be measured?
Using historic or forward-looking tracking error.
How might liability risks be measured?
Usually by an analysis of experience.
What is value at risk?
Value at risk represents the maximum potential loss on a portfolio over a given future time period, with a given degree of confidence.
It can be measured either in absolute terms or relative to a benchmark.
Issue with value at risk
Value at risk is frequently calculated assuming a normal distribution of returns, but this could be misleading as the actual distribution could be fat-tailed or skewed.
