Last minute Qs Flashcards

1
Q

4 SOURCES of operational risk

not operational risks, but sources of risk

A
  • inadequate or failed internal processes, people or systems
  • reliance on a single individual over the running of the business
  • reliance on 3rd parties to carry out various functions for which the organisation is responsible
  • failure of plans to recover from an external event
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2
Q

What is the incentive for self-regulation?

A

The incentive is the fact that regulation is:

  • an ECONOMIC GOOD
  • that consumers of financial services are WILLING TO PAY for and
  • which will BENEFIT all participants.

An alternative incentive is the threat by government to impose statutory regulation,
especially if a satisfactory self-regulatory system isn’t implemented.

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3
Q

Corporate Bonds:

Security

A

Corporate bonds are generally much LESS SECURE than government bonds.

The level of security depends upon the type of debt security considered, the company that has issued the bond and the term of the bond.

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4
Q

Corporate Bonds:

Yields: Running yields

A

Historically, running yields on conventional bonds have typically been HIGHER than running yields on equities and property.
This is because income on equities and property is expected to grow over time, creating capital gains.

Conversely, since the income stream on a conventional bond is flat and the scope for capital gains is limited (if the bond is held to maturity), income levels tend to be higher.

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5
Q

Corporate Bonds:

Yields: Real vs nominal

A

If bonds are held until redemption (with no default risk materialising), the monetary amounts of income and capital are known and fixed. To this extent, the expected nominal returns are known at outset. The actual return achieved might, however, be uncertain:

  • If an investor bought an n-year bond to meet an n-year liability, the coupon payments would have to be REINVESTED on terms that are not known at the outset.
  • If an investor plans to sell before redemption, the SALE PRICE IS NOT KNOWN at the outset.
  • Any DEFAULTS from the issuer will also impact the actual return achieved.
  • The REAL RETURN IS UNCERTAIN. If inflation turns out to be higher than expected at outset, the real returns from conventional bonds will be lower than originally anticipated.
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6
Q

Corporate Bonds:

Yields: Expected return relative to government bonds

A

The gross redemption yields on corporate bonds are higher than for similar government bonds, compensating for the

  • lower marketability and the
  • perceived additional default risk.

The lowest yield margins will be for larger issues from companies with high credit ratings.

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7
Q

Corporate Bonds:

Spread – volatility of capital values

A

Market values will fluctuate from day to day if there are changes in the supply and/or demand. Quite large shifts in market value are possible with less liquid, long-dated stocks.

The risk of falling market values may be a problem for:
• investors who need to prove financial strength by reference to the market value of assets (e.g. general insurers);
• investors who have to sell at the lower market prices (e.g. if an investor is required to meet a liability earlier than anticipated).

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8
Q

Corporate Bonds:

Term

A
Bonds can be classified as:
• shorts (< 5 years)
• medium-dated (5-15 years)
• long-dated (> 15 years)
• undated or irredeemable (no redemption date).
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9
Q

Corporate Bonds:

Expenses

A

For corporate bonds, the margins between buying and selling prices are typically wider than for conventional government bonds.

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10
Q

Corporate Bonds:

Exchange rate – currency risk

A

There will be a currency risk for an investor who is investing in bonds denominated in one currency but who has liabilities denominated in another.

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11
Q

Corporate Bonds:

Marketability

A

Corporate bonds are typically much less marketable than government bonds,
primarily because the SIZE OF ISSUE IS SMALLER.

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12
Q

Corporate Bonds:

Tax

A

The taxation of the income and capital gains will depend on the tax regime of the country concerned.
There will typically be both an income component (coupons) as well as capital gain (redemption value or sale price).

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13
Q

7 Sources of capital

A
  1. Share capital
  2. Policyholders
  3. Reinsurers (through financial reinsurance)
  4. Securitization
  5. Subordinated debt (into a holding company)
  6. Derivatives
  7. Past profits
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14
Q

Reasons why an insurance company might need capital

A
  1. Cushion for unexpected events
  2. Pay for future liabilities as they fall due
  3. To grow or expand / Finance new business
  4. As start up capital (will finance costs before revenue comes through)
  5. Required by regulator
  6. To finance known losses (for example to finance a loss leader product) or to finance losses incurred (for example due to adverse claims experience)
  7. To write business containing guarantees as it requires higher solvency margins
  8. To obtain a good credit rating (demonstrates financial strength)
  9. In order to have more investment freedom including the ability to mismatch to obtain higher returns
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15
Q

Why might the central bank increase interest rates?

A
  • government may want to CONTROL INFLATION
    Higher real interest rates mean a decreased quantity of money is demanded which is met by a decrease in the money supply.
    This can lead to reduced inflation. Higher real interest rates can assist in any inflationary pressures by decreasing demand in the real economy.
  • government may want to STRENGTHEN THE DOMESTIC CURRENCY
    If interest rates in one country are high relative to other countries, international investors will be more inclined to deposit money in that country. This increases demand for the domestic currency and tends to increase the exchange rate.
  • High real interest rates reduces investment spending by firms and decrease the level of consumer spending.

So increasing interest rates reduced the rate of growth in the short term.
The government may want to increase rates for political reasons. Eg to increase savings rates, strengthen financial institutions, or make future rate decreases possible (as hard to go below zero)

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16
Q

Effect of increased short-term interest rates on the EQUITY market

A

Equity markets should be REASONABLY INDIFFERENT towards high nominal interest rates and high inflation.
If the rate of inflation is high, the rate of dividend growth would be expected to increase.

Higher interest rates should REDUCE ECONOMIC ACTIVITY
… reducing corporate profitability
… reducing the general level of the equity market.

RATE OF RETURN REQUIRED by investors should be higher, so the present value of the future dividends will be lower.

The increase interest rates are also likely to REDUCE CAPITAL AVAILABLE to invest, leading to lower company growth.

CURRENCY MAY STRENGTHEN, doing damage to export-based industries.

IMPORTERS of raw materials will be better off.

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17
Q

Effect of increased short-term interest rates on the BOND market

A

Yields on short-term bonds are closely related to returns on money market instruments, so an increase in short-term interest rates will almost certainly reduce prices of short bonds.

However, the yield on long bonds might increase by a smaller amount, or even fall due to investors expecting deflation in the longer term.

Inflation-linked bonds may be more affected if the expectation is that inflation falls.

A significant part of the demand for government bonds in many markets comes from overseas. Increased expectations of future increases in the exchange rate will affect the demand from overseas investors. It will also alter the relative attractiveness of domestic and overseas bonds for local investors.

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18
Q

Describe factors other than interest rates which could influence the country’s investment markets

A

How attractive are ALTERNATIVE INVESTMENTS?

General MARKET SENTIMENT and investment FASHIONS

COMMODITY PRICES (and other input costs) will affect many companies

POLITICAL events or REGULATORY/TAX changes

ECONOMIC GROWTH OUTLOOK, expected improvements may generate market increases in anticipation of future growth.

EQUITY RISK PREMIUM - this is the additional return that investors require from equity investment to compensate for the risks relative to risk-free rates of return.

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19
Q

Set out what minimal underwriting may consist of.

A
  • Personal details
  • Age
  • Gender
  • Smoker status and other lifestyle issues (eg alcohol)
  • Height/weight/BMI data
  • Brief health questions (diagnosis / treatment)
  • Alternatively require a catch-all health declaration.
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20
Q

Outline the practical problems that may arise due to the lack of data held by a brand new insurer.

A

great difficulty in determining

  • appropriate PREMIUM rates
  • expected MORTALITY rates
  • what the key RATING FACTORS are, or how they will affect their target market.
  • expense loadings
  • capital requirements
  • difficult to predict BUSINESS VOLUMES
  • need data from OTHER SOURCES
  • – which will cost money
  • – may not be relevant / credible
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21
Q

Describe the commercial implications of a new insurer not having any past data / experience.

A
  • the uncertainty will lead to LARGE CONTINGENCY MARKETS.
  • they will rely heavily on REINSURANCE data and expertise (but this comes at a cost).
    Leading to high premium rates vs competitors.
  • the alternative is having low contingency markets, but could lead to premiums being too low for actual claims (ie large losses).
  • incorrect pricing structure could see the company ACCEPTING POOR RISKS.

they will be vulnerable to ANTI-SELECTION (owing to light underwriting standards).

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22
Q

Discuss the circumstances leading to a risk

NOT NEEDING FINANCIAL COVERAGE

A

The risk would need to be trivial.

Or there exist suitable insurance/guarantees from the government

Or the risk may be non-financial and there are processes in place to deal with it.

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23
Q

Discuss the circumstances leading to a risk

BEING RETAINED

A

The risk would be material if it arose.
However, the company may think that the risks are unlikely to bite.

Or, they might have SUFFICIENT FUNDS to cover any potential losses.

Suitable alternatives (transferrance) might be prohibitively expenses.

The company may be happy to take extra measures to deal with the risk.

The company may want to retain any UPSIDE OF THE RISK.

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24
Q

Discuss the circumstances leading to a risk

BEING FULLY TRANSFERRED

A
  • The company is risk averse.
    They believe that insurance is necessary, since - even if the risk is unlikely - the impact will be to great for them to cover themselves.

Alternatively, they may believe that they will be taking on significant risk but the premium represents value (and/or they can afford it).

It may be a LEGAL REQUIREMENT.

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25
Q

Describe how the costs of a policyholder protection scheme could be met.

A
  1. POLICYHOLDERS
    Higher premiums or charges applied to policyholder funds.
  2. CAPITAL PROVIDERS
    The ranking of capital provided on insolvency.
  3. COMPANIES
    Surcharges on surviving companies to provide benefits on insolvent schemes. There could be levies on all companies; these could be related to risk.
  4. STATE
    May step in directly. Could provide direct insolvency support or underwriting support, eg to provide confidence in benefit schemes. This could be funded through general taxation.
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26
Q

Outline how the actuarial control cycle could be used to manage the launch of a new insurance product:
SPECIFYING THE PROBLEM

A

Include an analysis of risks, including mitigations, and the problem seen from each stakeholder’s perspective.

Need to know the AIMS AND OBJECTIVE of the insurance company for this product.
We need to know its SUCCESS MEASURE.

Analyse the market to ensure the product is VIABLE.

Understand the NEEDS OF CONSUMERS

Understand who the COMPETITION IS

Understand COMPETITIVE ADVANTAGES

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27
Q

Outline how the actuarial control cycle could be used to manage the launch of a new insurance product:
DEVELOPING THE SOLUTION

A

Consider the MODELS to be used

ASSUMPTIONS that will need to be developed for the product.

Will need to COLLECT AND ANALYSE DATA.

INTERPRETATION OF RESULTS.

What level and form of benefit would be suitable?

are there any ALTERNATIVE SOLUTIONS AVAILABLE?

28
Q

Outline how the actuarial control cycle could be used to manage the launch of a new insurance product:
MONITORING THE EXPERIENCE

A
  • Ensure the model is dynamic so that it can be changed if required,
  • and in particular to reflect any identified experience.

Review the SALES OF THE PRODUCT, with an understanding of the profits actually achieved.

Show sufficient granular information on the demographics of policyholders and understand where the sales and expenses are coming from.

FEEDBACK TO MANAGEMENT

REFINE THE MODEL

REVIEW ALL Outline briefly the factors that would need to be considered when finalising the benefits to be offered.ASSUMPTIONS and elements of the model on a regular basis.

29
Q

Outline briefly the factors that would need to be considered when finalising the benefits to be offered on a new benefits scheme, which will provide the following benefits:
• Indemnity of certain medical expenses;
• A lump sum death benefit; and
• A “final salary” pension.

A
  • Accrual rate for pensions
  • Definition of “final salary”
  • Any restriction on total years of pensionable service
  • Will ill-health pensions be offered?
  • Is the death benefit fixed / multiple of salary?
  • Which medical events are to be covered?
  • Will it be full indemnity cover, or will there be deductibles or excesses?
  • What level of leaver benefits / transfer values will be offered?
  • Could there be discretionary benefits?
  • Consider any possible guarantees (pension increases, transfer values, commutation rate)
  • Consider any options offered (changing benefit levels, continuation after leaving employment)
  • Benefits need to be attractive to prospective employees?
  • Benefits should not be excessively complex, as the scheme needs to be administered.
  • Regulatory requirements/restrictions on benefits
  • Benefits should provide value for money
  • Benefits should operate within the financial constraints of the mining company
30
Q

Effects of an increase in short-term interest rates on:

GDP Growth

A
  • Raising short rates will take some time (6-9 month lag) to affect the real economy.
  • The time lag and the degree of impact will depend on the nature of borrowings by the private sector.

Eventually, however
- the economy will slow
- domestic demand will weaken
as consumers’ disposable income is reduced by the HIGHER DEBT SERVICING cost;
and as corporate profitability is hurt by the higher debt servicing costs and CONSUMPTION SLOWS.

31
Q

Effects of an increase in short-term interest rates on:

Inflation

A

Will not react immediately, but eventually as domestic demand slows, it will fall.

32
Q

Effects of an increase in short-term interest rates on:

the Exchange rate

A

This may weaken if inflation is increasing at a higher than expected rate,
as investors face increased uncertainty about future inflation levels and real investment returns and the extent of future increases to interest rates.

If the central bank is determined to maintain globally-attractive real short-term interest rates, then there might not be any change to the exchange rate as investors remain invested in the local market (switching from bonds and equities to the money market).

Attractive real short-term interest rates might attract foreign investors and could lead to a strengthening of the exchange rate.

This will help to dampen inflation and economic growth in as much as it will weaken the competitiveness of the export orientated sector and increase the level of cheaper imports.

33
Q

Items to include in a strategy document

A

It should set out:

  • AIM of the project
  • ISSUES necessary for implementation
  • AREAS OF RISK that could affect the viability
  • Alternative strategies for dealing with the risk.

In addition, it would include:

a clear identification of the OBJECTIVES of the project

    • statements on how these objectives will be met
    • ACCEPTABLE QUALITY STANDARDS for meeting the objectives
  • the financial and economic objectives
  • ROLES (sponsor & 3rd parties)
  • details of the expected cost of the project
  • the need for INSURANCE OR REINSURANCE
  • a structured BREAKDOWN of the work to be completed under the project
  • the KEY MILESTONES for reviewing the project

VARIOUS POLICIES

  • the risk managment policy
  • the communications policy
  • the IT policy
  • the technical policy
  • policy for dealing with legal issues
  • financing policy
34
Q

Risks associated with an acquisition of a smaller insurer.

A
  • Financial risks:
  • – Risks that you overpay for the company and require future capital injections, e.g. due to inadequate reserves or mispriced products.
  • Regulatory risks:
  • – Regulator might not approve the acquisition.
  • Operational risk:
  • – Loss of unhappy staff at the new company that leave could lead to poor customer service levels and unhappy customers.
- Project risk: 
Poor planning:
--- budgets
--- timescales
--- responsibilities
--- objectives not clearly specified
  • Reputational risk
  • – If takeover company mis-sold products, this could affect the reputation of the buying company.
  • Economic risk:
  • – Adverse changes in economy leading to poor sales, profits from the acquired company making it a poor investment.
35
Q

Role of the investment submission

A

to SUMMARISE the results of the detailed project appraisal

in a form that enables those with the ultimate responsibility to make an appropriate decision

It should show the EXPECTED NPV and a probability distribution of NPVs.

RISKS should be fully identified and analysed, and particular attention should be paid in the submission to any remaining risks that could have a catastrophic effect on the outcome of the project.

The proposed FINANCE METHOD the project should be specified.

Contain a RECOMMENDATION as to whether or not the project should be undertaken, based on the results of the appraisal.

36
Q

Factors other than the investment submission which could be taken into account when deciding whether or not to proceed with the project.

A
  • allowance for any likely bias or possible approximations in the estimates
  • “hunches” - any gut feelings or instincts that cannot be quantified
  • knowledge not in possession of those who prepared the submission
  • LAST-MINUTE developments
  • doubts over the FEASIBILITY or quality of implementation
  • the OVERALL CREDIBILITY of the project
  • whether or not the upside potential has been realistically estimated and allowed for.
37
Q

Factors that should be taken into account when determining the actual premium to be charged

A
  • theoretical risk premium
  • allocation of expenses (Direct expenses & Overhead)
  • commission payable to brokers
  • contribution to:
  • — cover the REQUIRED RETURN ON CAPITAL
  • — PROFIT
  • impact of TAXATION
  • REINSURANCE COSTS
  • any potential PROFIT SHARING
  • INVESTMENT INCOME
  • effect of COMPETITION
38
Q

Key differences between options traded on an exchange and options obtained through the over-the-counter (OTC) market.

A

Exchange-traded options:

  • enjoy lower counterparty/credit risk (due to the clearing house mechanism)
  • daily marked-to-market for the option writer
  • have daily quoted prices (useful for financial reporting purposes)
  • dealing costs are likely to be lower compared to OTC
  • Standardised (and so are less flexbile than OTC)
  • Better marketability
  • Easier to close out the position prior to expiry
39
Q

in-the-money

A

An option that is ‘in-the-money’ has a positive intrinsic value, namely:

  • Spot price of underlying - Strike price > 0 (call option)
  • Spot price of underlying - Strike price < 0 (put option)
40
Q

at-the-money

A

The intrinsic value of an option that is ‘at-the-money’ is zero, ie
Spot price of underlying - Strike price = 0

41
Q

Reverse yield gap

A

Reverse yield gap (RYG)
= GRY (gross redemption yield on a long-dated benchmark bond)
- d (equity gross dividend)

which can be split:

GRY = required risk-free real yield + expected inflation + inflation risk premium

d = required risk-free real yield + expected inflation + equity risk premium - g (expected capital gain)

ie
RYG = IRP - ERP + g

42
Q

Define moral hazard

not morale hazard

A

The risk that an insured may attempt to take an unfair advantage of the insurer,

e.g. by suppressing information relevant to the assessment of risk or by submitting a false claim.

This is not the same as anti-selection, which is also taking advantage of particular aspects of an insurance contract, but within the terms offered by the insurer.

43
Q

3 Key components likely to be included in a regulatory process

A
  • Quantitative measures of solvency
  • Qualitative aspects of managing the risk of insolvency (internal controls and risk management processes of the fund and monitoring visits by the regulator)
  • Disclosure requirements (public disclosure and private disclosure by the fund to the regulator)
44
Q

2 Key characteristics of money market instruments

A
  • highly liquid

- stable capital values

45
Q

Reasons why a general insurer might find investment in money market instruments attractive.

A
  • It might hold cash as a source of liquidity to meet outgoings.
  • The short-tailed nature of property claims makes money market investments suitable.
  • While liability claims are inflation-linked and can be long-tailed, many will be short-tailed, reducing the impact of inflation and thus making money market investment suitable.
  • Provides quasi-inflation protection as short term interest rates tend to be linked to inflation as investors expect real returns.
  • As a temporary holding strategy to avoid exposure to asset classes that are falling in value.
  • Some economic conditions might make cash temporarily attractive.
  • Generally speaking rising interest rates will depress both bond and equity markets.
  • Cash may be held due to premiums being paid which are waiting investment
46
Q

Why would investors not normally invest all of their assets in money market instruments?

A
  • Cash is not a good match for free assets which are likely to be eroded in real terms if invested in cash.
  • Historically, cash has underperformed other asset classes over long periods of time.
47
Q

Equation: Expected return on equities

A
Total expected return 
= dividend yield (d) + dividend growth (g)
= 
risk-free real rate of return (RFRR)
\+ expected inflation (EI)
\+ equity risk premium (ERP)
48
Q
Explain the effect of a prolonged recession on:
dividend growth (g)
A
  • In a prolonged recession the outlook for profits growth will be negative.
  • This means that expected dividend growth (g) will probably be negative as well.
49
Q

Explain the effect of a prolonged recession on:

Expected inflation

A

It is safe to assume that in a recession the Expected Inflation will also have fallen and could be negative.

50
Q

Identify the matching needs index-linked bonds are likely to meet for institutional investors

A

The cashflows on an index-linked bond are linked to an index and are thus known in terms of timing and in real terms.

Index linked corporate bonds can be used to match real, local currency outflows.
The terms of the outflows that can be matched will depend on the terms of the corporate bond issues - cashflows can be met through a combination of coupon payments and redemptions.

Index-linked bonds will not provide an exact match due to the lag in inflation and if outflows do not increase directly in line with the index.

51
Q

Accumulation of risk

A

Occurs when a portfolio of business contains a concentration of risk that might give rise to exceptionally large losses from a single event.
This results from the non-independence of risks.

52
Q

Actions which an insurer may need to take if it is concerned about the possibility of accumulations of risk

A
  • try to reduce its exposure to such risks by avoiding certain business
  • Diversify its business, e.g. by geographical region
  • Offer different products
  • Reduce benefits, or impose exclusions
  • Improve claims underwriting
  • Build in margins in pricing
  • Hold contingency reserves
  • Maintain adequate liquidity
  • Ensure systems are in place to monitor exposure and claims
  • Seek (XL) reinsurance
  • Enter reciprocal arrangements with an insurer in another area (or industry)
53
Q

discuss the considerations a company should take into account when deciding upon

  • an income REPLACEMENT RATIO
  • a deferred period
A
  • The RR should not be set too high or there will be no incentive for the insured to “recover” and return to work (moral hazard)
  • The RR should not be set too low that it does not provide a meaningful benefit and meet consumer needs.
  • Attention should be paid to COMPETITORS’ levels.
  • The impact on PREMIUMS should also be considered.
  • Seek REINSURER’S advice, as the reinsurer may not be prepared to offer cover for certain levels of RR.
  • There may also be REGULATIONS to be considered.
54
Q

discuss the considerations a company should take into account when deciding upon
- a deferred period

A
  • the deferred period should not be set so short that the policy ends up covering minor illnesses.
  • the deferred period should not be set so long that it no longer provides the required cover.
  • Attention should be paid to COMPETITORS’ levels.
  • The impact on PREMIUMS should also be considered.
  • Seek reinsurer’s advice, as the REINSURER may not be prepared to offer cover for certain levels of the deferred period.
  • There may also be REGULATIONS to be considered.
55
Q

Explain how a construction company should choose the risk discount rate to be used when valuing a project which comprises the building of a new shopping complex.

A

The key initial question: Does the project represent a NORMAL DEGREE OF RISK

Determine the discount rate for a project with a normal degree of systematic risk and then adjust it for exceptional project characteristics
— e.g. cost of raising incremental capital

The weights for equity and debt capital should be those of the optimal capital structure for the company

The debt-holders’ required return should be that for new borrowing by the company.

Shareholders’ required return should be the real return on Index-linked government bond + suitable margin to compensate equity investors for the additional risks they run.

risks are:

  1. uncertainty of level of future income
  2. additional volatility of price
  3. additional default risk
  4. lack of perfect inflation protection

Secondly, we should consider if this project has a higher degree of specific risk than is usual for the company’s projects.

One way of adjusting the rate would be to consider that rate which would be appropriate for a different construction company that habitually engages in such projects.

56
Q

What might the investment objective for a listed life insurance company be?

A

To maximise returns for shareholders subject to various conditions being met:
• Maintaining a specified level of solvency
• …over a specified time period
• …with a minimum degree of confidence or probability
• …taking into account profit volatility
• Maintaining a minimum level of dividends and dividend increases over time

57
Q

How would you determine the assumption for the claim rates to use in pricing the product?

A

Start with in-house information on frequency of events

ADJUSTMENT may be required to make the data relevant:

  • Exclude other causes of claims
  • Remove abnormal experience
  • Allow for trends where appropriate

Events are more likely to be relatively volatile from year-to-year so will need to look at many years’ worth of (credible) data.

Split the data into the different geographical areas (homogeneous groups).

Margins will be required to allow for:

    • it is a new market and there is significant degree of uncertainty.
    • catastrophic events)
    • accumulations of risk

Perform sensitivity tests / scenario tests

Talk to REINSURERS regarding data and assumption setting.

58
Q

Outline briefly the steps in the general risk management process

A
  • Establish the internal and external context.
    e. g. internal: risk appetite; available resources
    e. g. external: regulations and legislation
  • Analyse risks, i.e. quantify magnitude and likelihood
  • Evaluate risks against previously developed risk criteria
  • Identify risk treatment options
    e. g. risk avoidance, rejection, transfer, reducing probability of event occurring or severity.
  • Cost benefit analysis of available options
  • Adopt a risk treatment plan
  • Monitor and review
  • communicate and consult with relevant parties throughout the process.
59
Q

Describe the INVESTMENT IMPLICATIONS of a natural disaster for short-term insurers

A

CLAIM OUTGO:

  • insurers need liquidity
  • they presumable have reinsurance, but they need to pay claims before they receive the reinsurance recoveries.
  • the need for liquidity may result in the insurers realising more long-term assets
  • the equity market may be depressed due to the economic implications of the disaster. The need to sell off assets may further depress prices.

REINSURANCE RECOVERIES
- significant recoveries may allow for some reinvestment at a later stage

INCREASED EXPENSES
insurers will experience an increase in expenses related to claims underwriting, claims assessment and claims payment. This will also increase the need for liquidity.

DECREASED SOLVENCY
The insurer will need to move into a more matched position as solvency comes under pressure.

60
Q

Possible reasons for a sharp decrease in the availability of property cover in the immediate aftermath of a natural disaster

A

Reduced capital availability as they meet claims - do not have capital capacity for new business strain and to back additional business.

Solvency position may have been adversely expected, particularly as they would have had to realise assets to meet claims.

May not have processed all the claims yet. Due to potentially large liability they cannot take on additional business.

May have DEPLETED REINSURANCE COVER - cannot absorb additional risk

Risk of AFTERSHOCKS are high

61
Q

Key reasons for underwriting property insurance at the proposal stage

A
  • protect from anti-selection
  • enable the provider to identify risks for which special terms need to be quoted
  • for substandard risks identify the most suitable approach and level of terms
  • adequate risk classification ensuring risks are rated fairly
  • ensuring that claims experience does not depart too far from pricing assumptions
  • reduce the risk of over-insurance
62
Q

Benefits of having a stability clause

A
  • In an inflationary environment it will help to maintain the same real value of cover provided.
  • It will help keep premiums down, since without this the reinsurer would have had to make an allowance for the erosion of the Excess Point by inflation.
63
Q

Advantages of catastrophe cover

A
  • It reduces the potential for large losses due to the non-independence of risks (reducing the probability of ruin).
  • It allows the co. to take on risks which it might otherwise have had to avoid.
  • It can help stabilise profits from year to year in years where a catastrophe occurs.
  • It helps make more efficient use of the capital by reducing the variance of the claim payments.
  • Reduces the liquidity risk that arises from needing to pay large claims
  • Reinsurer may be in a better position to model and quantify catastrophe risk,
64
Q

possible contract conditions on catastrophe cover (that may differ) apart from the premium

A
	What constitutes a catastrophe
	events covered
	excess point
	upper limit
	reinstatement rules
	geographical limits
	“hours clause”
	Exclusions
  • Differences in support services provided, e.g. technical assistance or more efficient admin
  • Differences in the security of the companies (paying more to TrustRe for the greater security)
65
Q

Outline briefly the factors you would consider in order to decide with which reinsurer to place the catastrophe reinsurance business.

A
  • Ability (capacity) of reinsurer to provide the required cover.
  • Price will be an important factor to consider, relative to your estimate of the expected claims (& variability thereof)
  • Underpriced policies may not be appropriate as prices may increase significantly in the near future
  • The financial strength of the reinsurer.
  • Is price negotiable (considering that you place all of your other business with them)?
  • Since there is some cost to changing reinsurers and making use of more than one reinsurer (more admin), bear in mind the good past experience with the current reinsurer
  • If the size of the catastrophe premium is a relatively small proportion of total reinsurance premium there is less incentive to use a new reinsurer
  • Using more than one reinsurer may be appropriate for diversification and access to more technical knowledge
  • Any past knowledge/experience of other reinsurers.
  • What expertise, actuarial, claims, underwriting, does each reinsurer bring to the table.
  • Does any reinsurer have a particular expertise in your target market.
  • What terms and conditions does each reinsurer impose, e.g. underwriting and claims referral limits, onerous administrative conditions.
  • Is the reinsurer in the same city as you. If not, is this an issue.