Marshall

Question 1

Explain why qualitative approaches are preferred over quantitative approaches when populating a correlation matrix.

Answer 1

Quantitative techniques require a significant amount of data, time and cost to produce credible and intuitive results

Question 2

Briefly describe the bolt-on approach to determining risk margins.

Answer 2

A bolt-on approach occurs when separate analyses are completed to develop a central estimate of insurance liabilities and/or estimate risk margins. It is called a “bolt-on” approach because it does not involve a single unified distribution of the entire distribution of possible future claim costs

Question 3

Define the following terms: ⇧ Claims portfolio

Answer 3

The aggregate portfolio for which the risk margins must be estimated

Question 4

Define the following terms: ⇧ Valuation classes

Answer 4

The portfolios that are considered individually as part of the risk margin analysis

Question 5

Define the following terms: ⇧ Claim group

Answer 5

A group of claims with common risk characteristics

Question 6

Briefly describe systemic risk.

Answer 6

Systemic risk represents risks that are common across valuation classes or claim groups

Question 7

Briefly describe two sources of systemic risk and provide an example for each source.

Answer 7

⇧ Internal systemic risk – risks internal to the insurance liability valuation/modeling process (i.e. model parameter risk) ⇧ External systemic risk – risks external to the insurance liability valuation/modeling process (i.e. changes in building costs)

Question 8

Briefly describe independent risk.

Answer 8

Independent risk represents risks that occur due to the randomness inherent in the insurance process

Question 9

Briefly describe two sources of independent risk.

Answer 9

⇧ Parameter risk – represents the extent to which the randomness associated with the insurance process affects the ability to select appropriate parameters in the valuation models ⇧ Process risk – represents the pure effect of the randomness associated with the insurance process

Question 10

Identify two sources of risk that can be fully analyzed using modeling techniques such as bootstrapping or a stochastic chain-ladder model.

Answer 10

Independent risk and historical external systemic risk

Question 11

Identify two sources of risk that cannot be fully analyzed using modeling techniques such as bootstrapping or a stochastic chain-ladder model.

Answer 11

Internal systemic risk and future external systemic risk

Question 12

Briefly explain why traditional modeling techniques cannot capture all sources of uncertainty.

Answer 12

Since models fit past data, they are only able to remove past episodes of external systemic risk. They are not able to capture future external systemic risk

Question 13

Briefly describe three sources of internal systemic risk.

Answer 13

⇧ Specification error – the error that arises because the model cannot perfectly model the insurance process ⇧ Parameter selection error – the error that arises because the model cannot adequately measure all predictors of future claim costs or trends in these predictors ⇧ Data error – the error that arises due to the lack of credible data. Data error can also refer to an inadequate knowledge of the portfolio being analyzed, including pricing, underwriting and claims management processes

Question 14

Fully describe the balanced scorecard approach for assessing internal systemic risk.

Answer 14

A balanced scorecard is developed to objectively assess the model specification against a set of criteria. For each of the sources of internal systemic risk, risk indicators are developed and scored against the criteria. The scores are aggregated for each valuation class and mapped to a quantitative measure (CoV) of the variation arising from internal systemic risk. Despite the focus on objectivity, some subjective decisions must be made. These include the risk indicators, the measurement and scoring criteria, the weight given to each risk indicator and the CoVs that map to each score

Question 15

Briefly describe three external systemic risk categories.

Answer 15

⇧ Claim management process change risk – the uncertainty associated with changes in claim reporting, payment, estimation, etc. ⇧ Expense risk – the uncertainty associated with the cost of managing the run-off of the insurance liabilities or the cost of maintaining the unexpired risk until the date of loss ⇧ Event risk – the uncertainty associated with claim costs arising from events (i.e. cats), either natural or man-made

Question 16

For each risk category, provide an approach for assessing the risk.

Answer 16

⇧ Claim management process change risk • Analysis of past experience should help identify past systemic episodes impacted by the claim management process. Discussions with claim managers can help identify the process changes that contributed to those systemic episodes, as well as the potential for any future changes to the process • Sensitivity testing of key valuation assumptions is useful in the assessment of CoVs for this risk category ⇧ Expense risk • An actuary should spend time with product and claim management to better understand the key drivers of policy maintenance and claim handling expenses • Similar to claim management process change risk, an analysis of past expense levels can help identify past systemic episodes ⇧ Event risk • For outstanding claim liabilities, discussions with claim management should help set expectations on final claim cost outcomes. The range of development patterns on past events may influence the view on uncertainty as well • For premium liabilities, past experience for event claims, output from proprietary cat models, and output from models for perils not covered by cat models can help quantify liabilities

Question 17

Given the following sources of risk: ⇧ Independent risk ⇧ Internal systemic risk ⇧ External systemic risk Fully describe the correlation effects within AND between each source of risk.

Answer 17

⇧ Independent risk – assumed to be uncorrelated with any other source of uncertainty and between valuation classes ⇧ Internal systemic risk – assumed to be uncorrelated with independent risk, and with each source of external systemic risk. However, internal systemic risk tends to be correlated between valuation classes ⇧ External systemic risk – assumed to be uncorrelated with independent risk and internal systemic risk. However, correlation may exist between risks that belong to similar external systemic risk categories. If correlation occurs, correlated risk categories can be aggregated into broader categories that are not correlated

Question 18

Identify two distributions used to calculate risk margins. For each distribution, explain any differences in the calculated risk margins.

Answer 18

⇧ Normal distribution – produces a higher risk margin at lower probabilities of adequacy, irrespective of the size of the consolidated CoV ⇧ Lognormal distribution – produces a higher risk margin at higher probabilities of adequacy as long as the consolidated CoV is not too high. For extremely high CoVs, the risk margin can actually reduce as a percentage of the CoV

Question 19

Explain how scenario testing can be used in conjunction with risk margin analyses.

Answer 19

Scenario testing can be used to determine how key assumptions underlying the risk margin calculation would need to change in order to produce a risk-loaded actuarial central estimate. These scenarios include changes in claim frequencies, claim severities, loss ratios, etc.

Question 20

Given the following sources of risk: ⇧ Independent risk ⇧ Internal systemic risk ⇧ External systemic risk For each source of risk, describe any internal benchmarking that should occur.

Answer 20

⇧ Independent risk • Portfolio size – the larger the portfolio, the lower the volatility arising from random effects • Length of claim run-off – the longer a portfolio takes to run-off, the more time there is for random effects to have an impact ⇧ Internal systemic risk • Classes with homogeneous claim groups should have similar CoVs • Long-tailed portfolios should have higher CoVs than short-tailed portfolios ⇧ External systemic risk • Long-tailed portfolios should have higher CoVs than short-tailed portfolios in most cases (exceptions include event risk and liability risk for home classes)

Question 21

Briefly describe a situation in which external benchmarking is useful.

Answer 21

External benchmarking is beneficial when little information is available for analytics

Question 22

Briefly describe general hindsight analysis.

Answer 22

General hindsight analysis compares past estimates of liabilities against the latest view of the equivalent liabilities. Any movement/variation can be converted to a coe

Question 23

Describe mechanical hindsight analysis and give an example of how it can be used to analyze independent risk.

Answer 23

⇧ Mechanical hindsight analysis applies a mechanical approach to estimating liabilities by systematically removing the most recent claims experience. For example: • Apply the chain-ladder method to a triangle of cumulative claims • Use an objective approach to calculate the development factors (volume-weighted average) • The outstanding claim payment derived using all of the data up to the valuation date is the ‘current’ estimate • Remove diagonals one at a time and apply the same method to derive the outstanding claims payments at past valuation dates • Compare each of the past estimates with the current estimate ⇧ To analyze independent risk, mechanical hindsight analysis should be applied to periods with stable experience

Question 24

List the 3 sources of risk, modeled in assessing risk margins

Answer 24

-Independent risk -Internal systemic risk -External systemic risk

Question 25

What are the subrisks in independent risk?

Answer 25

-Parameter risk -Process risk

Question 26

What are the subrisks in internal systemic risk?

Answer 26

-Specification error -Parameter selection error -Data error

Question 27

What are the subrisks of external systemic risk?

Answer 27

-Economic and social risks -Legislative, political and claim inflation risks -Claim management process change risk -Expense risk -Event risk -Latent claim risk -Recovery risk

Question 28

Formula for independent CoV

Answer 28

Question 29

Formula for Internal Risk CoV

Answer 29

Question 30

Formula for Risk Margin

Answer 30

Question 31

Formula for total company CoV

Answer 31