Other Risk Controls Flashcards
Diversification: Risk can be managed through diversification within the following
• lines of business
• geographical areas of business
• providers of reinsurance
• investments - asset classes (e.g. bonds, equities, property, etc)
• investments - assets held within a class (e.g. different sectors in equities)
Diversification can also be achieved by entering into reciprocal reinsurance arrangements - insurance companies swopping risks with each other (could also involve reinsurance companies)
Risk factors vs rating factors
Risk factor: can have an impact on price; age, health status, etc
Rating factor: enables the insurer has a better understanding on the risk they take in
All risk factors are rating factors
Underwriting
The assessment of potential risks so that each can be charged an appropriate premium
It is used to manage risk in the following ways:
• it can protect the provider from anti-selection
• it enables a provider to classify risks into homogenous groups for which a standard premium can be charged, and thus helps to ensure that all risks are rated fairly
• it enables a provider to identify risks for which special terms need to be quoted
• for substandard risks, the underwriting process identifies the most suitable approach and level for the special terms to be offered (can be declined offer)
• it helps in ensuring that claim experience does not depart too far from that assumed in pricing of the contracts being sold
• for larger proposals, it will help to reduce the risk of over-insurance (to prevent incentivizing certain behavior)
What life insurance initial underwriting is likely to involve:
• medical underwriting - assessing the applicant’s health
• lifestyle underwriting - assessing the impact of lifestyle (e.g. occupation, leisure pursuits, country of residence) on the level of risk
• financial underwriting - to reduce the risk of over-insurance
What can special terms include for a substandard risk?
• an addition to the premium (e.g. a loading)
• a reduction to the benefit
• an exclusion clause, e.g. preexisting conditions in healthcare, subject to a time period where they can’t claim
• deferring the cover until more info known
• declining an applicant (either on a temporary or permanent basis)
Claims control systems
Claims control systems mitigate the consequences of a financial risk that has occurred by guarding against fraudulent or excessive claims
For some products (e.g. income protection), claims management continues during the claim
Management control systems include
• data recording - it is important that the company holds good quality data in all the risks it insures, with particular emphasis on the risk factors identified when the product was designed or when the risk was underwritten
While this cannot change the company’s exposure to the business risks underwritten, it can assist in ensuring adequate provisions are established for those risks, and reduce the operational risks from having poor data
• accounting and auditing - again good procedures cannot change the risks accepted, but they can enable proper provisions to be established and regular premiums to be collected
These procedures may also be required by regulation
The company’s providers of finance and others, e.g. reinsurers, will expect to see appropriate systems in place to be reassured as to its financial position
• monitoring of liabilities taken on - it is important to monitor the liabilities taken on by the company to protect it against aggregation of risks of a specific type to an unacceptable level
Where the acceptance of risk requires the provider to set aside material capital requirements, it is important to quantify and potentially limit the amount of new business to ensure that it is within the company’s available capital resources
In addition, premium rating may involve cross-subsidies from one type or class of business to another. If the business mix expected in the premium rates is not achieved in practice, the profitability of the contract may be at risk
• management of options and guarantees - offering options and guarantees introduces additional risks, which may be managed using controls such as eligibility criteria and asset-liability matching (e.g. use of derivatives)
Techniques for managing options and guarantees
• liability hedging and asset-liability matching, including the use of derivatives and dynamic hedging
• restricting option eligibility conditions
Low likelihood, high impact risks
Such risks are commonly difficult to managed, and:
• can only be diversified in a limited way
• can be transferred to an insurer or reinsurer
• can be mitigated by management control procedures, e.g. disaster recovery planning
Some such risks can only be accepted, with capital held against them. Very rare events can fall beyond the company’s risk tolerance (e.g. with a less than 0.5% probability of happening within a year) and so may be disregarded
Risk financing
The price accepted for a risk must be adequate, allowing the risk taker to continue in business and also provide a contribution to profit
It is necessary to determine the amount of capital to hold against the risk accepted or retained, e.g. to target a ruin probability over a specified period
Risk management should be co-ordinated in order to be capital efficient and to reduce the total cost of risk
