Part 7: Chapter 25, 26, 27 and 28 Risk Governance, Risk identification and classification, Financial product and benefit scheme risks, Accepting Risk Flashcards
Risk management control cycle
Identify
Classify
Measure (ProSCoCo)
Control
Finance
Monitor
Risk management helps to
AEIOU
Avoid surprises and threats to business
Exploit risk opportunities
Improve stability and quality of business
Opportunities from natural synergies identified
Uncertainty of stakeholders reduced (increase confidence)
Risk control methods
Avoid
Reduce
Retain
Transfer
Reject
Combination of the above
Choice depends on:
Likelihood/severity of risk event
Existing resources in place to meet the cost of the risk
Price/willingness of a 3rd party to take on risk
Why ERM is effective
Company’s BUs are spread out in different ways
Key features:
Consistency across business units
Holistic – Consider enterprise as a whole - leading to better:
- Diversification
- Pooling of risks
- Offsetting of risks
- Economies of scale
- Identification of opportunities
Risk measurements
ProSCoCo
Probability
Severity
Correlation (Between risks)
Controllability
Investment risks
Default
Reinvestment
Uncertainty over timing/amount of return
Mismatching of A/L
Opportunity cost of capital
Liquidity risk
Inflation (income and capital proceeds)
Taxation
Expenses
Withdrawal risk
Equity risk
Property risk
Clients expectation not met
Under performance to benchmark
Risk identification
Brainstorm with experts(MILEP) - senior, internal and external
- Discuss risks and their interdependencies
- Place broad evaluation on each risk
- Generate intitial mitigation options
Desktop analysis to supplement the results from brainstorming session
Risk analysis at high level / High level prelim risk analysis
- Determines if the project isnt too risky
Risk register/matrix
Upside/downside, likely/unlikely - Identification or risks
Brainstorming with experts should yield
Project risk identification – likely, up/downside
Mitigation options
Interdependent risks
Long term strategic thinking
Evaluation of risks: frequency, consequences
Business Risk for insurers
Business mix and volumes
Reinsurance
Expenses
Withdrawals
Claims
Options and guarantees
Underwriting
- Insufficient premium charged for the risk taken on by the company
New business strain
Risks in Life and General insurance
Reinsurance/ Reputational
Investment/ Reinvestment risk
Systematic risk
Competition risk
Liquidity risks
Inflation (medical, expense and price)
Fraud (Operational risks)
Expenses
Data (quality and amount)/Model and parameter risk
Rates (Mortality, Unemployment, morbidity)
Options and Guarantees
Withdrawals
New business(vol, mix and strain) risk
Credit risk/ failure of third parties
Aggregation of risk/Concentration risk
Tax changes
Selection (Anti Selection, Moral Hazard)
Marketing/ Market risk
Underwriting risk
Sources of operational risk
Dominance in management
Reliance on third parties
Internal process failures
Human error
Key person risk
Cyber crime
Fraud
Failure of plans to recover from external risks
Define Liquidity risk
The risk that a company, although solvent, does not have the financial resources to meet its liabilities as they fall due or can only secure these resources at excessive cost. Usually caused by a sudden surge in liabilities that fall due.
Market risk definition
ALM
Market risks are the risks related to changes in investment market values or other features (interest, inflation, exchange rate) related to the investment markets.
Divided into:
Asset changes
Liability changes
Matched position changes
Business risk definition
Risk specific to the business undertaken
Also refers to all the risks underwritten by insurance companies.
Operational risk
PPES
The risk of loss resulting from inadequate or failed:
- Processes(Internal)
- People
- External events
- Systems
Systematic risk vs Diversifiable risk
Systematic risk is the risk that affects an entire financial market or system.
Diversifiable risk arises from an individual component of a financial market or system.
It is not possible to avoid systematic risk through diverisification. It is possible not to take on diversifiable risk since you can diversify it away.
Risk Diagram
Risk of benefits for a DB scheme
Inadequate funds due to:
- Sponsor insolvency
- Under funding
- Mismatching of A and L / Mortality rates (pre and post retirement)
Liquidity of the scheme to meet benefits (Mismatching)
Benefit changes risk -Changed by State, scheme provider
Needs of member not met - design or inflation
Take over by company who’s unwilling to meet beneficiary promises
State sponsored benefits changed
Risks in a DC scheme
Operational risk- Fraud
Longevity risk- Terms of annuity to not meet the needs
Investment risk- bad investment performance, annuity price
Expense risk - higher than expected
Market Risk - Inflation
Defined Benefit scheme definition
Under a defined benefit scheme, the scheme rules define the benefits independently of the contributions payable, and the benefits are not directly related to the investment of the scheme.
Defined contribution scheme definition
A defined contribution scheme provides the benefits where the amount of an individuals members benefits depends on the contributions paid into the scheme in respect of the member, accumulated by investment return earned on those contributions.
Risk to sponsors of a benefit scheme
Risk of cost of providing benefit more than expected
o Cost of benefit changing
o More people accruing benefit
o More people receiving benefit
- Improved rates
o Inflation
o Investment return
Risk of payments coming at an inopportune time
- Difficulty in setting Investment strategy due to
uncertain nature
- Liquidity problems
Factors that influence risk appetite
- Regulatory control
- Existing risks faced
- Culture of individual/company
- Size of the company
- Current level of capital
- Nature of business
- Risk attitude of stakeholders
- Local or international
- Upside of risk
Quantified definition of Risk appetite
- Solvency level
- Earnings / ROE / Ability to pay dividends
- Credit rating
- Economic value
- Statistical measure of risk (VaR, volatility, Ruin Prob)
Insurable risk criteria
- Financial/quantifiable- quantifiable loss
- Interest in the risk being insured (from policyholder perspective)
- Indemnifies the insured, insurance not for profit making, protection
- Amount payable relates to size of loss - profit principle
- Moral hazard eliminated (as far as possible)
- Ultimate limit on liability payable- upper limit to the insured amount enable liability valuation
- Data available for accurate pricing
- Pooling large number of homogeneous risks - partial funding of risk is possible
- Independent risk events insured. (catastrophe risk, easier stats done)
- Small probability of occurrence- high risk events are not cost effective. Meaning that people can save the money rather than taking out insurance on it.
General risks in pension schemes
Default of sponsor/provider
Failure by sponsor/provider to pay contributions on time
Takeover of sponsor/provider
Decisions by sponsor/provider to reduce benefits/contributions
Inadequate sponsor by sponsor/provider
Economic mismanagement of funds
