Part 7: Chapter 25, 26, 27 and 28 Risk Governance, Risk identification and classification, Financial product and benefit scheme risks, Accepting Risk

Question 1

Risk management control cycle

Answer 1

Identify
Classify
Measure (ProSCoCo)
Control
Finance
Monitor

Question 2

Risk management helps to

AEIOU

Answer 2

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)

Question 3

Risk control methods

Answer 3

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

Question 4

Why ERM is effective

Answer 4

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

Question 5

Risk measurements
ProSCoCo

Answer 5

Probability
Severity
Correlation (Between risks)
Controllability

Question 6

Investment risks

Answer 6

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

Question 7

Risk identification

Answer 7

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

Question 8

Brainstorming with experts should yield

Answer 8

Project risk identification – likely, up/downside

Mitigation options
Interdependent risks
Long term strategic thinking
Evaluation of risks: frequency, consequences

Question 9

Business Risk for insurers

Answer 9

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

Question 10

Risks in Life and General insurance

Answer 10

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

Question 11

Sources of operational risk

Answer 11

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

Question 12

Define Liquidity risk

Answer 12

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.

Question 13

Market risk definition

ALM

Answer 13

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

Question 14

Business risk definition

Answer 14

Risk specific to the business undertaken

Also refers to all the risks underwritten by insurance companies. 

Question 15

Operational risk

PPES

Answer 15

The risk of loss resulting from inadequate or failed:

• Processes(Internal)
• People
• External events
• Systems

Question 16

Systematic risk vs Diversifiable risk

Answer 16

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.

Question 17

Risk Diagram

Answer 17

Question 18

Risk of benefits for a DB scheme

Answer 18

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

Question 19

Risks in a DC scheme

Answer 19

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

Question 20

Defined Benefit scheme definition

Answer 20

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.

Question 21

Defined contribution scheme definition

Answer 21

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.

Question 22

Risk to sponsors of a benefit scheme

Answer 22

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

Question 23

Factors that influence risk appetite

Answer 23

• 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

Question 24

Quantified definition of Risk appetite

Answer 24

• Solvency level
• Earnings / ROE / Ability to pay dividends
• Credit rating
• Economic value
• Statistical measure of risk (VaR, volatility, Ruin Prob)

Question 25

Insurable risk criteria

Answer 25

• 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.

Question 26

General risks in pension schemes

Answer 26

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