Part 8: Chapter 29, 30 and 31 Risk measurement & reporting, Risk Transfer, Other risk controls

Question 1

Why risk reporting is important

Answer 1

New and changing of risks identified
Appropriate capital requirements can be set
Quantify impact of individual risks
Monitor effectiveness of existing control systems
Assess interaction between risks
Assess proper risk allocation by business units (ERM)

Question 2

When quantifying the capital required for each retained risk, consider

Answer 2

The term of the risk exposure
Correlation allowances
Interdependencies of risk
Low likelihood high impact risks (especially operational risks)
Past data’s credibility

Question 3

Scenario analysis

Answer 3

Group risk exposures into broad categories - input from several senior managers
Develop Plausible adverse scenario for each category - ideas!!
Set assumptions for the risk factors of each scenario
Calculate consequences based on certain assumptions - ideas!!
Total cost is cost of all risks in relevant scenario
Run several different scenarios - one for each group risk exposure

Question 4

Probabilistic Risk measures

Answer 4

VaR/Tail VaR
Liability risk - measured by analysis of experience vs. expected
Asset risk - Active risk measure (forward/backward looking tracking error)
Deviation

Question 5

Purpose of a stress test

Answer 5

Volatilities of results checked
Identify weak areas – where high volatility and correlation exists
Correlations between risks checked and held consistent
Sensitivity of certain risk factors
Impact of market turmoil on parameters
Reactions of rest of business on stress scenario: Ideas!

Question 6

The pros and cons of VaR

Answer 6

Applicable to all risk types
Benchmark can be set from its outcome
Units are understandable
Comparable between various risk sources
Simple expression

Distribution of losses > than VaR not considered
Underestimation of fat tailed distributions
Sensitive to choices of data, assumptions and parameters
Addition of risks won’t increase the overall risk exposure

Question 7

The contents of a risk register

Answer 7

Probability
Impact / Severity
Correlation
Risk score to compare risks with each other

Extension of risk register:
Diversified risk
Retained risk
Avoided risk
Mitigated risk
Controls measures
Owner of the risk
Concentration of risks
Key strategic risks identified

Question 8

How to do a stress test

Answer 8

Subject portfolio to extreme market movements ( In the case of testing adverse claims experiences or solvency levels, subject portfolio to relevant extremes such)
- This can be done by for changing assets and liabilites to extreme low or high values, making new business volumes extremely high etc. Or by changing key assumptions such as the claim rate, interest rate, inflatiion

correlations should be considered carefully. This may lead to the need to do stress scenario testing

Two types of stress testing:
Identify weak areas in the portfolio
gauge the impact of major market turmoil

Question 9

Reasons for reinsurance
SAD LIFES CLAP U

Answer 9

Smoothing of results / Smaller capital requirements Avoid large losses - Single/aggregated events or claims
Diversification

Limit exposure to large risks caused by:
- Single risk
- Single event
- Aggregation of events
Increase capacity to write more business/large risks
Financial assistance
Expertise
Solvency risk reduces

Credit risk
Liquidity risk
Administration cost
Profitability affected as premiums are ceded

Underwriting

Question 10

Reasons for ART include

Answer 10

Diversification
Exploits risk as opportunity
Solvency management, sources of capital
Cheaper than other types of cover
Available when other cover might be unavailable
Results stabilized (Smoothing of results)
Tax advantages
Effective provision of risk management

Question 11

Examples of ART contracts include

Answer 11

Post loss funding
Insurance derivatives
Securitisation (Catastrophe bonds)
Swaps
Integrated risk covers

Question 12

Merits of XoL reinsurance:

Answer 12

+Caps losses, so can take on large risks
+Protects against individual/aggregate large claims
+Efficient use of capital (less provisions) due to less volatility
+Helps stabilise profits

• Premiums are expensive
• XL premiums may occasionally be far greater than pure risk premium due to underwriting cycle
• General poor claims experience not protected against

Question 13

Expertise of reinsurer

Answer 13

Product Design/Data
Underwriting and claims control systems
Pricing
Actuarial services
Policy wording
Administration help

Question 14

Merits of Proportional Reinsurance

Quota share
Surplus

Answer 14

PR Quota share
+ Simple to administrate
+ Reciprocal Business encouraged
+ Helps to diversify risk
+ Larger portfolios of risk written

• The same Proportion of each risk is ceded regardless of size
• and volatility
• It does not Cap the cost of very large claims

PR Surplus
+Reduces company’s exposure to certain risks
+Flexible, useful in achieving a well-balanced portfolio of risk
+Helps insurer to spread risk / Heterogeneous risks can be insured with this agreement
+Allows insurers to accept large risks

-More complex administration compared to share quote due to proportions changing for each risk

Question 15

Factors affecting the extent of risk Transfer

Answer 15

Appetite for risk
Cost of transferring the risk

Counter party risk
Resources existing to finance the risk event if it happens
Probability of the risk Occurring
Willingness of a third party to take on the risk

Question 16

ART definition

Answer 16

A means of transferring risk other than traditional reinsurance. It produces tailor-made risk transfer solutions for risk transfer that the conventional market would regards as uninsurable

Question 17

Reinsurance definition

Answer 17

An arrangement whereby one party (the reinsurer), in consideration for a premium, agrees to indemnify another party (cedant) against part or all of an insurance liability.

Question 18

Risk management tools include
MURDA

Answer 18

Management control system
Underwriting and claims control
Reinsurance
Diversification
Alternative risk transfer ART

Question 19

Managing options and guarantees

Answer 19

Derivatives purchased OTC
Option pricing methods - stochastic model
Liability hedging
Immunisation

Question 20

Management control systems

DOLA

Answer 20

Data recording
- Data of insured risk factors held
- Cannot change risk exposure - ensures adequate
provisions have been made for the risks retained
Options and guarantees
- Liability hedging (e.g. matching, immunisation,
derivatives)
- Option pricing methods
- Anti-selection risk
Liability monitoring
- Risk aggregation prevented
- Ability to take on new business assessed
- Will the business mix allow cross subsidizing?
- Cost of reinsurance reduced
Accounting and auditing
- Ensures adequate provisions made for risk
- premiums are collected
- Reassurance of the company’s financial position

Question 21

Reasons for underwriting include
SAFER E

Answer 21

Special risks offered special terms (change premium/benefit, apply exclusions or refuse) DARE
Avoid anti-selection
Financial underwriting to avoid overinsurance
Ensure experience matches expectations
Risk classification; all risks rated fairly and identified properly - homogenous groups

Ensure provider charges a fair premium for the risk that it is taking

Question 22

Diversification can be achieved within the following

Answer 22

Reinsurance providers and products
Investments – asset classes
Geographical areas of business
Investments – assets held within a class
Different classes of business (lines of business)
Sales channels
Other service providers - third parties
Business mix can be diversified

Question 23

If applicants do not meet the minimum underwriting standards, they may be offered special terms such as

DARE

Answer 23

Declining the applicant either temporarily or permanent
Addition to the premium
Reduction in the benefit
Exclusion clause - also temporary to prevent anti-selection

Question 24

Underwriting definition

Answer 24

The process of consideration of an insurance risk. This includes assessing whether the risk is acceptable and, if so, the appropriate premium, together with terms and conditions of the cover. It may also include assessing the risk in the context of the other risks in the portfolio.