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CA1 > Part 9 > Flashcards

Part 9 Flashcards

1
Q

Categories of risk

A
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2
Q

3 examples of credit-linked event

A
  • Bankruptcy
  • Rating downgrage / upgrade
  • Failure to pay
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3
Q

The principles of good lending relate to (4)

A
  • Character and ability of the borrower (is he trustworthy?)
  • Purpose of the loan
  • Amount of the loan
  • Ability of the borrower to repay
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4
Q

Difference between marketability and liquidity

A
  • Marketability is how easy it is to convert an asset into cash
  • Liquidity is a measure how quickly the asset can be converted into cash at a predictable price
    • call deposit at a bank is very liquid
    • long-term government bond is marketable but not liquid since the market value is volatile
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5
Q

Consequences of mismatching (2)

A
  • Higher liquidity risk
  • reinvestment risk
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6
Q

Categories of business risks (4) and examples

A
  • Underwriting risk
    • inadequate underwriting standards and therefore taking on risks at an inadequate price
  • Insurance risk
    • Insurer suffering more claims than anticipated
  • Financing risk
    • investing in a business that fails to be successful
  • Exposure risk
    • A reinsurer having greater exposure than planned to a particular risk event
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7
Q

Main claim risk for an insurance company

A
  • Mortality
  • Longevity
  • Morbidity
  • Medical advances (diagnosis, cures, etc.)
  • loose policy wordings
  • Accumulation of risks and catastrophes
  • anti-selection and moral hazard
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8
Q

Main claim risks for a general insurance company

A
  • Claim frequency
  • Claim amount
  • Claim inflation
  • Claim volatility
  • Claim delays
  • Claims handling
  • Loose policy wordings
  • Accumulation of risks and catastrophes
  • Anti-selection and moral hazard
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9
Q

Define operational risk

A

Operational risk refers to the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.

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10
Q

Operational risk can arise from: (4)

A
  • Inadequate or failed internal processes, people or systems
  • The dominance of a single individual over the running of a business (dominance risk)
  • Reliance on third parties to carry out various functions for which the organization is responsible
  • The failure of plans to recover from an external event
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11
Q

Examples of defined benefit pension schemes (3)

A
  • Final salary schemes: benefits are based on earnings in the last three years prior to retirement
  • Career average scheme: benefits are based on earnings over career, possibly revalued
  • Fixed benefit scheme: fixed amount for each year of service
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12
Q

Examples of defined ambition schemes (2)

A
  • A cash accrual scheme where benefits are defined as a lump sum rather than as a pension
  • A defined contribution scheme offering a defined benefit underpin e.g. the benefit will not be less than 1/100th of final salary for each year of service
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13
Q

3 key benefit risks for a defined contribution scheme

A
  • Investment returns being lower than expected, or expense charges higher
  • Annuity purchase terms poorer than expected
  • Members’ needs not being met, either due to design or inflation erosion of value
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14
Q

6 key benefit risks for a defined benefit scheme

A
  • Inadequate funds due to underfunding (insufficient funds set aside)
  • inadequate funds due to sponsor insolvency
  • inadequate funds due to asset liability mismatching
  • illiquid assets
  • risks that the benefit promised is changed, e.g. by the state
  • members’ needs not met, either due to design or inflation erosion of value
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15
Q

Further benefit risks for both, DB and DC schemes

A
  • default by sponsor
  • failure by sponsor to pay contributions/premiums in a timely manner
  • takeover of the sponsor
  • decision by the sponsor that benefits will be reduced
  • inadequate communication by sponsor / provider of assets and liabilities
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16
Q

The overall level of the contributions for a defined benefit scheme depend on (5)

A
  • The amount of the promised benefit
  • The probability of individuals being eligible to accrue the beneftis
  • The probability of individuals being eligible to receive the benefits
  • The effect of inflation on the level, or the real level, of the benefits
  • The investment return achieved on the contributions (net of tax and expenses, if appropriate)
17
Q

Contribution risks for defined benefit schemes

A
  • Future contributions unknown and depend on
    • the amount of the benefit
    • eligibility to accrue benefits
    • eligibility to receive benefits
    • inflation
    • investment returns net of tax and expenses
  • Extra contributions may be required to meet a shortfall, resulting in liquidity risk or excessive contributions
18
Q

Contribution risks for defined contribution schemes (3)

A
  • Unafforadable contributions
  • Insufficient liquidity to make the payments in a timely manner
  • Contributions may be linked to an inflationary factor, introducting an inflationary risk
19
Q

Other word for “timing” of the investment return

A

Incidence of the return on investments

20
Q

10 key investment risks for a benefit scheme

A
  • Uncertainty over the level and incidence of income
  • Uncertainty over the level and incidence of capital
  • Reinvestment risk arising from mismatching assets and liabilities
  • Default risk
  • Tax and expenses
  • Benefits are not appreciated due to poor investment returns
  • Inflation erosion
  • Opportunity cost of the capital
  • Liquidity risk
  • Lack of diversification
21
Q

Define risk classification

A

Risk classification is a tool for analyzing a portfolio of prospective risks by their risk characteristics, such that each subgroup of risks represents a homogeneous body of risk.

E.g.

  • male/female
  • smoker/non-smoker
22
Q

3 criteria that a risk must satisfy in order for an insurer to be preprated to take on the risk (insurability)

A
  • Policy holder must have an interest in the risk being insured (to distinguish between insurance and a wager (Wette))
  • A risk must be of a financial and reasonable quantifiable nature
    • Insurer need to be able to assess the risk and set an appropriate premium
  • The amount payable by the insurance policy in the event of a claim must bear some relationship to the financial loss incurred
    • If the claim amount is too small, the policyholder is unlikely to deem the insurance worthwhile, if it is too large, this will encourage fraud and moral hazard
23
Q

6 additional desirable criteria for a risk to be insurable

A
  • Individual risk should be independent
  • the probability of the event occuring should be relatively small
  • large number of similar risks should be pooled to reduce variance
  • There should be a limit on ultimate liability undertaken
  • Moral hazard should be eliminated as a far as possible
  • there should be sufficient existing data / information in order to quantify risk
24
Q

Define risk management

A

Risk management is the process of ensuring that the risks to which an organisation is exposed

  • are the risks to which it THINKS it is exposed
  • and tho which it is PREPARED to be exposed
25
Q

The risk management process consists of (5)

A
  • risk identification
  • risk measurement
  • risk control
  • risk financing
  • risk monitoring
26
Q

Risk management process - risk identification

A

Recognition of the risks that can threaten the income and assets of an organisation

  • high level preliminary analysis
  • brainstorming with experts
  • desktop analysis
  • risk register or risk matrix
27
Q

Risk management process - risk measurement

A

measuring the probability and severity of a risk

28
Q

Risk management process - risk control

A

Mitigation to reduce the probability / severity of a loss

29
Q

Through risk managment a provider will be able to

A
  • avoid surprises
  • improve the stability and quality of their business
  • improve their growth and returns by exploiting risk opportunities
  • improve their growth and returns through better management and allocation of capital
  • identify opportunities arising from natural synergies
  • give stakeholders in their business confidence that the business is well managemed
  • price products to reflect the inherent level or risk
  • improve job security and reduce variability in employee costs
  • detect risks earlier meaning they are cheaper and easier to deal with
  • determine cost-effective means of risk transfer
30
Q

When faced with a risk each stakeholder can choose wheter to (5)

A
  • avoid the risk
  • reject the need for financial coverage of that risk because it is either trivial or largely diversified
  • retain all the risk
  • pay a premium to another party to transfer all the risk to that party
  • retain some of the risk and pay a premium to transfer the balance of risk to another party
31
Q

Risk management process - risk financing

A

Determining the likely cost of a risk

… and ensuring the availability of adequate financial resources to cover the risk

32
Q

Risk managment process - risk monitoring

A

Regular review and reassessment of risks together with an overall business review to identify new / previously omitted risks

33
Q

Main weakness of VaR

A

Does not quantify the size of the “tail”

34
Q

Expected shortfall

A
35
Q

Calculate 95% VaR

A
36
Q

Conditional Tail VaR

A

Expected shortfall divided by the shortfall probability

CA1 (10 decks)

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