QA Bank Part 9 Flashcards
Credit risk
The risk of failure of 3rd parties to repay debts
4 Examples of credit risk
- the issuer of a corporate bond defaulting on payment
- a corporate bond’s credit rating being downgraded
- counterparty or settlement risk
- debtor default
Liquidity risk
occurs when a market does not have the capacity to handle the volume of an asset that is to be bought or sold at the time when the deal is required.
Market risk
The risk related to changes in investment market values or other features correlated with investment markets such as interest rates or inflation
3 Examples of market risk
- the consequences of a fall in asset values (insolvency)
- the consequences of a fall in liability values
- the consequences of mismatching
Business risk
A financial risk specific to the business undertaken
Examples of business risk
- insurance risk
- underwriting risk
- financing risk
- exposure risk
Operational risk
Risk of loss resulting from inadequate or failed internal processes, people or systems
5 Main reasons for an individual receiving a lower pension than anticipated from the arrangement
- Less is paid in contributions than expected
- Lower investment return is achieved than expected
- The pension annuity purchased may cost more than expected
- The member may choose to take some of the funds as cash, so less money is available to purchase the annuity
- There may be changes to regulation that affects benefits
reasons why less might be paid in contributions (4)
- salary increases being less than expected
- individual taking career breaks
- individual retiring earlier than expected
- net invested contributions less than expected due to higher charges
reasons why less investment return might be achieved (5)
- under-performance of assets leading to lower than expected investment income
- underperformance of assets leading to lower than expected capital growth
- contributions being paid later than expected, so there is less time to earn investment returns
- a fall in market values at the time that the pension is purchased
- investment expenses being greater than expected.
reasons why the pension annuity purchased may cost more than expected (4)
- fall in the investment return the annuity provider expects to receive post-retirement
- improving mortality, so more benefit payments are expected to be made
- a change in the type of annuity purchased (eg inclusion of a spousal pension, pension increases)
- expense and profit allowances in the cost of the annuity may be greater than expected.
Factors that might lead an individual to purchase an inappropriate private medical insurance policy
- Incompetence or insufficient experience of the advisor
- lack of integrity of the advisor
- the use of an unsuitable model or parameters
- errors in the data
- state-encouraged but inappropriate actions
- over-complicated products
Ways to mitigate against inappropriate advice
- Check that the advisor is appropriately qualified
- Only use a financial advisor who has been recommended by a trusted source
- The individual could carry out some research of their own into private medical schemes before consulting the advisor so as to be better equipped to understand and question the advice given
- Look for an advisor who operates on a fee basis, rather than using commission
- Make sure the product sold incorporates a cooling off period, so that the policy can be cancelled during an initial period if it is found that inappropriate advice has been given
- seek a wide range of quotes for comparison
- the individual should be honest about their needs, state of health and financial position so that the advisor has the correct data with which to offer advice.
- The individual should make sure that they are financially aware and question government advice
- the individual should read the small print, and check their understanding of the product before committing to purchase
- if the individual discovers that inappropriate advice has been given, they could write to the regulator/ombudsman.
List the benefits of risk management
- 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 managed
- price products to reflect the inherent level of 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
4 Options for dealing with 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 the risk to another party.
- manage/mitigate the retained risks
4 Factors affecting the approach to dealing with risk
- how likely the risk event is to happen
- the existing resources that the stakeholder has to meet the cost of the risk event should it happen
- the amount required by another party to take on the risk
- the willingness of another party to take on the risk
3 Examples of operational risk
- the dominance of a single individual over the running of a business
- reliance on 3rd parties to carry out various functions for which the organisation is responsible
- the failure of plans to recover from an external event
Underwriting risk
Poor underwriting procedures and hence incorrect pricing
Exposure risk
Overexposure to a particular class of business or geographical area.
Defined contribution scheme
A defined contribution scheme provides a benefit payment that is dependent on
- contributions paid into the scheme in respect of that member,
- together with the investment return earned on those contributions
- and the annuity rate available at retirement
2 Steps to reduce the likelihood of pension being lower than expected
- regular reviews of the fund
- matching of assets
Claims under Employer’s Liability Insurance:
Variability
Policies will be heterogeneous, since employers will vary significantly in the types of risk to which they are exposed.
In addition claims may be quite variable from year to year.
Claims under Employer’s Liability Insurance:
Unusual claims
There is significant risk of:
- single large claims
- catastrophic events
- accumulations
- latent claims
Claims under Employer’s Liability Insurance:
Reporting and settlement delays
Reporting delays are common (e.g. symptoms from industrial disease)
Settlement delays are also common, since claims need to be validated and complex cases may undergo court proceedings.
Claims under Employer’s Liability Insurance:
Nature of claims
Some types of claim may have fixed payments that have been agreed in advance, whereas other claims are likely to be real in nature, linked to lost earnings.
What is a risk portfolio?
A risk portfolio provides a means by which to categorise the risks to which the business is exposed.
For each risk, both impact and probability might be recorded.
An indication of how the risk has been dealt with might also be recorded.
It can also help identify any concentrations of risk and highlight the need for management action in these areas.
Risks portfolio:
4 Financial risks
- credit risk
- liquidity risk
- market risk
- business risk
Risks portfolio:
Indicating how risks have been dealt with (4)
Indicate whether the risk has been:
- retained (and how much capital is needed to support it)
- transferred
- mitigated (with a revised assessment of the remaining risk)
- diversified (with a revised assessment of the remaining combination of risks)
How might risk be managed at the business unit level?
The parent company decides on its overall risk appetite and then divides this between the business units…
… the management of each business unit then manages the risks of the business within the allocated risk appetite.