Risk Management Flashcards
Whose risk appetite is catered for in design of a contract?
Company
Stakeholder groups
Individuals within stakeholder groups
What can a stakeholder do with his risks?
What does his decision depend on?
Retain - immaterial, diversified, mental
Transfer - some or all
Minimise - locks on front door
Depends on - probability, surplus, price of insurance
How is risk classification used in the design if a contract?
Price charged more accurate
Remove useless parts like child rider
The fundamental rationale of insurance is what?
If price one company will accept a risk is lower than expected cost of keeping it to an individual then insurance is mutually beneficial
Why must there be credible and volumous data in insurance?
To make accurate frequency and size assumptions of risks
What is the process of underwriting?
Collect data (form, report, exam, tests)
Assess customer risk (specialist underwriters, see if required standard for normal rates)
Give special terms if high risk, or reject
Set premium commensurate with risk (fair price paid)
How does underwriting manage risk?
Substandard lives identified and terms set
Avoid anti-selection
Financial underwriting against over insurance
Experience equals expected when contracts priced
Risk classification to ensure fair price charged
Reinsurance is easier to obtain
What special terms are possible after underwriting?
Standard premium plus extra for risk
Standard benefit minus extra for risk
Exclusion clause, no payment if claim due to specific event
What factors effect mortality and morbidity ratings factors?
Current health
Occupation
Leisure pursuit
Normal country of residence
Why is medical underwriting done?
Find if applicant meets required standard of health, if not, how bad is it?
What’s the big decision in whether to reinsure?
Risk held versus cost of mitigating plus assistance in other ways from reinsurer
What are the 3 main benefits of reinsurance?
Reduce variability of claims (smooth profit, reduce capital requirements, reduce risk of insolvency)
Limit large losses (aggregate and single)
Benefit from reinsurer expertise and financial assistance
How can a reinsurer provide financial assistance?
Administration costs
Actuarial services costs
Other actuarial advice costs
What risk is retained with any reinsurance?
Default of the reinsurer
What two overall types of reinsurance are there, what are the 3 categories, with products?
Reinsurer takes risk completely on Reinsurer pays insurer at time of claim Proportional (surplus, quota share) Non proportional (risk, aggregate, catastrophe, stop loss) Financial reinsurance
Why would the value of benefits expected to be paid by reinsurer be lower than the price to purchase reinsurance?
Profit plus expenses plus contingencies
What is the process of deciding on reinsurance?
Assess holding risk vs reinsurance cost plus benefits of reinsurance
Find expected value of benefit to be paid
Sensitivity test this using various assumptions to find expected cost and variance
Weigh up liquidity risk if not purchasing reinsurance
Give 2 points about proportional reinsurance?
Administered automatically
Requires a treatee
What is quota share reinsurance, what are its 3 uses?
Fixed percent of risk is reinsured
Spread risk
Write larger portfolio of risk
Encourage reciprocal business
Explain surplus reinsurance.
What type of business is it used, what is specified in treaty
What are the disadvantages to the reinsurer
The disadvantages to the insurer
When might the disadvantage happen?
What might be the outcome of the disadvantage?
Fixed percentage of each risk reinsured
Retention limit
Maximum level of cover
High volume business, fixed percent in treaty
Low volume, percent varies per risk
No cap on total pay out if reinsurer or insurer
Bankruptcy
Events are 1 large claim, many claims overall, many from 1 incident
Give 2 advantages of non proportional reinsurance and what they mean for the company
Give a disadvantage and what you can do about it?
Liability to insurer is capped (accept business with risk of very high claims)
Reduces variation of claims (smoothing, solvency more secure, capital requirements lower)
It may come back to the insurer if over the maximum cap
Purchase more reinsurance
3 point on risk xl
Relates to individual losses
Affects only 1 insured risk at a time
Has total claim limit to protect against use as a cat xl substitute
Give 2 points and an example on cat xl
Reduce risk relating to non independence of risks insured
Renegotiate premiums each year
Eg. Hurricane destroys 50 houses insured by insurer
Give 7 point on aggregate xl
Reduces risk of many claims over a year leading to large outgo
Better than risk xl for this as that wouldn’t protect against many small claims
Retention level
Upper limit
Defined perils
Defined period e.g. 1 years claims
If all perils covered on whole account it’s stop loss reinsurance
What is ART?
What is the mnemonic for them and their uses?
Tailor made covers for risks conventional markets regard as uninsurable
DIPSIS
DESCARTES
Uses of DIPSIS covers?
Discounted cover, don’t need to fully finance un discounted liability
Integrated risk cover, avoid buying excess cover, smooth results, lock into attractive terms
Post loss funding, funding on specific loss
Securitisation, managing catastrophe risk
Insurance derivatives e.g. Weather options
Swaps, swap oppositely correlated risks
Explain discounted covers and uses
Don’t need to fully finance un discounted liabilities
Manage solvency
Capping losses
Risk transfer
Explain integrated risk covers and uses
Between insurer and reinsurer Alternative to debt and equity Avoid buying excess cover Smooth results Lock into attractive terms
Explain securitisation and uses
Transfer insurance risk to capital markets
Used for managing catastrophe risk
Not correlated with market risk
Explain post loss funding and uses
Pay fee now for funding on specific loss
Funding will be loan or equity
Explain insurance derivatives
Example is weather options
Explain swaps
Swap negatively correlated risks
E.g. Gas (cold weather) or water company (hot weather)
Explain DESCARTES
Diversify risks Efficient risk management Smooth results Cheaper Available where regular insurance say uninsurable Solvency management Reduce capital requirement Increase security of company and payments Tax
How can a company diversify risks?
Line of business e.g. Term and annuity Geographical area Different reinsurers Asset classes, multiple Within asset classes, multiple
What are 2 problems of diversifying by business class (line of business)
Many products, different risks - expensive admin, staff training etc,
Many companies with many products - all generalists, no niche players
How do you solve the main problem in diversification by business class (many products, expensive admin)
Why does that help?
Reinsurance with other company who will reinsure some parts of their business to you, reciprocal quota share
Business exposed to more risks but can concentrate marketing, sales, administration on core products
What type of fat sir is reinsurance?
Transfer of risk
What type of fat sir is claims control?
Mitigation of consequence of financial risk that’s happened
What do you compare when deciding which claims control to use?
What are the types if claims control?
Cost of the type versus benefits (money saved) from using it Claim form Estimates Loss adjust Ongoing monitoring Inspection by employees or agents
What type of claims control are done for small/medium/large/phi claims?
Claim form and 1 estimate
Form and 2 or 3 estimates
Inspection by employee or agent and loss adjusting
Monitor receiver of money to make sure not fraudulent, length of claim
What type of fat sir are management controls?
Reduce exposure to risk
What do management controls include?
Data recording Data checking Accounting Audit Monitor assets and liabilities Options and guarantees, liability hedging (matching)
Explain data recording
Assists in adequate provisions for risks taken on
Reduce operational risk of poor data
Still same exposure to business risks (insurance, underwriting, financial over insurance, exposure)
Good quality data needed
Emphasis on risk factors
Explain accounting and audit in context of management controls
Enable adequate provisions
Still same exposure to business risks
Ensures providers of finance about financial position if company
Explain monitoring liabilities taken on in context of management controls
Reduces risk of aggregation of risks getting to unacceptable levels
Helps cross subsidies products, new business strain and monitoring
Explain special care of options and guarantees
Even if they have no value now, might change with economic conditions over long term
In the risk management if options and guarantees, what can be done? Give 3 examples
Liability hedging
Choose assets to move in same way as liabilities
E.g.
Immunisation hedges interest rate risk
Derivatives if guarantee relates to movement in an index
Option pricing methods, suitable assets don’t always exist
What are the 3 reasons to hold reserves?
Liabilities accrued not yet paid
Future liabilities where premiums have been received
Claims incurred, not yet settled
Give a formula for SCR
Best estimate liabilities plus
MAD plus
Buffer for general adverse experience
What two ways might an SCR be calculated, bearing in mind we know its formula
Prescriptive, prudent valuation, little extra amount
Best estimate provisions plus lots of additional capital
What are the 3 pillars
Capital requirement and risk exposure quantification
Supervisory regime
Disclosure requirement
Explain what courses if action when fall below mcr, SCR
Not allowed to trade
Discuss remedies with regulator (close to new business etc)
What model do you calculate the SCR ?
Internal or standard
What 5 uses are there of an internal model?
Calculate solvency requirement using normal methods
Calculate economic capital using different risk measures, like var and tail var
Calculate levels of confidence in the ec requirement calculated
Apply different time horizons
Include other risk classes not in standard model
Explain economic capital
What to use
What the balance sheet looks like
What ec is based on
Determines appropriate capital requirement
Balance sheet has market values if assets, liabilities and surplus
Uses assets, liabilities and business objectives
Based on risk profile of individual assets in portfolio
Based on risk correlations
Based on desired maximum depreciation of credit rating
In needing working capital, what is the insurer aiming to do?
Ensure liabilities met
Ensure future growth
Maximise reported profits
What need does an individual have for capital
Unexpected events
Big future expected events, or not expected
Why does a general company need (working) capital?
Expansion Volatility of trade volumes Finance stock Finance work in progress Start up capital (premises, staff, equipment)
Why does an insurer need capital
REG CUSHION
Cashflow timing, payout before sufficient funds gained
Management Systems to administer payments
Collecting premiums
Commission
Investment expenses
Administration expenses
Higher volumes of new business so larger new business strain
Interest rate risk if holding unmatched position
Mergers, aquisitions, demutualisation, new ventures
Smooth profits, mismatching
Improve solvency
Show strength to attract new business, impress market, credit rating agencies
Holding for guarantees and options, impact solvency merging and therefor capital requirements increase
Why does a government or state sponsored organisation not need much spare working capital?
When does it need that small amount?
Borrow money in developed market
Raise taxes in developed market
Print money (inflationary)
Short term fund because of cashflow timing if government income and outgo.
Some reserves to smooth exchange rate fluctuations, balance of payments, economic cycle, gold and foreign currency.
How might a company raise capital? (Increase their assets minus liabilities, raise money)
What special thing might a mutual have to do?
Retain profits, don’t distribute as dividends or bonuses
Keeps surplus in business, don’t distribute as dividends or bonuses
Issue shares to existing shareholders, rights issue
Issues debt securities to existing shareholders, rights issue
Issue shares or debt to new people, tender offers
Issue subordinated debt, the liability is after other creditors paid, so increase assets but not liabilities
Reinsure to limit capital requirements
Capital management tools
In mutual, someone must lend money with no requirement to be repaid unless profits emerge, no liability to pay back on balance sheet
Why are capital management tools used, what are they?
Processes to meet, match and manage capital requirements
Model. FinRe securitisation subordinated debt liquidity facilities contingent capital senior unsecured financing derivatives equity internal sources of capital
Explain how model used in capital management tools
Model existing business and projected new business
Find capital requirement at given ruin probability
Explain how FinRe used in capital management tools
Efficient management of capital solvency tax position of provider
Takes advantage in some way of position of reinsurer, may be overseas
Explain how securitisation used in capital management tools
Convert illiquid asset to tradeable instrument
Transfers risk associated with it to a value of asset
Explain how subordinated debt used in capital management tools
Raise capital that improves free capital position
Payments come after all others made so not used in solvency valuation
Explain how liquidity facilities used in capital management tools
From banking sector
For short term financing and rapid growth
Explain how contingent capital used in capital management tools
Capital provided on contingent event
Improves financial strength and credits rating
Explain how senior unsecured financing used in capital management tools
By group for subsidiary
Cost effective
Group level strength decreases
Explain how derivatives used in capital management tools
Use if reduce risk overall
Dangerous
Explain how equity used in capital management tools
Increase assets without increasing regulatory liabilities, paid after all others
Explain how internal sources of capital used in capital management tools, give examples
Reorganise internally to get better financial structure
Merge funds
Merge assets
Weaken valuation basis(assumptions)
Defer distribution of surplus
Retain capital by not paying dividends or bonuses
What is the chart of risks, and what under each risk?
Financial Market, assets, liquidity, matching Credit, asset default, counterparty risk, debtors Business, wife Liquidity
Non financial
Operational, business continuity, third party admin, key person dominance, people processes systems
External
Regulations, tax, war, nature, competition, building setting on fire
Why do active management funds exist
Not everyone has same estimates of risks and returns
They hold less diversified portfolio in in belief that their expected return over the market compensates for the diversifiable risk
Risk appetite determines extent to which they are prepared to hold diversifiable risk
Give a one liner for credit risk
And on it’s 3 components
What’s the questions that need to be asked in good lending?
How Can a lenders position be enhanced?
Failure of 3rd parties to repay debts
Asset default, issuer of corporate bond defaulting on interest or capital
Counterparty, one party fails to meet their side of bargain
Debtors, purchaser of goods fails to pay
CASPAR
Security enhances, not an excuse for bad lending, must be within ability to realise it
Give examples of character and ability of borrower?
Known Competent Trustworthy Who introduced them References Don't lend to liars Key personnel have good skills and experience?
Give examples of purpose of lending
What purpose will money be put
Is the sector the borrower is in very risky
Already have diversification in that sector
Currency, environmental, resource, technological risks to borrower?
Ethical or moral?
Controls to ensure how money used?
Give examples of amount in good lending?
Is it reasonable amount considering purpose
Is the borrowers contribution adequate
Who loses if project fails?
Examples of repayment in good lending?
Can borrower repay when due
How certain is source of payment
What margin of safety is in projections
Margin if safety in assumptions
What do decisions of what type of security is needed depend on!
Nature of project underlying borrowing Covenant of borrower Negotiating strength of borrower and lender Market circumstances What security is available
If a company takes actions to improve credit rating, what can it effect
Market for that company’s and others shares
One liner on liquidity risk
Risk an individual or co pant although so,vent, doesn’t have sufficient financial resource to meet obligations when they fall due
Why might a trading company go into liquidation?
Has sufficient assets, stock, work in progress to cover liabilities
Bit assets can’t be realised
Why do insurers and benefit schemes not have much of a liquidity problem, why do banks?
How do collective investment schemes, hedge funds counter liquidity risk?
As they invest in cash, bonds, stock market
Banks take shirt term deposits and lend for longer periods, risk of a run
Lock in periods
What is marketability risk?
A type of liquidity risk
In financial markets
Market doesn’t have capacity to handle volume of an asset to be traded @without adverse impact on price@
One liner on market risk
One liners on its components
Risks related to changes in investment market values or features correlated with investment markets, like inflation and interest rates
Assets, consequences of changes on asset values
Liabilities, consequences of investment market value changes in liabilities
Matching, consequences of provider not matching when investment returns change
Why might asset values change, market risk
Market values of equities and property change
Change in interest and inflation effecting bond markets mainly
Why might liability values change, market risk
Guarantees directly related to investment markets, or inflation or interest rates
Provisions relating to the same thing, interest rates decreasing will increase present values
What’s the fundamental principle of investment?
Assets should be invested to match nature term currency of liabilities
If it were possible to find a match then market risk could be completely removed
Why is a perfect match not possible?
Not wide enough range of assets
Assets not long duration
Uncertain cashflow of liabilities after option date
Uncertain cashflow of liabilities from discretionary benefits
Cost of maintaining matches portfolio prohibitive
What is additional capital used for in market risk thoughts
Allow freedom for mismatching
Covers cost of risk taken
You can’t remove operational risk, what can you do?
Control or mitigate
4 types of area where operational risk can arise
.
Failed or inadequate processes, people, systems
Dominance, single individual over running business
3 parties, carrying out major functions for the organisation
Failure of recovery plans from external event
What types if external risk are there?
It’s systematic in general
Storm, fire, flood, terrorism, change in regulations and tax
Give a one liner on business risks
Examples of business risk for an insurer, a company like Samsung
Risks specific to business undertaken
Operational risk are non financial events having financial consequences, these are financial events
Insurer, poor underwriting so price not adequate, more claims than anticipated, greater exposure to event than panned, failed project
Samsung, competitor launching new product a week before yours
