Risk Management and Role of Insurance Industry Flashcards
How do we effectively manage risks? (4 strategies)
Risk avoidance
Risk mitigation
Risk retention
Risk Transfer
Risk Retention Strategy
Individuals/companies might opt for higher retention, choosing to absorb small losses and cope with financial consequences. Believe they can manage those small losses effectively and economically.
Risk Mitigation Strategy
Proactively reducing potential risk. Fire resistant construction materials - LOSS PREVENTION sprinkler systems are examples of LOSS CONTROL
Risk Transfer Strategy
Passes financial burden of potential losses to TP.
Insurance companies face what risks? (name 3)
Underwriting risk
Market risk
Operational risk
Who is considered a policyholder?
Businesses or individuals who want to transfer risk that they are exposed to.
What is a risk carrier?
Refers to entities (typically insurers/reinsurers) that assume and manage the financial responsibility for covering risk in exchange for premium from policyholders.
Name 4 types of risk carriers
Insurers
Reinsurers/Retrocessionaires
Captives
Special-purpose vehicles
Explain what is a captive
Financially strong companies set up their own insurance companies to insure or organise the insurance of their own risks rather than buying insurance.
Name two advantages of a captive
Allows a company to control the management and spread of the risk themselves. It allows them to gain direct access to the insurance market.
What is a special-purpose vehicle (SPV)?
It is a company or trust established for a specific purpose. Example, SPV is set up to act as a reinsurer/retrocessionaire. e.g an insurer wants to cede part of all of its exposure to an EQ in Tokyo and decides to cede this risk to an SPV rather than a conventional reinsurer. SPVs are funded by issuing securities to investors. These securities are known as insurance linked securities (ILS).
What are the 4 key methods of risk sharing between risk carriers?
Coinsurance
Reinsurance/retrocession
(Re)Insurance pools
Insurance linked securities (ILS)
Define coinsurance
The policyholder transfers the risk to several insurers who each assume a percentage of the risk. Usually has a lead insurer.
Why is reinsurance a preferred method for the insurer to share risk? Name three
- Policyholder can deal with a single insurer.
- Insurers prefer to be a client’s sole insurer. It prevents names of competitors becoming known to the client. They can insurer 100%, then partially reinsurer some risk.
- Policy issuance incurs fixed costs for primary insurers irrespective of size of premium. Reinsuring means the insurer can keep a larger share of prem, and the fixed costs only make up a small percentage.
What is a (re)insurance pool?
It’s where several insurers join together to form a central pool consisting of a pool containing all insurance contracts for similar groups of policies that are threatened by similar risks. Insurers participating in the pool then accept different sized shares of the total business ceded to the pool.
Explain insurance-linked securities (ILS)
SPVs (set up by insurers) issue securities/bonds, which investors then purchase and deposit the money in the SPV. The money raised by the SPV is then invested in risk free investments and any interest earned is paid to the investors. Usually cover ranges from 3-5 years.
In terms of ILS, what is a coupon?
The return paid to investors.
What are the three advantages of ILS?
- Insurer can be certain they will receive fixed XYZ amount if a loss happens (because the money in the SPV cannot be used for anything else).
- Spreads the risk amongst a larger number of investors, insuring large risks that a conventional reinsurer might be reluctant to accept.
- Since the structure has a multi year duration, the insured entity locks in a guaranteed price for the period of cover.
When is ILS used?
Generally used to cover peak risks e.g NAT CAT as they are costly to set up and manage.
Explain risk avoidance
Risks that can be avoided altogether e.g individuals can choose not to engage in hazardous activities, running a bakery business rather than chemical manufacturing.
Name three examples of personal insurance products
Life
Health
Accident
Name three examples of property insurance products
Fire
NAT CAT
Theft
Name 3 examples of pecuniary loss insurance
Liability - bodily injury, property damage
BI
Credit
