Risks

Question 1

Market risk

Answer 1

Risk of losses in investments due to fluctuations in market prices. This can include changes in stock prices, interest rates, exchange rates, and commodity prices. Subcategories include:

Equity risk
Interest rate risk
Investment return risk
Inflation risk
Currency exchange risk
Mismatching risk
Reinvestment risk

Question 2

Reinvestment risk

Answer 2

The risk that an investor will have to reinvest cash flows (such as coupon payments or principal repayments) from an investment at lower interest rates than the original investment. This can reduce overall returns, especially if market interest rates decline after the initial investment.

Question 3

Mismatching risk

Answer 3

The risk that arises when there is a discrepancy between the cash flows of assets and liabilities, particularly in financial institutions. This can occur when the timing of cash inflows from assets does not align with cash outflows required for liabilities, leading to liquidity issues.

Question 4

Currency exchange risk

Answer 4

The risk that fluctuations in currency exchange rates will affect the value of investments denominated in foreign currencies. This risk is particularly relevant for investors holding international assets, as changes in exchange rates can lead to gains or losses.

Question 5

Inflation Risk

Answer 5

The risk that inflation will erode the purchasing power of money over time. If investment returns do not keep pace with inflation, the real value of investments will decrease, impacting long-term financial goals.

Question 6

Investment Return Risk

Answer 6

The uncertainty associated with the returns on an investment, which can be influenced by various factors including market conditions, economic trends, and the specific characteristics of the investment itself. This risk reflects the variability of expected returns and can impact overall investment performance.

Question 7

Interest Rate Risk

Answer 7

The risk that changes in interest rates will negatively impact the value of fixed-income investments, such as bonds. When interest rates rise, the value of existing bonds typically falls, leading to potential losses for bondholders.

Question 8

Equity Risk

Answer 8

The possibility of losing money due to a decline in the market price of stocks. Equity risk is often associated with fluctuations in the stock market and can affect individual investors and portfolios as a whole.

Question 9

Credit risk

Answer 9

Risk that a borrower or counterparty will default on their obligations, failing to repay borrowed funds or meet contractual obligations, which can lead to financial losses.
Subcategories include:
Default risk - The risk that a borrower will be unable to repay a loan or meet debt obligations, leading to a default. Company might fail to make bond repayments.
Counterparty risk - Risk of default or underperformance by reinsurers, outsourcing partners, or investment counterparties

Question 10

Liquidity risk

Answer 10

Risk of being unable to buy or sell an asset quickly enough in the market without causing a significant impact on its price. This can affect an investor’s ability to access cash when needed. Subcategories include:
Asset Liquidity Risk: The risk of not being able to sell assets quickly or at a fair price to meet benefit payments.
Funding Liquidity risk - Risk of insufficient funds to meet benefit payments. May arise from insufficient reserves, insufficient free assets, inability to raise additional capital, or unexpected benefit improvements.

Question 11

Business risk

Answer 11

Business risks arise from the operations of the business itself. These can stem from strategic decisions, market competition, and economic conditions. Different from operational risk as it can arise from external factors too.

Question 12

External risks

Answer 12

External risks arise from outside the organisation and are typically beyond its control. These risks can affect the entire industry or economy. This may include:
Legal, regulatory and tax risk
Catastrophe risk
Changes in lifestyle and prevalence of medical conditions
New diseases or epidemics
Aging population
Changes in the cost of medical treatment due to medical innovations and advances in technology

Question 13

Operational risk

Answer 13

Operational risks arise from internal processes, systems, or human factors. This may include:
Model risk
Policy data risk
Other data risk (external and internal)
Internal audit failures
Fraud risk
Reputation risk
Poor claims control
Risks related to member or policyholder choices
Advice risks (quality and cost of advice to assist members/policyholders)

Question 14

What are some risk mitigation tools for longevity risk?

Answer 14

Buy-out transactions
Buy-in transactions
Longevity derivatives
Longevity bonds

Question 15

What are some risk mitigation tools for morbidity risk?

Answer 15

Avoidance (through underwriting)
Management (immunisation, wellness promotion, managed care)
Transfer (reinsurance)

Question 16

What are risk mitigation tools for market risk?

Answer 16

Diversification across asset classes, sectors, and geographies
Use of derivatives for hedging (e.g., put options to protect against downside risk)
Implementation of stop-loss orders
Regular rebalancing of portfolio to maintain target asset allocation
Use of factor investing to manage exposure to specific risk factors

Question 17

What are risk mitigation tools for credit risk?

Answer 17

Diversification across issuers and credit ratings
Setting limits on exposure to individual issuers or sectors
Use of credit default swaps for hedging
Regular credit analysis and monitoring of issuers
Implementing collateral requirements for certain transactions

Question 18

What are risk mitigation tools for liquidity risk?

Answer 18

Maintaining a cash buffer
Investing in highly liquid assets (e.g., large-cap stocks, government bonds)
Implementing liquidity management policies (e.g., limits on illiquid investments)
Use of stress testing to assess liquidity under various scenarios
Establishing lines of credit as a backup liquidity source

Question 19

What is underwriting risk?

Answer 19

This is the risk that claims and expenses exceed what was expected when pricing the product.

Question 20

What are claim risks?

Answer 20

Risks related to claims usually have to do with claims being very different to what was expected.

This may be caused by:
Product design: indemnity breeds uncertainty, claims management processes (preferred providers), options and guarantees
Providers: affecting utilisation
Environment: medical innovation, currency fluctuation, new diseases
Policyholders: changes in lifestyle, prevalence of medical condition, fraudulent claims, ageing population
Claim event: mortality or morbidity risks

Question 21

Main morbidity risk for each product

Answer 21

PMI: provider has limited control over the size of the benefit payments.
CI: main risk the in the rate of diagnosis of CI.
LTC: the main risk is probability of transition to claim inception rate in the multi-state model.
Retirement: main risk is benefit payments happening earlier than expected.

Question 22

Concerns with managed care

Answer 22

Provider networks may prevent certain individuals from having access to care.
Providers may resent external parties imposing clinical protocols on them and influencing the way in which they practice medicine.
Managed care may compromise the quality of care provided to patients by encouraging under-servicing of patients by providers
Use of formularies and other financial-based managed care initiatives may result in the additional cost being transferred from the scheme to the member, with no overall cost reduction

Question 23

Strategies used by managed care organisations

Answer 23

Reduce the cost of medical events (provider networks, pre
Improve the quality of care, reimbursement methods)
Deliver medical services in an appropriate setting.
Manage and provide appropriate care to high-risk members (case management, disease management, risk adjustment
Reduce the number of unnecessary medical services (pre-authorisation, utilisation reviews)

Question 24

Ways to manage claim costs related to morbidity

Answer 24

Robust policy design and clear policy terms
Limitations and exclusions
Co-payments and levies
Medical savings accounts (MSAs)
Approved provider networks
Preventative medicine and wellness programmes
Medicine formularies
Tariff negotiations and alternative reimbursement mechanisms

Question 25

Data risk

Answer 25

Internal data risk: Inadequate, inaccurate, or incomplete policy data can lead to incorrect results and recommendations in actuarial investigations.
External data risk: Missing, inaccurate, or insufficient internal data. Inappropriate data due to advances in medical technology, changes in market practices, or unusual events (e.g., COVID-19). Industry data being inappropriate for specific use cases.

Question 26

Excess asset risk

Answer 26

In DB fund, this may be due to excess contributions and sponsor may not be able to reclaim surplus assets built up in the fund. In a DC fund, excess assets may mean that too little was allocated to members’ savings or too much was set aside in reserves. This can be redistributed to members but there may be risk of equality in distribution e.g. members who joined after surplus

Question 27

Risk of options and guarantees

Answer 27

The risk that the option is exercised, leading to financial strain.
Increased product complexity, which can impact marketability.
Greatest risk when premiums cannot be reviewed.
The need for early reserving and holding additional reserves.
Low customer take-up rates.
Increased risk of anti-selection.
More complex investment strategies to find matching assets.

Question 28

What are longevity derivatives?

Answer 28

Swap contract between a fund and a swap provider (bank, reinsurer, or life office) where fund does series of payments based on expected mortality and swap provider pays them according to actual mortality. Fund pays a fee to provider in exchange for certainty of payments. Fund retains assets and therefore retains risks such as investment, inflation. This does create a credit risk but less liquidity risk than buy-in or buy-out. Or can get longevity bonds which pays coupons based on the mortality of a specified cohort group or population. If mortality decreases, the coupon or principal payment increases. Disadvantage is that the cohort group in bond may not reflect insured group

Question 29

Entities exposed to longevity risk

Answer 29

Uninsured individuals: Risk of outliving personal savings and investments
Retirement funds paying pensions: Risk of paying out benefits for longer than anticipated
Employers paying post-retirement benefits: Risk of extended duration of benefit payments (e.g., healthcare, pensions)
Insurers offering pension products: Risk of paying annuities or other lifetime benefits for longer than expected
State or other national funds paying lifetime income benefits: Risk of extended duration of benefit payments (e.g., state pensions)

Question 30

Entities exposed to mortality risk

Answer 30

Families of uninsured individuals: Risk of income loss if breadwinner dies unexpectedly
Retirement funds offering death benefits: Risk of higher than expected payouts due to increased deaths among fund members
Insurers providing death or funeral cover: Risk of higher than expected claims due to increased mortality rates
State and national funds: Risk of increased demand for death-related benefits (e.g., survivor benefits)

Question 31

What are the risks that can be transferred between funder and provider?

Answer 31

Price risk - fee received by provider does not cover variable costs or makes inadequate contribution to overhead and profit

Intensity risk - more services are needed in encounter than anticipated

Severity risk - cases are more severe than anticipated

Frequency risk - more people need treatment than anticipated

Actuarial and marketing risk - actuarial risk is that demographics (eg age, income and chronic disease) are not as anticipated, thus pricing is not correct; marketing risk is that enrolment is not as anticipated, thus demographics are not as anticipated, which contributes to the actuarial risk.

Question 32

What does underwriting achieve?

Answer 32

● protects insurer against anti-selection
● identify the lives with substandard health risk
● identify the special terms to offer to the substandard risks
● help ensure that all risks are rated fairly
● help ensure that mortality experience is consistent with the pricing basis.
● reduce the risk from over-insurance (through financial underwriting).

Question 33

What are the different types of medical underwriting?

Answer 33

Full medical underwriting: super detailed, costly and time-consuming but learn most about state of health of individual

Medical history disregarded (group PMI): no regard paid to the individual’s past medical history and no exclusions for pre-existing conditions, less costly and time-consuming but greatest potential for anti-selection

Moratorium underwriting: no formal underwriting at time of acceptance - past medical history is examined at time of claim. moratorium period, no pre-existing conditions can be claimed for during this time. encourages sales & reduced NB costs but PH cannot be sure for what illnesses they are insured (standard exclusions are arguably clearer).

Question 34

What is risk adjustment and why is it useful?

Answer 34

Risk adjustment refers to adjusting for underlying factors, which are drivers of utilisation, or which impact the underlying morbidity, when evaluating utilisation levels and/or cost.
Under alternative reimbursement arrangements, a risk-adjustment mechanism should be used to ensure that providers are remunerated appropriately for the health risk of their patients.
This will avoid encouraging providers to compete based on the health status of their patients, providers should be incentivised to compete on the basis of efficiency and quality of care provided.