Sep 2017 P2 Flashcards
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When is reinsurance more economical compared to ART?
Reinsurance is more economical for lower risk exposures.
When is ART more economical than reinsurance?
ART is economical for large aggregate exposures, such as hurricane risk for the specialist insurer.
What is an integrated risk cover?
And how does the specialist or global insurer benefit from it?
An integrated risk cover is similar to a large reinsurance treaty that covers many lines of business over many years. So it will protect the insurer from large losses and claims and so will stabilize profits (financial results) over time.
The global insurer may benefit from lower premiums as the provider of ART cover gains greater stability of results due to diversification.
What is securitisation?
Securitisation is the transfer of insurance risk to the banking and capital markets. Among other things it is used for managing risks associated with catastrophes, as the financial markets are large and capable of absorbing catastrophe risk.
How does securitisation work?
- An investor purchases a bond from the insurance company and therefore provides a sum of money to the insurer.
- The repayment of capital (and possibly interest) is contingent on a specified event not happening, eg an earthquake not happening.
- If the event does happen, eg the earthquake, the insurer uses the sum of money provided from the investor (in purchasing the bond) to cover the cost of claims arising from the earthquake. The investor may get part of his capital (and interest) back depending on the seerity of the claim.
- If the event does not occur, the investor gets his interest and capital back ni the normal way.
When is securitisation useful?
Securitisation can be useful where large amounts of cover are required, as there may be capacity issues in reinsurance markets.
What are insurance derivatives?
Think of the energy company using a temperature index and purchasing a put OTC to protect itself against really mild winters. (when less heating is used)
What is a swap and when are they used?
Organisations with matching but negatively correlated risks can swap packages of risk so that each organisation has a greater risk diversification, ie swaps can be set up between non-insurance organizations with opposite risks.
A unit of trding will be required. This could typically be a given sum assured in insurance swaps, eg 1m sum assured of property risk, classified by location and peril. Therefore, the swap might be X units of property risk for Y units of some other risk.
For non-insurance risks, the unit of trading may be an amount of revenue or profits.
What is post loss funding?
Post loss funding can help by securing the terms in advance under which capital can be raised following a catastrophe. The funding is typically provided by a bank.
Post loss funding guarantess that in exchange for a cimmitment fee, funding will be provided on the occurence of a specific loss. The funding is often a loan on pre-arranged terms or equity.
How do we load for investment management expenses of an endowment assurance?
Ask Frans
Discuss why the theoretical expense loadings may not be used in practice?
And what are theoretical expense loadings?
Ask Frans See Sep 2017 P2 Q5
Suggest how a regulatory framework set by the government may limit what financial institutions are able to do in terms of investment?
Use acronym TECHSCAM Types of assets that may be held Extent to which mismathcing is allowed Currency matching Hold certain assets, eg government bonds Single party maximum exposure Custodianship of assets Amount of any asset to be held to demonstrate solvency may be restricted Mismatching reserve
Suggest Possible reasons why the government chooses to lend to the banks rather than directly to the banks’ customers?
Role of the government
- The government may feel that it is not its role to lend directly, which could interfere in the market
- There may be conflicts of interest for the governmentif they lend directly (the govt may be accused of only lending to customers they favor (for political gains), they may be accused of increasing the base rate to increase the interest they receive on loans
Practical reasons
* The government may not have the financial resources to lend to customers
* The government may not have the infrastructure or administrative processes to issue loans
* The government may not have the expertise to decide which loans should be accepted.
Economic reasons
* Routing loans via a bank has gearing advantages, creating credit may boost economic growth
* Lending to the two banks directly may reduce the risk to the government of loans defaulting.
* The government could require the two banks to lend enough so that its macro-economic aims are met.
What are the factors that need to be considered when designing a contract?
AMPLE DIRECT FACTORS
Administration systems Marketability Profitability Level and form of benefits Early lever benefits
Discretionary benefits Interests and needs of customers Risk appetite of parties involved Expenses vs charges Competition Terms and conditions of the contract
Financing (and capital requirements) Accounting implications Consistency with other products Timing of contributions or premiums Options and guarantees Regulatory requirements Subsidies (cross)
Why may derivative investments not be completely effective i managing the risks associated with the guarantee?
Cost
- The cost of purchasing the derivative may be too high
Counterparty risk
- The risk that the counterparty to the derivative defaults may be significant
Availability
Suitable derivatives may not be available
, particularly derivatives of a suitably long duration
Matching
- It may not be possible to match the payputs exactly eg due to
A time lag (ask frans what time lag?)
Currency risk
