Test 3: 35-43 Flashcards
Reasons for calculating provisions : Need for Individual – for each contract/product BAD MEDICS Need for global provision CARD
Benefit improvements/contribution reductions for a benefit scheme
Accounts and reports (to show liabilities in them) published accounts, internal management
Discontinuance and surrender benefit
Merger and Acquisition value
Excess of assets over liabilities possible discretionary benefits
Disclosure information provided to beneficiaries
Investment strategy
Contributions and premium level setting
Statutory requirement- demonstrating supervisory solvency
Cover financial and non-financial risks - provisions in excess already held
Additional protection against insolvency
Reflect degree of A-L-mismatch
Demonstrate unambiguous solvency
Ways to counter anti-selection:
MES
Modify assumptions used
Eligibility criteria
Set terms that favour one option over another
Reasons for continuous analysis of surplus:
DIVERGENCED
Divergence of the actual experience vs the expected results financial effect
Information given to management and for accounts
Variance in the total financial effect is described by the variance of the individual levers does individual levers add up to total.
Experience monitoring to feed back into the ACC
Reconcile valuations for successive years to check consistency of the assumptions
Group into recurring/once-off sources of surplus enabling appropriate decisions to be made on the distribution of surplus
Executive remuneration scheme data - golden handcuff schemes: bonus of 10m if you stay 5 years. etc
New business strain affects
Check on valuation assumptions and calculations
Extra check on valuation data and process
Determine the assumptions that are the most financially significant
Disclosure is important in a benefit scheme because (SIMMERS):
Sponsor aware of financial significance of benefits
Informed decisions can be made
Miss-selling is avoided
Manages expectations of members
Encourages take up
Regulatory requirement
Security of scheme improved as sponsor/trustees more accountable
Individual disclosures are often made on (PRICE):
Payment commencement Request Intervals Combination Entry
Information to be disclosed includes (DISCLOSURE SRC):
Director’s pension costs
Investment strategy and performance
Surplus/deficit (last year, accumulated to date)
Calculation method and assumptions
Liabilities (accrued over year, accrued to date)
Options and guarantees
Sponsor’s contributions and members’ contributions
Uncertainties (risks)
Rights on wind-up
Expenses
Strategic report - Key performance indicators shown
Risk report - attitude, management approach, risk based capital requirement calculation
Corporate governance - the management structure of board set out
Levers/sources on surplus/profit
CRIEC CLIM VVACC
Claim likelihood and amount Renewal rates Investment strategy Effective management strategies (Tax and accounting and fraud) Control expenses
Commission
Lapse rates
Inflation (Claim size and expenses)
Mix of business
Volume of business Valuation basis and method Assumptions from formula of product , Demographic and 5CIET Carried forward surplus/defici Change in tax, policies
Carrying out surplus analysis
PCEEA
Project income statement and balance sheet of product into future, starting with initial pricing model and ensuring assumptions are consistent and realistic
Compare three models:
Expected experience and expected volume of business
Expected experience and actual volume of business
Actual experience and actual volume of business
Types of risk: COMBEL
Credit risk: FR Operational risk: NFR Market risk: FR Business risk: FR - CAROLINE MC External risk NFR Liquidity risk: FR
The principles of good lending relate to the: (CASPAR)
“Cannons of good lending”
Character and ability of borrower(known, competent, trustworthy, references?)
Amount (reasonable for purpose?)
Security (nature of transaction, covenant, market circumstances, security available)
Purpose or borrowing (risks associated with where the monies will be used)
Ability to repay (certain source of repayment? Any margins of safety?)
Risk vs. reward (is reward appropriate to risk level, has due diligence been done)
Causes of inappropriate advice (CRIMES)
Complicated products Rubbish/incompetent advisors Integrity of advisor lacking Model/parameter error Errors in data State encouraged, but inappropriate, actions
Investment risks (DRUMOLITE):
Default Reinvestment Uncertainty over timing/amount of return Mismatching of A/L Opportunity cost of capital Lack of appreciation from beneficiaries Inflation (income and capital proceeds) Taxation Expenses
Insurable risk criteria (FIA MUDPIS):
Financial/quantifiable
Interest in the risk being insured (from policyholder perspective)
Amount payable relates to size of loss
Moral hazard eliminated (as far as possible)
Ultimate limit on liability payable
Data available for accurate pricing
Pooling large number of homogeneous risks
Independent risk events
Small probability of occurrence
Risk management helps to (AEIOU PRC D)
ASGrow SPIDO D
Avoid surprises
Effective use of capital to improve growth/returns / Exploit risk opportunities
Improve stability and quality of their business
Opportunities from natural synergies identified
Uncertainty of stakeholders reduced (increase confidence)
Product pricing improved
Reduce variability in employee costs and job security
Cost effective risk transfer
Determine risks earlier and more cheaply
Avoid surprises
Stability and quality of business improved
Growth and returns improved by exploiting risk opportunities
Growth and returns improved by better management and allocation of capital
Stakeholders in business given confidence that business is well managed
Price products to reflect level of risk
Improve job security and reduce variability in employee cost
Detect risk earlier meaning they are cheaper and easier to deal with
Opportunities identified from natural synergies
Determine cost effective means of risk transfer
Risk registers are a way to categorise risks faced by a business or individual. Need to quantify: ICorP
Impact
Correlation
Probability
Assessing capital requirement is difficult because (CRISPS):
Correlation matrix required - reduce stochastic variables. More than 2 stochastic variables are impractical
Risk probability parameters
Interactions between risks -the effect of multiple risk events is greater or less than the sum of individual risks.
Subjectivity of constructing adverse scenarios- such as setting risks such as operational risk
Past data for rare events - be cautious.
Stochastic model duration of the risk is determined (Should ruin prob be expressed over one year or over whole run off of the business
Factors to consider when valuing options DECS CICA
Demographics
Expensive options not always exercised
Cultural bias
State of the economy
Consumer sophistication and needs
Immediate benefit vs. Higher deferred benefit
Cost increases in the valuation
Anti-selection
Mitigating against inappropriate advice:
CARSHoW GRound
Cooling off periods
Advisors: Trusted source, qualifications, fee basis
Research on products done individually
Shop around for quotes
Honesty about needs, health and financial state
Write to regulator or ombudsman if inappropriate advice was given
Government advice questioning
Read fine print
Factors determining the application of surplus for a benefit scheme:
LIST DiSS CEFE
Legislation
Industrial relations
Scheme rules
Tax benefit
Discretionary decision making
Risk exposure carried by the various parties
Source of surplus
Speed of corrective action
Consistency with other funds / employers
Expectations of members
Funding level of the fund
Ease of calculation
Differences that exist in disclosure relates to
AFASI
Actuarial methodology chosen
Flexibility in the setting of assumptions
Amount of information to be disclosed
Smoothing of year on year fluctuations
Importance of the balance sheet and income statements in demonstrating a true financial picture
Factors influencing the choice of valuation method and assumptions when determining the value of insurers liabilities
PuLSGRiDBNS
Purpose of the valuation DID PISC
Legislation/regulation or accounting principles
Size of solvency capital - larger solvency capital the less significant the margins in the individual provisions
Guarantees or options being valued - tend to use more cautious basis
Risk characteristics of business being considered
Data used - quality and quantity
Going concern vs breakup basis
Needs of the client - Individual, Shareholder, Investment
Sensitivity testing
Factors determining the application of surplus for a life insurer:
PP WOES
Provision of capital and margins
Pace of surplus and distribution difference
Working capital retained
Objectives of the business
Expectations of the policyholder and competition
Smoothness of results / smoothness in the distribution
Factors causing overall uncertainty of benefit schemes
Da CoMPaS
Data errors - beneficiaries or parameters
Contributions or premium calculation error
Model error
Parameter error
Security of the sponsor
Factors affecting the contribution level for a benefit scheme (I PIE)
Inflation
Promised benefit
Investment return
Eligibility to accrue/receive benefits
Risk of benefits for a DB scheme
ISUME LiBeNT
Inadequate funds due to:
- Sponsor insolvency
- Under funding
- Mismatching of A and L
- Economic mismanagement
Liquidity of the scheme to meet benefits
Benefit changes
Needs of member not met - design or inflation
Take over by company who’s unwilling to meet beneficiary promises
Risk identification:
DR RUB
Desktop analysis Risk analysis at high level Risk register/matrix Upside Brainstorm with experts (MILEP)
Brainstorming with experts should yield:
MILEP
Mitigation options Interdependent risks Long term strategic thinking Evaluate risks: frequency, consequences Project risk identification – likely, up/downside
Risk Measure should identify:
ProSCoCo
Risk Measures:
LEAV
Probability
Severity
Correlation
Controllability
Liability risk - actual vs expected analysis
Expected shortfall- Expected loss given benchmark
Asset risk- measurement of active risk such as forward/backward tracking error
VaR- Maximum potential loss given a confidence and a time horison
Risk control methods:
FAT SIR LEP
Further research Avoid Transfer (likely, existing resources, cost/willingness of 3rd party) Share Insure Reduce
Choice depends on:
Likelihood/severity of risk event
Existing resources in place to meet the cost of the risk event should it occur
Price/willingness of a 3rd party to take on the risk instead
Risk financing should:
DRC MiD
Diversify
Reduce likelihood
Control price paid (e.g. insurance)
Mitigate consequences of risk events that do occur
Determine the amount of capital to hold to cover the retained risk
Accounting ratios that indicate insurer’s financial position and profitability:
SARPY and ICOCO
Solvency ratio Asset/liability ratio Return of capital employed Price/earnings ratio Yields of dividends
Incurred expenses
Claims ratio
Operating ratio - (Claims + expenses)/premium income
Commission income
Outward reinsurance premium to premium income
Factors affecting the certainty of contributions made to the benefit scheme (LUI IFANTA)
Liquidity constraints
Unaffordable premiums
Inflationary increase of contributions
Incorrect contributions made Fraud Advice not correct Non-compliance to regulation - fine or loss of tax reduction Tax terms change Administration costs
The method of scenario analysis
GroP CaST/ GroDe CaRuT
Group risks - input from several senior managers
Develop Plausible adverse scenarios for each group - ideas!!
Calculate consequences - ideas!!
Several different scenarios run
Total cost is financial cost of all risks in relevant scenario
Group risks
Develop Plausible adverse scenarios for each group
Calculate consequences
Run several different scenarios
Total cost is the financial cost of all risks in relevant scenarios
The method of stress testing:
SIM
Subject portfolio to extreme market movements to determine sensitivity to certain risks:
- Identify weak areas and effects of localised stress situations- what correlations exist withing the risk
- Measure impact of market turmoil on all parameters
Why ERM is effective:
VIS PROE SO
Variety of risk handled Interdependence of risk used Senior management take responsibility of risk management Pooling of risks done Risk is diversified Offsetting between risks Effective allocation of capital Stable results are produced Opportunities in the risks can be seen and exploited F
Interpreting accounts Nicr Fap/
ClEO IRP
Nature of the business:
- investment mix
- claim settlement pattern
- reinsurance
Financial condition:
*asset to liability ratio to assess financials strength
- profitability and performance
- Claims ratio (gross and net) (c/p)
- Expense and commission ratio (e+com/np)
- Operating ratio (nc+e/np)
- Investment performance ratio (inv income/ A)
- return on capital ratio (post tax profit/ free reserves)
- profit margin (gprof/np)
Similar aims for different accounting standards CARS
Consistency in account treatments from year to year
Appropriate information disclosed
Recognize realistic cost of benefit accrual
Smooth benefit provision done
Market risk - why holding a matched position is difficult:
CDC
Changing value of L - Options or Discretionary benefits’
Duration of A does not match L
Cost of keeping matched position
Business Risk for insurers BREW CO
Business mix and volumes Reinsurance Expenses Withdrawals Claims Options and guarantees
Risks in Life and General insurance
RISK LIFE DROWN CATS MUn
Reinsurance/ Reputational
Investment/ Reinvestment risk
Systematic risk
Kompetition risk
Liquidity risks
Inflation
Fraud
Expenses
Data Rates (Mortality, withdrawal, morbidity) Options Withdrawals New business(vol and mix) risk
Credit risk/ failure of third parties
Aggregation of risk
Tax
Selection (Anti Selection, Moral Hazard)
Marketing/ Market risk
Underwriting risk
Methods for calculating reserves:
SPEC
Statistical analysis: Large population exposed to risk and consequence of risk has a known distribution
Proportionate: prop of outstanding premiums allocated to the expected future claims is the provision held
Equalisation reserve: stable/smooth annual results, catastrophe, deferring of tax and profit
Case by case: Rare events
Different methods of allowing for prudence:
MaCoR
Margin built into each assumption
Contingency loading: increase liability by some value
Risk premium built into the discount rate
Enterprise risk management - definition
Risk management becomes a major activity at enterprise level
Combine several unit level risk models to assess risk at entity level
Company can then allow for pooling of risk, diversification, and economies of scale -PED
Take advantage of risk based opportunities
Similar risk assessments methods used - risk can be combined in a risk model
Effective capital allocation
Risks in a DC scheme
OLIE
Operational risk- fraud
Longevity risk- Life annuity purchase price higher
Investment risk- bad investment performance
Expense risk - higher than expected
Additional considerations for a insurance company in a group scheme agreement:
PRe ABC
- Profit sharing arrangements that might be put in place
- Relationship between the company and the group scheme
- Additional benefits to provide
- Bargaining power
- Company reputation
Causes of a change in claims experience:
CaRBEN VRUIF DRINKS
Claims frequency:
Catastrophe
Random variation
Business mix changes
Education of clients on eligibility of claims
New Risk factors not allowed for
Volumes of Business
Risk factors missed by underwriting
Underwriting standards decreased - Claims and proposal stage
Internal claims processing improved Fraud
Claim Size:
Demand for services increased
Regulation increased, increasing cost of benefit
Inflation
New services available - cheaper or expensive
K - ???
State subsidizing Decreased
Sources of operational risk DIRH COFF
Dominance Reliance on third parties Internal process failures Human error Cyber crime Outsourcing Fraud Failure of plans to recover from external risks
Factors affecting the risk appetite REC SCAN
Regulatory control Existing risks faced Culture of company Size of company Capital level Attitude of stakeholders Nature of business
