Test 4: 44-48 Flashcards
Risk management tools include MURDA/MURDAC:
Management control system Underwriting and claims control Reinsurance Diversification Alternative risk transfer ART
Reasons for reinsurance (SAD LIFES):
Smoothing of results Avoid large losses - Single/aggregated events or claims Diversification Limit exposure to risk Increase capacity to accept risk Financial assistance Expertise Services (Operational/Strategic)
Reasons for ART include (DESCARTES):
Diversification
Exploits risk as opportunity
Solvency management, sources of capital - CatBond
Cheaper than other types of cover
Available when other cover might be unavailable
Results stabilized (Smoothing of results)
Tax advantages
Effective provision of risk management
Security of payment greater
Examples of ART contracts include (PISSI)
Post loss funding Insurance derivatives Securitisation (Catastrophe bonds) Swaps Integrated risk covers
Managing options and guarantees (DOLI):
Derivatives purchased OTC
Option pricing methods - stochastic model
Liability hedging
Immunisation
Management control systems (DOLA):
Data recording
- Data of insured risk factors held
- Cannot change risk exposure - ensures adequate
provisions have been made for the risks retained
Options and guarantees
- Liability hedging (e.g. matching, immunisation,
derivatives)
- Option pricing methods
- Anti-selection risk
Liability monitoring RACCo
- Risk aggregation prevented
- Ability to take on new business assessed
- Will the business mix allow cross subsidizing?
- Cost of reinsurance reduced
Accounting and auditing
- Ensures adequate provisions made for risk
- premiums are collected
- Reassurance of the company’s financial position
Why is capital needed?
Individuals: CuS
Companies: CLOFFS
Providers of financial services and products: REG CUSHION
Cushion against unexpected events. Car breakdown.
Saving for future
Cushion against fluctuation trade volumes and other events
Liquidity issues due to difference in timing of revenue and cost
Opportunities - mergers and acquisitions
Finance expansion
Finance work in progress and stock
Start-up capital
Regulatory requirement to demonstrate solvency - provision above best estimate
Expenses of new product launch (product development, administration systems)
Guarantees
Cashflows timing management
Unexpected experience cushion
Smooth accounts (e.g. catastrophe equalisation reserve, dividends distribution and bonuses)
Help demonstrate financial strength (and attract new business)
Investment and pricing freedom (mismatching reserve and loss leaders )
Opportunities; Mergers &Acquisitions, new ventures etc
Need to achieve strategic aims/ New business strain
Capital management tools include:
BRIDES CC
Banking products (also Business written) FiCL
- Liquidity facilities
- Contingent capital, provided when needed - similar to
post loss funding
- Financing at group level: Distributing funds to products
Reinsurance (financial) to exploit capital/solvency/tax
regulation arbitrage
Internal restructuring: FAVS VaCS
Derivatives - hedge risk
Equity capital - (parent, rights issue, new market issue)
Securitisation and subordinated debt
Other courses of action may include
- Closing to new business: which will reduce the level of new business strain on the capital because of a reduction in:
* initial expenses
* The need to establish cautious levels of
regulatory capital when new business is written
* will cause diseconomies of scale in long run
* will reduce future profits
- Change types of business underwritten
Internal restructuring FAIR VaCS
Funds merged
Assets changed
Increase matching position
Replace admissible assets
Valuation rate of interest used to discount liabilities
could be based on assets. A switch in assets may
change the valuation rate of interest.
Valuation basis weakened -Not usually permitted by regulation
Change L valuation
Surplus distribution deferred (less bonuses and dividends)
Three pillars of Solvency II:
QSD
A quantification of risk exposures and capital requirements
A supervisory regime
Disclosure requirements
Reasons for monitoring experience:
PAUMPIE OP
Part of ACC
Actual experience of a provider monitored to check:
- If the method and assumptions adopted for financing
the benefits continue to be appropriate
- If not - changes made to achieve the desired level of
profit.
Update assumptions as to future experience (for pricing, reserving etc)
Monitor any adverse trends in experience to take corrective actions
Provide management information`
to monitor
Investment performance and strategy investigated
Effectiveness of management control systems in place
OP = Investment returns + Premiums - Expenses - Commission - change in reserves
Merits of PR
Quota share: SHeRiL PC
Surplus: FHAM
PR Quota share \+ Simple to administrate \+ Reciprocal Business encouraged \+ Helps to diversify risk \+ Larger portfolios of risk written
- The same Proportion of each risk is ceded regardless of size and volatility
- It does not Cap the cost of very large claims
PR Surplus
+Flexible, useful in achieving a well-balanced portfolio of risk
+Helps insurer to spread risk / Heterogeneous risks can be insured with this agreement
+Allows insurers to accept large risks
-More complex administration compared to share quote due to proportions changing for each risk
Merits of XoL reinsurance:
CaPESH PPG
+Caps losses, so can take on large risks
+Protects against individual/aggregate large claims
+Efficient use of capital (less provisions)
+Stabilises technical results
+Helps stabilise profits
- Premiums are expensive
- XL premiums may occasionally be far greater than pure risk premium due to underwriting cycle
- General poor claims experience not protected against
Benefits of holding significant amounts of free capital:
FM PEER
Freedom: Investment, Strategic and from regulator
Can use as a Marketing advantage
Protects against volatility and allows you to take on more
Enables to write large amounts of new business
Enables to write more risky products
Reduces risk aversion
Reasons for underwriting include:
SAFER E
Special risks offered special terms (change premium/benefit, apply exclusions or refuse) DARE
Anti-selection avoided:
- Taking out cover when you know your risk is higher than what the premium allows for
Financial underwriting to avoid overinsurance
Ensure experience matches expectations
Risk classification; all risks rated fairly and identified properly - homogenous groups
Ensure provider charges a fair premium for the risk that it is taking
Diversification can be achieved within the following:
RIGIDS OB
Reinsurance providers and products Investments – asset classes Geographical areas of business Investments – assets held within a class Different classes of business (lines of business) Sales channels Other service providers - third parties Business mix can be diversified
If applicants do not meet the minimum underwriting standards, they may be offered special terms such as: DARER
Declining the applicant either temporarily or permanent
Addition to the premium
Reduction in the benefit
Exclusion clause - also temporary to prevent anti-selection
Reinsurance could take on the risk
Economic capital:
The amount of capital that a provider determines is appropriate to hold given its assets, liabilities and business objectives, calculated with an internal model . Will depend on:
Risk profile of assets and liabilities
Correlation of risks
Desired level of credit deterioration the provider wishes to be able to withstand
Liability monitoring as a management control system
RACCo / CAR Co.
Risk aggregation prevented
Ability to take on new business assessed
Will the business mix allow cross subsidising?
Cost of reinsurance reduced
Merits of a standard capital model
LLLEP USA / MECCAI USA
Less complex and time-consuming SCR calculations
Less costly because of less modeling requirements
Less risk of parameter/model error
Easier to monitor in the industry
Public confidence is higher
Updates of the factors need to be made regularly
Subjectivity introduced when choosing risk factors
Approximations of risks may not be suitable to non-standard companies
Manipulating of financial results cannot be done
Easier monitoring by regulator
Consistency between valuation of companies - makes financial position more comparable
Cheaper way of modelling requirements
Avoids complex and time consuming calcs
Increased confidence of the financial sector
Merits of a internal capital model SWUAR CATU
/ SWARt CARTHUN
Smaller capital requirements - might lead to smaller capital requirements
Wider range of economic scenarios tested
Unique risks of company considered
An internal model will reflect the insurers specific risk profile
Risk appetite of company allowed for
Relevant risk factors considered
Calculations will be complex and time consuming Approval needed from regulator - admin and time consuming
The internal model could be very costly to the company especially if stochastic modelling is used
Using standard model will help give financial sector confidence in the results
/
Smaller capital requirements potential
Wider range of economic scenarios tested
An internal model will reflect the insurers specific risk profile
Relevant risk factors considered
Calculations will be complex and time consuming
Approval needed from regulator
Regulator will pressure company to keep the model up to date
The internal model could be very costly to the company especially if stochastic modelling is used
Higher risk of model, parameter error due to complexity
Using standard model will help give public confidence in the results
No Guarantee of reduced capital requirements
Solvency capital:
Capital providers of financial benefits need to hold for:
Accrued liabilities which have not yet been paid
Future periods of insurance for which premiums have already been received
Claims already incurred but not settled
Consists of:
- Margins above the best estimate basis (Regulatory basis)
- Additional capital required not related to liabilities
Requirement from data for monitoring : RRASH VoC
Reliable Regularly received Automated Stable Homogeneous
high Volume
Consistent - similar form, source and time
The process of monitoring a past experience: C RRASH VoC D FaR I CART R
- Check if data meets requirement RRASH VoC
- Divide data into homogeneous groups consider
- Factors of risk that are relevant (Demographic and economic)
- Reduction of the credibility of the data - Identify past:
- Cycles
- Anomalies
- Random variation
- Trends - Revise the previous models and assumptions accordingly
Reasons why a (general) insurance company would want to monitor their experience
PPRInC F MaMa
- To set assumptions for Provisioning and to monitor the run-off of claims against expectations
- to assess the Profitability of its business and the key components of profitability
- to assess Reinsurance requirements and to monitor the adequacy of reinsurance
- to determine an appropriate Investment strategy or to monitor effectiveness of existing one
- to determine Capital requirements
- to assist with Financial planning and strategy
- to provide Management information
- to help with Marketing new contracts
Reasons for investigating the appropriateness of the investment strategy:
FLIDA
Funding or Free Asset level might have changed
Liability structure could have changed
Investment manager’s relative performance should be investigated
Discount rate used to value L should be assessed
Allocation of investment income between classes of business
Why solvency position might have changed?
Think A/L as well as BEE
Basis and methods used change
- change in valuation method
- change in the valuation assumptions
Experience between valuation periods
- claims experience VRUIF CaRBEN DRINKS
- Investment experience FLIDA
- mortality/morbidity experience
- expense experience
- new business volumes
Events that happened between valuation periods
- Fraud
- Distribution of surplus via special dividend
- Errors in data, model or valuation.
