Actuarial Control Cycle and Risk Management

Question 1

Define the actuarial control cycle headings

Answer 1

Specifying the problem
Developing a solution
Monitoring the Experience

Question 2

What is the actuarial control cycle?

Answer 2

The Actuarial Control Cycle is a schematic approach based on a scientific approach to problem solving. Its useful for long term products where its important to have a feedback loop .
Things in the context and environment change all the time and previous assumptions cna become invalid.
Helps have a better understanding of assumptions. You’re ref8ning what you’re doing each time.

Question 3

Explain stage 1 of the actuarial control cycle

Answer 3

Recognising, measuring, analysing and managing risks for your client.
Analyse the Risk- consider the impact of risks and each potential solution on all stakeholders
Assess Client’s Situation - and inform them
Consider high-level options: risk be transferred or managed? Can we mitigate, diversify, hold capital, pass risk?

Question 4

Explain stage 2 of the actuarial control cycle

Answer 4

Developing a solution
Selection, adapting or construction of a model occurs and assumptions are discussed
Calculate and interpret results
Results of models are interpreted and the implications for all stakeholders are analysed, summarised and communicated.
Determine solution proposed and main alternatives identified
Formal proposal/report

Question 5

Explain stage 3 of the actuarial control cycle

Answer 5

Monitoring the Experience - model must be updated, its a feedbakc loop and we want to reflect current experience.
Compare with model
Review model: You will have a cycle for updating certain assumptions
Review business context
Identify scope for improvement and also identification of the causes of any systematic departure from the targeted outcome
You will either then refine the initial solution to the problem or have to take a fresh look at the problem.

Question 6

What are the steps in the extended actuarial control cycle?

Answer 6

Specifying the problem
Developing a solution
Investment process
Monitoring the Experience

Question 7

What should be the risk management process - high level.

Answer 7

1. Assess risks: identification and measurement, also identify who is responsible for each risk.
2. Risk control measures: reduce occurrence or severity of impact - trying to limit the financial consequences of a risk
3. Monitor the residual risk portfolio

Question 8

What is the overall idea of risk amnagement?

Answer 8

Risk is the distribution of possible outcomes. Our goal, by the risk management process, is to change the shape of the distribution to better adhere to our objectives

Question 9

Define systematic risk

Answer 9

Risk not possible to avoid by diversification, i.e., it affects all participants in a particular system

Question 10

Define diversifiable risk

Answer 10

Risk that can be reduced, by apportioning the aggregate risk exposure across different, not fully correlated, entities in the system

Question 11

What is the fundamental business model of insurers in relation to risk

Answer 11

Clearly many insurance and protection companies’ fundamental business model is on forming a portfolio of diversified risks. Pooling of risks.

Question 12

How should risks be identified?

Answer 12

Asking personnel anonymously.
Ideally risks should be grouped into homogenous groupings.
Risks should be then prioritised and each division of risk should be given a manager.

Question 13

Name some types of non financial and financial risks.

Answer 13

Non-financial risks: Operational risk (e.g., administration, business continuity), Business risk (e.g., making bad business decisions)
Financial risks: Market risk (investment of Assets to meet Liabilities), Credit risk (e.g., counterparty risk, debtors, assets), Liquidity risk, Business risk (e.g., underwriting, financing, reinsurance)

Question 14

What is operational risk?

Answer 14

Risk arising from internal processes, systems or staff or from some unprepared for external event – E.g., failure to insure premises and they burn down, failure to back-up of records
Operational risks are mitigated by good management
In Insurance or reinsurance: Third party reliance is big risk!

Question 15

Explain business risk

Answer 15

Business risk is the risk inherent in the business undertaken – E.g., poor underwriting
The risk is managed by being good at your business: training.
In insurance business risk would be not pricing financial risks correctly.

Question 16

What is the difference between operational and business risk?

Answer 16

Business risk is when you make bad business decisions and operational risk is when business decisions are not properly implemented

Question 17

What is market risk?

Answer 17

Market risk comprises risks that arise due to a change in market values or in economic variables.
A principle of investing to meet liabilities is that the assets should be selected to broadly match the liabilities in timing, currency and nature.
These matching techniques control the market risk.

Question 18

Define credit risk

Answer 18

Credit risk is the risk that a debtor fails to pay all of the debt at the due date

Question 19

What are the two meanings of liquidity risk

Answer 19

1. firm, though solvent, cannot meet a contractual payment because it has no free cash flow
2. asset cannot be sold in the short-term without an adverse impact on its expected price.

Question 20

Define marketability

Answer 20

‘Marketability’ is used to describe how quickly an asset can be turned to cash so it is closely related to liquidity

Question 21

When does liquidity risk strike for insurers and banks

Answer 21

Liquidity risk is big for banks as assets are illiquid loans but liabilities are liquid deposits. Confidence is important in banking.
Liquidity risk applies for insurers when catastrophe strikes mostly and you need to payout a lot quickly.

Question 22

What can you do with a risk

Answer 22

Retain - with sufficient capital and expertise
Exploit the risk - accept more and manage it
Transfer the risk - third party indemnifies you
Reduce the risk
Reject the risk (if possible)
Diversify the risk

Question 23

Why is there a market for insurance?

Answer 23

Individuals often do not have sufficient free capital. By insurance, they are sold contingent capital – on the occurrence of a specified event they effectively have adequate capital.

Question 24

Retaining risk - what considerations are there?

Answer 24

Different stakeholders will have a different risk appetite in terms of ability and willingness to retain risk. Business often have a risk appetite statement
regulator will ensure firm has enough capital.

Question 25

When are risks exploitable?

Answer 25

1. Can be priced by probability and severity (has sufficient data)
2. Probability of event is low
3. Large numbers of similar risks that are independent of each other.
4. Insurable interest
5. Ultimate limit on payout

Question 26

Explain how risk can be transfered

Answer 26

The market is said to be risk efficient if there is a good market for risk transfer.
So insurance/reinsurance replaces event risk with (the much smaller) event-counterparty risk combination.
Reinsurer also offers expertise.
Something to be aware of passing risk: If a reinsurer can go bankrupt on the same event may not be worth it.

Question 27

How can diversification be acheived?

Answer 27

Diversification: Can be done in multiple ways: geographically, between lines of business, between multiple years, multiple customers, diversifying asset and liability risk.

Question 28

What are the main tools for risk management?

Answer 28

Diversification
Reduce the likelihood of the risk occuring ex: alarms
Mitigate the consequences of a risk occuring ex: seat belt
Ensure price for the risk is fair ex: underwriting.

Question 29

Explain underwriting

Answer 29

Underwriting is the assessment of potential risks so that each can be charged an appropriate premium, or special terms applied

Question 30

Explain rating factor

Answer 30

A factor that can be measured in an objective way and relates to the likelihood or severity of the risk. It is a risk factor or proxy for a risk factor.

Question 31

Explain rating basis

Answer 31

The collection of rating factors used to assess the risk premium for the proposer.

Question 32

Explain risk factor

Answer 32

Risk factor: a factor that is expected to have an influence on the quantum of risk in an insurance contract.

Question 33

What are the benefits of good underwriting?

Answer 33

Premium charged is fair which protects the company’s solvency and profitability.
Protects firm against anti-selection
Identifies the risks for which special terms need to be quoted
Claims experience will not depart too much from prices assumptions with underwriting

Question 34

What is the purpose of claims controls systems

Answer 34

Claims control systems: reduce excessive claims, catch fraud, reduce consequences of occurred risks.

Question 35

How does good management better manage the companies exposure to risk?

Answer 35

Data recording
Monitoring liabilities
accounting and auditing
Options and guarantees.