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CAS Exam 7 > Brehm #4 > Flashcards

Brehm #4 Flashcards

1
Q

Operational risk

A

risk of loss from failed internal processes, people, and systems or from external events

> > includes legal risk, but excludes strategic and reputational risk

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2
Q

Categories of operational risk (7)

A
  1. internal fraud
  2. external fraud
  3. employment practices and workplace safety
  4. clients, products, and business practices
  5. damage to physical assets
  6. business disruption and system failures
  7. execution, delivery, and process management
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3
Q

Explanation of internal fraud and examples (3)

A

attempts to defraud, misappropriate property, or circumvent rules/regulations from an inside source

ex:
1. intentional misreporting
2. employee theft
3. insider trading

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4
Q

Explanation of external fraud and examples (3)

A

attempts to defraud, misappropriate property, or circumvent rules/regulations from an outside source

ex:
1. robbery
2. forgery
3. damage from computer hacking

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5
Q

Explanation of employment practices and workplace safety operational risk and examples (3)

A

acts inconsistent w/ health and safety laws/standards, result in personal injury, or diversity and discrimination issues

ex:
1. WC claims violation of health and safety rules
2. discrimination claims
3. GL claims

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6
Q

Explanation of clients, products, and business practices operational risk and examples (3)

A

unintentional or negligent failure to meet a professional obligation

ex:
1. misuse of confidential customer info
2. improper trading activities
3. money laundering

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7
Q

Explanation of damage to physical assets operational risk and examples (5)

A

physical damage from natural disaster or other events

ex:
1. terrorism
2. vandalism
3. EQ
4. fire
5. flood

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8
Q

Examples of business disruption and system failure operational risk (3)

A
  1. hardware/software failures
  2. telecommunications problems
  3. utility outages
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9
Q

Explanation of execution, delivery, and process management operational risk and examples (3)

A

failed transaction processing or process management and relationships w/ partners or vendors

ex:
1. data entry errors
2. incomplete legal documentation
3. vendor disputes

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10
Q

Primary cause of insurer failures

A

operational risks

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11
Q

Explanation of bridging process for plan LR determination

A

mature prior year ultimate LRs are bridged forward based on estimates of yr-over-yr LC and price level changes

ultimates for immature prior years are set using the BF method w/ELR = initial plan LR

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12
Q

Operational risk problem with the bridging process for plan LR determination

A

high degree of interdependence b/w prior yr ultimate LRs

optimistic prior year LRs roll forward and lead to optimistic plan LRs, producing a string of optimistic forecasts

as older years deteriorate, BF ELRs increase, producing reserve conflagration

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13
Q

Management options when facing reserve conflagration as a consequence of optimistic planning process (2)

A
  1. book reserve deficiency and suffer rating downgrade

2. change reserving process

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14
Q

Possible explanations for failed LR planning bridging process (3)

A
  1. inherent uncertainty - plan LR / reserve review model could not accurately forecast the LR / reserves
  2. people failure - plan LR / reserve review model could accurately forecast the LR / reserves, but was improperly used
  3. process and governance failure - plan LR / reserve review model did accurately forecast LR / reserves, but indications were ignored
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15
Q

UW cycle management

A

management of UW capacity as market pricing changes w/ the UW cycle

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16
Q

Types of problems resulting from inefficient UW cycle management (2)

A
  1. stability and availability problem - increases losses from increased exposures increases risk of ratings downgrades which could drive customers away
  2. reliability and affordability problem - risk of insolvency from recognition of mounting exposures and potential partial claim payments to policyholders
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17
Q

Key components of effective UW cycle management (4)

A
  1. intellectual property (aka intangible assets) - focus on retaining and developing top talent and investment in systems, models, and databases while maintaining presence in core market channels
  2. adaptable UW incentives - should be tied to supporting portfolio goals and adapt to changing market conditions
  3. preparation for market overreaction - firms with most available capital during price improvements will see profits that can offset years of UW losses
  4. owner education - owners must understand how to interpret results and what to do with that information
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18
Q

Examples of KPIs that may seem out of line under effective UW cycle management (2)

A
  1. drop in premium volume - understand that premium is result of amount of exposures and price per exposures - management should not make calls to increase market share at worst possible point in UW cycle
  2. overhead expense ratio - high expense ratio could indicate capital investments in intellectual property vs. operational inefficiency
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19
Q

Key concept of agency theory

A

considers management agents of a firm’s owners, whose interests are not always aligned (which creates operational risk)

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20
Q

Goals of agency theory (2)

A
  1. align management and owner interests (reduce operational risk)
  2. understand impacts of potential divergence
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21
Q

Potential issues with management incentives under agency theory (2)

A
  1. if management incentives are tied to company performance, managers may be more willing to take on risk than owners b/c they are allowed to “gamble with the owner’s money”
  2. if management incentives are firm stock options, managers may be less diversified (and more risk averse) than owners
22
Q

Additional operational risks in banking and manufacturing (5)

A
  1. pension funding - financial and HR component
  2. IT failure
  3. other HR risks incl. loss of important staff, fraud, inadequate training, rule-breaking, or incompetence
  4. reputational risk
  5. lawsuits

monitoring and control more important than quantifying and funding

23
Q

Examples of reputational risk (3)

A
  1. products tampering
  2. bad press coverage
  3. off-hours employee behavior
24
Q

Primary objectives (5) of control self-assessments (CSA)

A
  1. reliability and integrity of info
  2. compliance w/ policies, laws, and regulation
  3. safeguarding assets
  4. economical and efficient use of resources
  5. accomplishment of established objectives/goals for operations
25
Q

Critical component of key risk indicators (KRIs)

A

must have trigger levels that require management action

26
Q

Main categories of KRIs (4)

A
  1. production
  2. internal controls
  3. staffing
  4. claims
27
Q

Examples of production KRIs (4)

A
  1. hit ratio
  2. retention ratio
  3. pricing level
  4. rate per unit of exposure
28
Q

Examples of internal control KRIs (2)

A
  1. audit results

2. audit frequency

29
Q

Examples of staffing KRIs (4)

A
  1. employee turnover
  2. training budget
  3. premium per employee
  4. policies per employee
30
Q

Insurer processes that could benefit from six sigma management framework process improvements (3)

A
  1. UW
  2. claims
  3. reinsurance
31
Q

Steps for operational risk modeling (5)

A
  1. identify exposure base for each operational risk source (ex: payroll, policy count, CC, premium volume)
  2. measure exposure level for each business unit
  3. estimate loss potential (frequency and severity) for each unit reflecting internal controls and process effectiveness
  4. produce modeled frequency and severity distributions by business unit
  5. estimate impact of mitigation, process improvement, or risk transfer
32
Q

Strategy and two things strategy is NOT

A

long term series of actions designed to take a company from its current state to its desired future state and aims to provide a sustainable competitive advantage over other companies in the same market

NOT:

  1. pure business planning - goes beyond understanding market position and how to outperform
  2. tactics = short term and detailed vs. strategy = long term and broad

** often overlaps w/operational risk definitions

33
Q

Strategic risk vs. strategic risk taking

A

strategic risk = unintentional risks that occur as a result of strategic planning/execution

strategic risk-taking = intentional risk-taking as part of strategic execution

34
Q

Strategic risk categories for insurers (7)

A
  1. industry
  2. technology
  3. brand
  4. competitor
  5. customer
  6. project
  7. stagnation
35
Q

Highest (3) and lowest (1) strategic risk categories for insurers

A

highest: industry, project, and stagnation
lowest: technology

36
Q

Examples of industry strategic risk (5)

A
  1. capital intensiveness
  2. overcapacity
  3. commoditization
  4. de-regulation
  5. cycle volatility
37
Q

Examples of technology strategic risk (2)

A
  1. technological advancement in internet distribution

2. data management

38
Q

Example of customer strategic risk

A

concentration risk for large commercial insurers

39
Q

Examples of project strategic risk (3)

A
  1. failure of mergers and acquisitions
  2. underinvestment in research and development
  3. underinvestment in IT
40
Q

Examples of stagnation strategic risk (4)

A
  1. redeployment of intellectual assets (highly task-specific)
  2. extensive reporting lags
  3. mismatch in timing of revenue and expenses
  4. poor insurer response to market price cycles
41
Q

Key distinction b/w scenario planning (in strategic risk management) and simulation

A

scenario planning involves subjective interpretations of factors that cannot be modeled

42
Q

Plan or actual LR calculation using traditional planning forecast methods

A

LR = [ base LR * ( 1 + cost trend ) ] / ( 1 + price change )

43
Q

Potential problems stemming from management reluctance to deviate from plan results (2)

A
  1. unforeseen reserve deficit

2. overall portfolio mix may not be what was intended

44
Q

Components of scenario planning for strategic risk management (3)

A
  1. scenarios (price changes)
  2. likelihoods
  3. response plans
45
Q

Advantages of scenario planning (2)

A
  1. company considers scenarios and responses ahead of time, getting consensus on best response and saving time during crisis
  2. reduced organizational inertia (= more flexible plan)
46
Q

Considerations when combining scenario planning for multiple LOB (3)

A
  1. consistency
  2. correlations
  3. UW capacity/allocation across LOB
47
Q

Advanced scenario planning

A

simulates large sets of scenarios and allows for re-balancing of the portfolio to find the best strategy

best strategy maximizes a performance metric (ex: net income or economic value) and reduces downside risk (ex: TVaR)

48
Q

Example of portfolio re-balancing actions in advanced scenario planning (2)

A
  1. sell bonds

2. change investment allocations

49
Q

Agent-based modeling

A

considers impact of strategic interactions b/w companies (“agents”)

50
Q

Control self assessment (CSA)

A

A process for examining and assessing internal control effectiveness

51
Q

Examples of brand strategic risk (2)

A

Erosion or collapse from

  1. Bad press
  2. Class action suits
52
Q

Example of competitor strategic risk (3)

A
  1. Predatory pricing
  2. Entrance into new lines/territories with inadequate expertise, systems, or capabilities
  3. Multiple competitors simultaneously targeting the same market segment

CAS Exam 7 (21 decks)

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