Ch 15: Risk 3

Question 1

Summary Card

Answer 1

• Insurance company aims
• Overall risk considerations
• Credit failure

Question 2

State the overall aims of a life insurance company (2)

Answer 2

Maximise (or optimise with an acceptable level of risk):

• Profits, either for shareholders or with-profits policyholders
• Return on available capital, for capital providers

Usually these are complementary objectives ie. they work together.

Question 3

Comment on aggregation and concentration of risks that an insurer is exposed to (2)

Answer 3

1. It’s important to understand risks individually
2. But the financial impact on the insurer will also depend on
   
   1. how these risks emerge in future, and
   2. how they relate to each other

Question 4

How might a company go about asessing its overall risk, allowing for aggregation/accumulation of risks? (5)

Answer 4

1. Carry out financial projection with the greatest insight being provided if stochastic methods…
2. …incorporating probability distributions of the key risks, are adopted.
3. This will allow for correlation between the parameters.
4. Running the projection model many times to test sensitivities and different scenarios ..
5. …will produce results that enable the insurer to assess the inherent risk in the business.

Question 5

State 3 considerations in assessing the overall level of insurer risk.

Answer 5

1. Capital and other resources available to insurer
   
   • More capital => greater emphasis on return on capital
   • Company may be willing to take on risks with higher severity of loss if these risks could result in greater return
2. Cost of failing to meet public interest need for compnay to avoid insolvency
3. Cost of failing to meet requirements of any other applicable legislation

Question 6

Credit rating

• What do we mean by an insurer’s credit rating? (1)
• Why is downgrading of credit rating a risk to the insurer? (4)

Answer 6

1. An insurer’s credit rating is an external, objective measure/assessment of the insurer’s risk profile…hence its aggregation of risks

Life office will want to ensure it arranges its business practices/overall risk profile to minimyse chances of downgrade

1. Downgrading of company’s credit rating is a risk because it would lead to:
   
   1. adverse publicity
   2. greater difficulty + cost of raising additional capital in market

…and as a consquence

1. profitable activities available to do may be constrained
2. policyholders may be less likely to maintain/purchase policies=> less business