Chapter 26: Risk Optimization and responses

Question 1

Ways to optimize risk-adjusted return on a profile PAN LESS ART:

Answer 1

• Pricing with risk-based pricing approach
• Allocate capital and resources to BU’s with the highest risk adjusted returns
• New business assessed on risk adjusted returns
• Limit setting – control risk exposure
• Exposure limits
• Stop loss limits
• Sensitivity limits
• Active portfolio management
• Reduce risk – duration matching, hedging
• Transfer risk

Question 2

Benefits of active portfolio management CALUTI TROS

Answer 2

• Capital allocation optimized
• Aggregation of risks done across the organization
• Limits of concentration and allocation created
• Unbundling of the organization’s projects
• Transfer pricing of risks done
• Investment strategy set up
• Treatment of each project decided on
• Reporting is improved
• Optimizing allocation and treatment of the risks
• Specialized teams can look after certain projects

Question 3

Features of a good risk response SAD EMO

Answer 3

• Simple
• Active – it should result in action being taken
• Dynamic – react to changing circumstances
• Economical – cost of ceding risk and loss of upside considered
• Matches risk
• Optimize risk-adjusted performance of the company

Question 4

Ways to transfer risk IP SODA

Answer 4

• Insure (Re or Co) – acquire contingent capital for a premium
• Product design features
• Securitization
• Outsourcing
• Derivative purchasing
• ART

Question 5

Considerations when transferring risk ECO CURL

Answer 5

• Economics
• Capacity of the market
• Operational constraints
• Counterparty risk
• Upside risk ceded
• Regulatory constraints
• Liquidity risk

Question 6

Ways in which risks can be reduced MUCH U DOOS

Answer 6

• Matching of A and L
• Uncorrelated risks exposures
• Capital position strengthened
• Hedging/offsetting of risks
• Underwriting improvements
• Due diligence with counterparties
• Operational risk management
• Organizational structures improved to reduce agency risk
• Size of portfolio increased

Question 7

Considerations when removing risks COO

Answer 7

• Cost of avoidance
• Objectives at risk
• Opportunities lost

Question 8

Why risk may be accepted EDUCTS

Answer 8

• Economical approach
• Diversifying effect of retaining the risk
• Unsuitable or unavailable risk responses
• Core part of the business
• Trivial risk

Question 9

Why residual risks may exist SIR

Answer 9

• Secondary risk
• Imperfect risk treatment
• Retention decision

Question 10

Requirements to develop ART products QUPS

Answer 10

• Quantify risk
• Underwrite products
• Package policies
• Selling capability

Question 11

Advantages of ART MOC FACTS

Answer 11

• Market based price for risk transfer established
• Organizational focus ensured
• Capital access increased
• Flexible solution
• Administratively easier
• Cost reduction of risk management
• Tax benefit
• Smoother earnings

Question 12

Problems with ART MECE

Answer 12

• Management approach could change
• Expensive
• Complex
• Education of organization required

Question 13

Basics of risks optimization SLER

Answer 13

Selective business growth
Limit setting on risks taken on
Existing management (TAARA)
Risk based pricing

Question 14

Risk responses TAARA

Answer 14

Transfer
Avoid
Active portfolio management
Reduce
Accept

Question 15

Steps to create a risk response RICSA

Answer 15

• Research possible responses
• Implemented response chosen
• Cost and benefit of each response assessed
• Assign risk manager to implement response
• Secondary risks considered

Question 16

Unconventional ART products REC SMIRF

Answer 16

• Risk retention groups - Self-insurance done by a pool of smaller insurance companies
• Earnings protection - insurance policies for in earnings drop below a certain level
• Captives – subsidiaries for the purpose of insurance
• Self-insurance
• Multi-trigger policy – only pay out if a set of events occur in a given time period
• Insuratization – insurance policy covering a basket of risks
• Rent a captive – a captive subsidiary rented by a group of small insurers
• Finite insurance – multiyear insurance to smooth results

Question 17

Capital market ART products WICS CC

Answer 17

• Weather derivatives - policies triggered by a weather event
• Insurance linked bonds - bonds which repayments (interest or in full) is forfeited if a determined risk event occurs
• Cat-E-puts – option to allow a company to buy or issue share at a set price if a certain risk event occurs
• Securitization
• Contingent surplus notes – capital access during a loss event
• CDS – Premiums paid to in exchange for default protection