Chapter 31: Other risk controls Flashcards
(19 cards)
List the 4 risk management tools available to a financial product provider, other than reinsurance and ART
- Diversification
- Underwriting at the proposal stage
- Claims control processes / procedures (underwriting at claims stage / loss-adjusting)
- Management control systems
How can risk be diversified?
Risk can be diversified within the following:
* lines of business
* target customers
* geographical areas of business
* providers of reinsurance
* investments - asset classes
* investments - assets held within a class
Why might an insurance company use reciprocal QS reinsurance to diversify its risks in preference to selling a wider range of insurance contracts itself?
Marketing and selling a wide range of contracts is expensive. It also gives the insurance company the reputation of being a “generalist” rather than a specialist player, which might not be the company’s desired strategy.
Reciprocal quota share reinsurance, where one company reinsures a part of another company’s business and vice versa, enables the insurance company to concentrate its marketing, sales and administrative effort on its chosen segment of the market (whilst still achieving a diversified portfolio). This should be more efficient.
What is underwriting?
Underwriting generally refers to the assessment of potential risks so that each can be charged an appropriate premium.
Why do insurers underwrite business?
- It can protect against anti-selection
- Enables risk classification into homogeneous groups for which a standard premium can be charged
- Identify risks for which special terms need to be quoted.
- Identify the most suitable approach and level for the special terms to be offered.
- Helps to ensure that claims experience is close to assumed experience.
- Reduce the risk of over-insurance
What are the 3 main types of underwriting?
- Medical
- Financial (to reduce the risk of over-insurance)
- Lifestyle
Who might interpret medical underwriting information?
Medical evidence is interpreted by specialist underwriters employed by the company
List 3 factors that lifestyle underwriters may investigate
- Applicant’s occupation
- Applicant’s leisure pursuits
- Applicant’s normal country of residence
What is the purpose of performing financial underwriting for a life insurance contract, and what information on the applicant may be obtained in order to carry it out?
The purpose of financial underwriting is to assess whether the proposed SA is reasonable relative to the financial loss that the applicant would suffer if the insured event occurs. The aim is to reduce the risk of over-insurance.
Information obtained may include:
* The applicant’s occupation and salary
* The proposed SA selected by the applicant
* Details of other insurance policies held by the same applicant
* Whether the applicant has an insurable interest in the insured life.
What are the main ways in which the special terms can be specified?
- An addition may be made to the premium that would have been charged, commensurate with the degree of extra risk
- A deduction may be made from the benefit, commensurate with the degree of extra risk
- An exclusion clause may be appended to the contract, which excludes payment of benefit claims that arise due to specified causes
What are claims control systems?
Claims control systems mitigate the consequences of a financial risk that has occurred.
They guard against fraudulent or excessive claims.
Give 4 examples of claims control systems
- Requiring claimants to submit a claim form
- Requiring evidence of eligibility to claim, e.g. death certificate
- Requiring continued evidence of eligibility to claim, e.g. for LTCI
- Requiring estimates of the extent of a loss, e.g. by the policyholder, or a company approved by the insurer, or by a loss adjuster
Explain why insurers may encourage income protection insurance benefit claimants to make a partial return to work, with a continued benefit
This will benefit the insurer in terms of paying a lower claim amount, plus the longer-term health of the policyholders may be improved by entering active employment again. This can reduce the time to recovery from the current claim and reduce the likelihood of future claims.
Describe the 4 types of management control systems used to reduce risk
- Data recording - the company should hold good quality data on all risks insured and on the risk factors identified during underwriting, to ensure that adequate provisions are established and to reduce operational risks
- Accounting and auditing - effective procedures enable adequate provisions to be established, regular premiums to be collected and finance providers to be reassured.
- Monitoring of liabilities taken on - this protects against aggregation of risks to an unacceptable level. Also, by monitoring new business volumes, it helps ensure the provider is not exceeding the resources available; new business mix to monitor the risk to profitability due to cross-subsidies
- Options and guarantees - care is needed, in particular, monitoring will determine whether the options and guarantees are likely to bite.
Outline how the investment risks associated with options and guarantees can be managed
Liability hedging can be used, i.e. choosing assets which match the liabilities so that they move consistently with each other.
For example:
* where the benefit is linked to an external index, the liabilities can be hedged using derivatives linked to the same index
* put options can be used to hedge guaranteed minimum benefits under UL or WP products
The hedging can be dynamic, i.e. rebalancing the underlying hedging portfolio as market conditions change.
How should low likelihood, high impact risks be dealth with?
Low probability, high impact risks:
* can only be diversified in a limited way
* can be passed to an insurer or reinsurer, usually by some form of catastrophe insurance or whole account aggregate excess of loss cover
* can be mitigated by management control procedures.
Some such risks can only be adopted as part of the consequences of the business undertaken, and the management issue then becomes how to determine the amount of capital that it is necessary to hold against the risk event.
How does a provider decide how much capital to hold against a retained risk?
This might be expressed by reference to a ruin probability over a specified period, or a ruin probability over the entire run-off of the existing portfolio.
The shorter the period chosen, the lower the ruin probability must be.
Risk management can support and optimise the risk / return profile of an organisation by…
Supporting selective growth of the business:
* Establish a process for assessing new business opportunities
* Allocate capital and other resources to business units or activities with high risk-adjusted return
Supporting profitability through risk-adjusted pricing:
* Prices should reflect the cost of risk in addition to funding costs and operational expenses.
Using limit setting to control the size and probability of potential losses:
* Set basic exposure limits
* Set stop loss limits
* Set sensitivity limits
Employing techniques to manage existing risks:
* Active portfolio management
* Reduce risk
* Transfer risks to a third party.
List 5 components of the total cost of risk
- Expected loss costs
- Disruption to business
- Insurance premiums
- Risk managers’ salaries
- Other items
Risk management programmes should also reduce the total cost of risk.
