Principal Terms & More Flashcards
Terms and other potentially useful info (100 cards)
1
Q
BEL
A
Best estimate liability. Reported insurance contract liability minus the sum of RA and CSM
2
Q
RA
A
Risk adjustment
3
Q
CSM
A
Contractual service margin. The unearned profit that an insurer expects to earn as it provides services
4
Q
How do adverse scenarios impact CSM?
A
Impacts on onerous groups or groups that become onerous due to depletion of CSM are reflected in earnings immediately. (Otherwise, impacts hit CSM?)
5
Q
EaR
A
Earnings at risk. The reduction in earnings that would occur if a predefined event occurs
6
Q
EBIT
A
Earnings before interest and taxes
7
Q
EPS
A
Earnings per share
8
Q
EVA
A
Economic value added.
Earnings - opportunity cost * capital allocated.
9
Q
What are EVA and NPV used for? Pros and cons?
A
Methods for evaluating new investments and business performance. They’re based on book capital which doesn’t fully capture expected loss, much less unexpected loss. So it tends to overstate the profitability of risky business and understate the profitability of low-risk business.
10
Q
FCF
A
Fulfilment cash flows. A market consistent measure of liabilities
11
Q
MCEV
A
Market consistent economic value. EVA + cost of capital
12
Q
What is MCEV used for?
A
It represents the PV of shareholders’ interests in the earnings distributable from assets allocated to the covered business after sufficient allowance for the market price for risk (where reliably observable)
13
Q
NAR
A
- Net amount at risk
- The sum assured minus the reserve.
- The additional amount that must be paid in excess of what has been reserved.
14
Q
ROE
A
- Return on equity
- Net income for the period / average equity for the period
- An effective measure of profitability
15
Q
Security
A
Securities are instruments (like stocks and bonds) that are issued to raise capital
16
Q
ACI
A
Actuarial climate index. Measures the extent of sea level change and the frequency of extreme weather in Canada and the US.
17
Q
How does the ACI work?
A
Expressed in units of standard deviations from the mean of the reference period. Measures changes in: high and low temps, high winds, heavy precipitation, drought, and sea level
18
Q
How did COVID affect insurers?
A
Insurers had to:
1) cope with earnings volatility
2) better understand exposures
3) strengthen online channels
4) optimize product mix
5) prepare for increased insurance fraud
19
Q
Stranded asset
A
An unrealized investment
Ex: fossil fuel reserves never extracted even though they are valued as assets
20
Q
Impacts of standed assets
A
- decreasing stock prices
- business cash flow issues
- increased number of defaulted loans due to investors divesting from greenhouse gases
21
Q
What are the social science theories that attempt to explain why ESG has a positive correlation with financial performance?
A
- Stakeholder theory
- Shared value theory
- Legitimacy theory
- Resource-based theory
22
Q
Stakeholder theory
A
The ESG theory that successful companies need to manage for a wide variety of stakeholders such as employees, civil society, suppliers, and investors
23
Q
Shared value theory
A
The ESG theory that companies that create shared value for all rather than some stakeholders do better, financially
24
Q
Legitimacy theory
A
The ESG theory that there is a social contract between the corporation and society, which, if broken, leads to consumers reducing demand or governments imposing regulatory restrictions
25
Resource-based theory
The ESG theory that emphasizing internal resources such as employees and intangible assets achieves a competitive advantage
26
Captive
Insurance for the purpose of self-funding the owners' risks
27
How might a parent company support a subsidiary?
1. Capital injections
2. Funding
3. Reinsurance
4. Technical assistance
28
How to assess the likelihood of a parent supporting a subsidiary
Assess:
1) the importance of the subsidiary to the insurer
2) the extent to which failure to support the subsidiary would negatively impact the parent
3) any explicit support provided
29
A subsidiary is more likely to be supported if:
1) they operate in the same country
2) the subsidiary is extensively integrates in the parent's operations
3) the names and brands are very similar
4) the parent has commitments to the subsidiary
5) the parent has a strong track record with high competency of supporting subsidiaries (especially foreign ones)
30
ESG
Economic, social and (corporate) governance. A framework that assesses a company's performance and impact on the environment and society.
31
Pros of ESG
Studies show that good corporate management of ESG issues typically results in:
- Improved financial performance and operational metrics such as ROE, ROA, or stock price, especially over a longer time horizon
- Downside protection, especially during a social or economic crisis.
- Improved risk management and more innovation
- ESG momentum, causing improvers to outperform leaders
32
Challenges of ESG
There's inconsistent:
- terminology
- data (different scores, different data providers)
- investing strategies (with different risk-reward implications that are often merged together)
33
Catastrophe bond
A bond under which principal may be forfeited if a specified loss event occurs
34
Coherent
A risk measure that satisfies the following criteria:
1) Translational invariance
2) Positive homogeneity
3) Subadditivity
4) Monotonicity
35
Translational invariance
Adding a constant to a risk adds the same amount to the risk measure
36
Positive homogeneity
Changing the unit of the loss changes the risk measure in proportion. Like changing the loss from one currency to another
37
Subadditivity
Consolidating risks cannot make the risk greater, but it might make the risk smaller if there's any diversification benefit. It should not be possible to reduce the capital requirement for a risk by splitting it into smaller parts
38
Monotonicity
If one risk is always bigger than the other, then the risk measures should be similarly ordered
39
Are VaR, TVaR, and standard deviation coherent risk measures? Why or why not?
TVaR is. VaR is not because it fails the subadditivity criteria. Standard deviation is not because it fails the monotonicity and sub-additivity criteria
40
Contagion
When one risk event generates another. Financial contagion is the spread of a financial shock throughout a wider group, such as a financial group, an economy, or the world.
41
Convexity
A second-order exposure for the fixed-income market
42
Corrective management action
Actions not considered by the insurer in the normal course of business and require escalation to senior management
Ex: non-routine rate increases, raising capital, implementing a new reinsurance arrangement, or suspending dividend payments
43
Credit event
Occurs when there is a change in the counterparty's ability to perform its obligations
44
Delta
A linear sensitivity for exposure of options to the underlying asset price
45
Duration
A linear sensitivity for exposure to interest rates
46
Exposure
The maximum amount of damage that will be suffered if some event occurs
Measured quantitatively for some risks (credit, market), measured qualitatively for others (operational and compliance)
47
Gamma
A second-order exposure for the options market
48
KRI and examples
Key risk indicator. Quantifications of important trends and risk exposures that can serve as early warning signals. Financial: VaR, P&L, credit exposure vs limit. Operational: errors, customer complaints
49
Mortality bond
Investors invest the principal, and if no extreme event occurs over the investment period, they receive the principal with interest (paid with premiums from the mortality insurance). If an extreme event occurs, the investors lose part or all of their investment, and the insurer uses the funds to pay the high number of mortality claims.
50
SWOT
Strengths, weaknesses, opportunities, and threats. A commonly used tool in setting strategic objectives for risks. PESTLE analysis results are typically used in the opportunities and threats piece. Internal forces come through strengths and weaknesses.
51
PESTLE
A framework used to analyze an organization's exposure (positive and negative) to political, economic, social, technological, legal, and environmental factors
52
Probability
The likelihood that an event will occur (frequency)
53
Severity
How impactful the event is likely to be
54
Time horizon
How long the company is expose to the risk
- For financial risks, the key issue is the liquidity of the position affected by the risk event.
- For non-financial risks, it can be thought of as the time required to recover from the risk event
55
Volatility
The variability of potential outcomes. Can be measured using the standard deviation of unexpected outcomes.
56
Alternative risk transfer
A non-traditional strategy to transfer risk (ie a strategy other than re/insurance). Examples are catastrophe and mortality bonds
57
Beta
A measure of the dependence of the returns of an investment on the market return. A linear sensitivity for exposure to stock market movements (systemic risk)
58
Adverse selection
A consequence of information asymmetry. Buyers of insurance may transfer a higher expected loss than the insurer is aware of and has allowed for
59
Transmission channels
For an exposure to have a systemic impact, it must spread to other market participants through transmission channels.
1) Asset liquidation
2) Exposure channel
3) Critical functions
60
Impacts of the asset liquidation transmission channel
- Trigger a decrease in asset prices
- Significantly disrupt trading or funding in key financial markets
- Cause significant losses or funding problems for other firms with similar holdings
61
Impacts of exposure channel
Through macroeconomic (indirect) exposure or direct exposure interlinkages between institutions:
- Transferring losses to other market participants
- Reduced liquidity or funding for financial institutions
62
Impacts of the critical functions transmission channel
Interruption of services of an insurer may have a systemic impact if:
- the insurer provides important services for the functioning of the economy
- there are few or no readily available substitutes
63
Risk map
A popular risk identification and assessment tool because of its flexibility to incorporate both financial and non-financial risks
64
Properties of a risk map
1) Comprehensive: identifies and assesses all risks faced by the company
2) Consistency: uses a standard taxonomy to discuss and evaluate risks
3) Accountability: BUs are directly involved in identification, assessment, monitoring, and management
65
How to make a risk map
1. Establish a top-down framework & taxonomy
2. Create a bottom-up list of specific risks
3. Evaluate the probability and severity of each risk
4. Identify existing controls and consider creating new controls
5. Assign responsibilities for implementing controls, monitoring, and reporting on specific risks
6. Aggregate individual risk maps into an enterprise level risk map
7. Go back to step 1 in order to update and refine the risk mapping process
66
Immunization
A risk management strategy such as matching asset and liability durations to minimize interest rate risk
67
Operating debt
Debt dedicated to funding an isolated block of policies regarded as having excess reserves. Over time, as the reserve reduces, the released funds are used to pay down the dedicated funding
68
Definition and benefit of record linkage
The process of joining data records from different sources. Can identify duplicate records for data cleaning and can be used to get the highest quality data from all available sources. (like if source 2 has some of the same infor as source 1, but worse quality)
69
Purchasing power parity
If there is price inflation in country A but not in country B, the value of country A's currency will fall relative to country B, such that the purchasing power of a unit of currency in country B remains the same.
70
CDO
Collateralized debt obligation. A financial product backed by a pool of loans, bonds, mortgages, etc.
71
How does a collateralized debt obligation work?
Investors in the CDO are divided into different groups or "tranches." Each tranche acts as if it has sold credit protection on a slice of the portfolio of underlying assets, receiving regular interest payments, and suffering losses when defaults occur.
- Lower rated tranches receive higher interest rates, but they suffer losses earlier when defaults hit the underlying portfolio.
- Higher rated (senior) tranches don't suffer losses from defaults until all lower tranches have been wiped out, so they receive lower interest payments.
72
Covenant
Stipulations in legal lending contracts which place restrictions on the borrower, including how they may use the funds.
- Ex: mortgages typically require that the property be maintained in good order
- Ex: bond contracts may require that companies maintain certain financial ratios or avoid taking excessive risks with the loan
73
CDS
Credit default swap. A derivative security that behaves like an insurance contract on the default of an organization, referred to as the reference entity
74
How does a credit default swap work?
The protection buyer will make premium payments to the protection seller. In return, the seller will make a payment to the buyer if/when the reference entity defaults on its debts.
- The level of the premium payments is determined by the CDS spread (which can be used as a market assessment of creditworthiness).
- When the spread increases, companies owning securities issued by the reference entity will suffer credit risk losses.
75
Duration matching
A common risk management technique under which a financial institution matches the interest rate sensitivities of its assets and liabilities to make sure that their prices change in the same way when interest rates change.
76
Efficient frontier
The set of optimal portfolios, where optimal means that no other combination offers a higher expected return for any given standard deviation
77
Fungibility
The ability to move funds freely from entity to entity within a group of companies in order to absorb losses wherever they arise
78
Hard market
Comes after catastrophic events. The price and demand of insurance coverage both increase
79
Soft market
Come several years after a catastrophic event. The event is gradually forgotten, so demand and price of insurance decreases
80
Definition of leverage and the pros and cons
Using borrowed money.
Pro: Makes derivatives efficient hedging instruments because of low transaction costs
Con: Absence of an upfront cash payment makes it more difficult to assess the potential downside risk
81
Speculate
Taking a market position that will generate profit if the prediction is correct, but loss if not
82
SAA
Strategic asset allocation: used to determine a long-term policy portfolio reflecting the desired systemic risk exposure
83
TAA
Tactical asset allocation: Specifies the allowable deviation from SAA to take advantage of short-term market opportunities
84
Repo
The borrower sells financial securities to the lender while committing to buy the securities back at a later date. The difference between the 2 prices at which the securities are sold represent the interest on the loan. The loan is fully collateralized because the lender can simply keep the securities if the borrower defaults
85
Business cycle
Economy-wide fluctuations in the economic environment.
- Supply and demand curve shift
- Unemployment rises and falls
- Countries move between high and low growth phases
86
Derivative
A contract deriving its value from some underlying asset price, reference rate, or index.
87
Market portfolio
A portfolio of all the investments represented in the market, each held in proportion to their total market capitalization.
When there's no investment in the risk-free asset, this line is tangential to the original efficient frontier. This point gives the risk and return of the market portfolio.
88
Replicating portfolio
An asset portfolio that replicates the value and sensitivities of liabilities. Often used to measure the market value of liabilities to quantify market risk.
89
Internal control framework
A process, effected by an entity’s board of directors and senior management, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting, and compliance
90
Model governance
The processes and policies established to ensure that models used by a firm are developed, reviewed, and maintained consistently with the risks involved and with the firm's risk appetite.
91
Properties of strong model management
Management:
1) Gives the highest priority in approval and monitoring to the models with the highest materiality and model risk
2) Regularly reviews models
3) Manages model risk throughout the life stages of a model
Audit:
1) Assesses whether the firm's model risk management framework and policies are effective, comprehensive, and consistent with the firm's model risk tolerance
2) Checks model documentation and the model inventory for accuracy and completeness
92
Model inventory
A catalogue of all the models used by the firm (currently used or decommissioned)
93
Components of a model inventory
- Model name and description of key features
- Actual, expected, and restricted uses
- Assessment of model risk and materiality
- Type and source of input data
- Links to other models (like if the model uses output from another model as an input)
- Details of all modifications over time
- Monitoring reports
- Dates of inception and decommission
- Model limitations
94
Extreme value theory
A method used to model events where data is scarce, frequency of events is very low, and the severity is high
95
Types of extreme value theory models
Block maxima models and Points over threshold models
96
Bear market
periods of falling prices and general market uncertainty
97
Bull market
periods of positive returns and relative calm
98
BSM
Black, Scholes, and Merton analysis. The Black-Scholes formula simultaneously offers a valuation framework and a risk management strategy.
99
Corporate governance
The process of running an organization
100
Properties of strong corporate governance
Board...
1. Constitution. Chairman and CEO should be different people.
2. Education and performance
3. Compensation. Should be linked to individual and firm performance.
4. Transparency. Communication with shareholders, regulators, customers, and employees.
