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3. Exam 3.1 > QA Bank Part 9 > Flashcards

QA Bank Part 9 Flashcards

1
Q

Credit risk

A

The risk of failure of 3rd parties to repay debts

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2
Q

4 Examples of credit risk

A
  • the issuer of a corporate bond defaulting on payment
  • a corporate bond’s credit rating being downgraded
  • counterparty or settlement risk
  • debtor default
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3
Q

Liquidity risk

A

occurs when a market does not have the capacity to handle the volume of an asset that is to be bought or sold at the time when the deal is required.

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4
Q

Market risk

A

The risk related to changes in investment market values or other features correlated with investment markets such as interest rates or inflation

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5
Q

3 Examples of market risk

A
  • the consequences of a fall in asset values (insolvency)
  • the consequences of a fall in liability values
  • the consequences of mismatching
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6
Q

Business risk

A

A financial risk specific to the business undertaken

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7
Q

Examples of business risk

A
  • insurance risk
  • underwriting risk
  • financing risk
  • exposure risk
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8
Q

Operational risk

A

Risk of loss resulting from inadequate or failed internal processes, people or systems

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9
Q

5 Main reasons for an individual receiving a lower pension than anticipated from the arrangement

A
  • Less is paid in contributions than expected
  • Lower investment return is achieved than expected
  • The pension annuity purchased may cost more than expected
  • The member may choose to take some of the funds as cash, so less money is available to purchase the annuity
  • There may be changes to regulation that affects benefits
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10
Q

reasons why less might be paid in contributions (4)

A
  • salary increases being less than expected
  • individual taking career breaks
  • individual retiring earlier than expected
  • net invested contributions less than expected due to higher charges
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11
Q

reasons why less investment return might be achieved (5)

A
  • under-performance of assets leading to lower than expected investment income
  • underperformance of assets leading to lower than expected capital growth
  • contributions being paid later than expected, so there is less time to earn investment returns
  • a fall in market values at the time that the pension is purchased
  • investment expenses being greater than expected.
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12
Q

reasons why the pension annuity purchased may cost more than expected (4)

A
  • fall in the investment return the annuity provider expects to receive post-retirement
  • improving mortality, so more benefit payments are expected to be made
  • a change in the type of annuity purchased (eg inclusion of a spousal pension, pension increases)
  • expense and profit allowances in the cost of the annuity may be greater than expected.
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13
Q

Factors that might lead an individual to purchase an inappropriate private medical insurance policy

A
  • Incompetence or insufficient experience of the advisor
  • lack of integrity of the advisor
  • the use of an unsuitable model or parameters
  • errors in the data
  • state-encouraged but inappropriate actions
  • over-complicated products
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14
Q

Ways to mitigate against inappropriate advice

A
  • Check that the advisor is appropriately qualified
  • Only use a financial advisor who has been recommended by a trusted source
  • The individual could carry out some research of their own into private medical schemes before consulting the advisor so as to be better equipped to understand and question the advice given
  • Look for an advisor who operates on a fee basis, rather than using commission
  • Make sure the product sold incorporates a cooling off period, so that the policy can be cancelled during an initial period if it is found that inappropriate advice has been given
  • seek a wide range of quotes for comparison
  • the individual should be honest about their needs, state of health and financial position so that the advisor has the correct data with which to offer advice.
  • The individual should make sure that they are financially aware and question government advice
  • the individual should read the small print, and check their understanding of the product before committing to purchase
  • if the individual discovers that inappropriate advice has been given, they could write to the regulator/ombudsman.
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15
Q

List the benefits of risk management

A
  • avoid surprises
  • improve the stability and quality of their business
  • improve their growth and returns by exploiting risk opportunities
  • improve their growth and returns through better management and allocation of capital
  • identify opportunities arising from natural synergies
  • give stakeholders in their business confidence that the business is well managed
  • price products to reflect the inherent level of risk
  • improve job security and reduce variability in employee costs
  • detect risks earlier meaning they are cheaper and easier to deal with
  • determine cost-effective means of risk transfer
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16
Q

4 Options for dealing with risk

A
  • reject the need for financial coverage of that risk because it is either trivial or largely diversified
  • retain all the risk
  • pay a premium to another party to transfer all the risk to that party
  • retain some of the risk and pay a premium to transfer the balance of the risk to another party.
  • manage/mitigate the retained risks
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17
Q

4 Factors affecting the approach to dealing with risk

A
  • how likely the risk event is to happen
  • the existing resources that the stakeholder has to meet the cost of the risk event should it happen
  • the amount required by another party to take on the risk
  • the willingness of another party to take on the risk
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18
Q

3 Examples of operational risk

A
  • the dominance of a single individual over the running of a business
  • reliance on 3rd parties to carry out various functions for which the organisation is responsible
  • the failure of plans to recover from an external event
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19
Q

Underwriting risk

A

Poor underwriting procedures and hence incorrect pricing

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20
Q

Exposure risk

A

Overexposure to a particular class of business or geographical area.

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21
Q

Defined contribution scheme

A

A defined contribution scheme provides a benefit payment that is dependent on

  • contributions paid into the scheme in respect of that member,
  • together with the investment return earned on those contributions
  • and the annuity rate available at retirement
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22
Q

2 Steps to reduce the likelihood of pension being lower than expected

A
  • regular reviews of the fund

- matching of assets

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23
Q

Claims under Employer’s Liability Insurance:

Variability

A

Policies will be heterogeneous, since employers will vary significantly in the types of risk to which they are exposed.
In addition claims may be quite variable from year to year.

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24
Q

Claims under Employer’s Liability Insurance:

Unusual claims

A

There is significant risk of:

  • single large claims
  • catastrophic events
  • accumulations
  • latent claims
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25
Q

Claims under Employer’s Liability Insurance:

Reporting and settlement delays

A

Reporting delays are common (e.g. symptoms from industrial disease)

Settlement delays are also common, since claims need to be validated and complex cases may undergo court proceedings.

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26
Q

Claims under Employer’s Liability Insurance:

Nature of claims

A

Some types of claim may have fixed payments that have been agreed in advance, whereas other claims are likely to be real in nature, linked to lost earnings.

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27
Q

What is a risk portfolio?

A

A risk portfolio provides a means by which to categorise the risks to which the business is exposed.

For each risk, both impact and probability might be recorded.

An indication of how the risk has been dealt with might also be recorded.

It can also help identify any concentrations of risk and highlight the need for management action in these areas.

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28
Q

Risks portfolio:

4 Financial risks

A
  • credit risk
  • liquidity risk
  • market risk
  • business risk
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29
Q

Risks portfolio:

Indicating how risks have been dealt with (4)

A

Indicate whether the risk has been:

  • retained (and how much capital is needed to support it)
  • transferred
  • mitigated (with a revised assessment of the remaining risk)
  • diversified (with a revised assessment of the remaining combination of risks)
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30
Q

How might risk be managed at the business unit level?

A

The parent company decides on its overall risk appetite and then divides this between the business units…

… the management of each business unit then manages the risks of the business within the allocated risk appetite.

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31
Q

How might risk be managed at the enterprise level?

A

A group risk management function is established.
The risks of the various business units are identified and then the results combined into a risk assessment model at the entity level.

32
Q

2 Advantages of managing risk at the business level

A
  • Each business unit feels a sense of responsibility / direct involvement in risk management
  • The management teams of the various business units are most closely involved in understanding the risks and how to deal with them
33
Q

3 Advantages of managing the risk at the enterprise level

A
  • makes allowance for the benefits of diversification or pooling of risk.
  • provides insight, at a group level, into the areas with undiversified risk exposures where the risks need to be transferred or sufficient capital set aside to cover.
  • it ensures efficient capital use across the group.
34
Q

5 Approaches to measuring investment risk

A
  • Historic tracking error
  • Forward-looking tracking error
  • Liability risks
  • Value at risk
  • Expected shortfall (or TailVaR)
35
Q

Historic tracking error

A

The annualised standard deviation of the difference between portfolio return and benchmark return, based on observed relative performance

36
Q

Forward-looking tracking error

A

an estimate of the standard deviation of returns (relative to the benchmark) that the portfolio might experience in the future if its current structure were to remain unaltered.

This measure is derived by quantitative modelling techniques and depends on assumptions including

  • the likely future volatility of individual stocks or markets relative to the benchmark
  • correlations between different stocks and/or markets
37
Q

Value at risk

A

Value at Risk (VaR) generalises the likelihood of underperforming by providing a statistical measure of downside risk.

VaR represents the maximum potential loss on a portfolio over a given future time period with a given degree of confidence.

38
Q

Expected Shortfall

A

The expected loss in a portfolio’s value given that the loss is occurring at or below the pth-quantile.

It gives the expected value of a portfolio in the worst p% of cases under consideration.

39
Q

3 ways of dealing with a low likelihood, high impact risk (earthquake, hurricane)

A
  • diversification, eg run the business from several locations
  • pass the risk to an insurance company
  • implement management control procedures, eg a disaster recovery plan
40
Q

5 Factors an FSP should consider when reporting on risk

A
  • whether the ruin probability should be expressed over a single year or over the whole run-off of the business
  • how to assess the correlation between the risks, the most common technique uses a correlation matrix
  • how to take account of the interactions between risks (since these may mean the combined effect is greater/less than the sum of the risks
  • how to deal with risks that are highly subjective
  • using past data to estimate future consequences of rare events needs to be undertaken with caution, since the past may not prove a good guide to the future.
41
Q

8 Risks to the provider of a with-profit endowment assurance

A
  • investment risk
  • mortality risk
  • anti-selection risk
  • withdrawal risk
  • marketing risk
  • expense risk
  • commercial risk
  • new business risk
42
Q

With-profit endowment assurance:

Investment risk

A

Investment values may be lower than expected.

For competitive reasons and to meet policyholders’ expectations, bonuses may be paid that are greater than can be justified by the investment returns achieved.

In a worst case scenario investment returns may be insufficient to provide the guaranteed minimum benefits.

43
Q

With-profit endowment assurance:

Mortality risk

A

there is a risk that more policyholders die than expected, in particular early deaths where the benefit may far exceed the premiums paid to date.

44
Q

With-profit endowment assurance:

Anti-selection risk

A

unless there is appropriate underwriting, unhealthy lives may select against the insurer.

45
Q

With-profit endowment assurance:

Withdrawal risk

A

there is a risk that more policyholders surrender their policies than expected, this is of particular concern if the surrender values are generous (perhaps prescribed by legislation).

In particular there is a risk of too many early surrenders meaning the initial expenses are not recouped.

46
Q

With-profit endowment assurance:

Marketing risk

A

it may be deemed at a later date that policies were mis-sold to individuals leading to the insurer having to pay redress.

47
Q

With-profit endowment assurance:

Expense risk

A

there is a risk that expenses, fixed and/or variable, are greater than expected.

48
Q

With-profit endowment assurance:

Commercial risk

A

there is a risk that payouts on the policies are lower than those of competitors. This could result in selling less new business than expected.

49
Q

With-profit endowment assurance:

New business risk

A

there is a risk that:
● volumes are too low, meaning that the fixed costs that need to be recouped per policy are too high
● volumes are too high, leading to capital strain.

As this is a new class, the volume and mix of business and the characteristics of the typical policyholder will be difficult to gauge in advance.

50
Q

With-profit endowment assurance RISK MITIGATION:

Investment risk

A

● Choose investments that match the guaranteed benefits as closely as possible.
● Manage policyholders’ expectations as to the level of bonuses, eg by:
–– disclosing information on investment strategy
–– making sure that illustrations / projections are not too optimistic.
● Don’t deviate too much from what competitors are investing in.
● Regularly monitor actual investment returns against expected, so as to be able to take corrective action if necessary, eg review premium rates.

51
Q

With-profit endowment assurance RISK MITIGATION:

Mortality and anti-selection risk

A

● Keep the guaranteed level of the benefit on death low (although this may make the product unattractive to customers).
● Review underwriting procedures (make sure that they are consistent with those of competitors) and carefully underwrite the risks involved.
● Make sure that the risk classification is appropriate to reduce the risk of anti-selection.
● Regularly monitor actual mortality against expected so as to be able to revise mortality assumptions as required, eg review premium rates.

52
Q

With-profit endowment assurance RISK MITIGATION:

Persistency (withdrawal) risk

A

● Keep any guaranteed surrender values to a minimum.
● If possible, have a zero surrender value in the first few years until the initial expenses are recouped.
● Regularly monitor actual withdrawals against expected so as to be able to revise persistency assumptions as required, eg review premium rates.
In particular, monitor withdrawals by sales channel and sales agent and stop selling through channels where withdrawals are high, or through agents who are deliberately “churning” business.
● Pay regular rather than initial commission to sales agents to encourage persistency.
● Require that a certain amount of commission be “clawed back” from the agent on early withdrawal.

53
Q

With-profit endowment assurance RISK MITIGATION:

Marketing risk

A
  • Ensure that sales agents are adequately trained.
  • Make sure that policy literature is clear and understandable, and explains the risks associated with the product.
  • Make sure that projections show a range of values and are not overly optimistic
  • Carry out spot checks on the sales process
  • Provide regular policy reviews, eg annual updates on the value of the policy.
54
Q

With-profit endowment assurance RISK MITIGATION:

Expense risk

A

● Regularly monitor actual expenses against expected so as to be able to revise expense assumptions as required, eg review premium rates.
● Carry out expense budgeting and ensure that expense controls are in operation.
● Regularly review sales volumes and mix of business, to ensure that fixed expenses are being spread appropriately.
● Reduce the extent of expense cross subsidies.

55
Q

With-profit endowment assurance RISK MITIGATION:

Commercial risk

A

Make sure that pricing and investment strategy are not out of line with competitors.

56
Q

With-profit endowment assurance RISK MITIGATION:

New business risk

A

● Use reinsurance to help with new business strain.
● Monitor levels of new business sold so as to be able to stop selling if volumes are too high, or take remedial action (eg further advertising, training of sales agents, redesign the product) if volumes are too low.

57
Q

6 Factors that might affect the risk appetite of a large multinational pharmaceutical company

A
  • the size of the company (larger companies are able to take on more risk)
  • the nature of the company’s business
  • the company being multinational (scope for diversification, but also currency risks)
  • the level of capital available
  • any regulatory requirements
  • the culture of the company:
  • — past experience
  • — views of the board
  • — view of shareholders
58
Q

4 Approaches to managing risk

A
  • Diversify the risk away
  • Implement control measure to reduce the likelihood of the risk event occurring
  • Implement control measures to limit the severity of the effects of a risk that does occur
  • Implement control measure to mitigate the consequences of a risk that does occur.
59
Q

Describe an approach to evaluate the risk to a general insurer of poor strategic decision making.

A

The risk is difficult to model mathematically, given the subjective factors involved.
An appropriate approach to evaluation may be to use scenario analysis.

This will involve:

  • dividing the risk into broad categories
  • deriving plausible adverse scenario for each risk
  • assessing, for each adverse scenario, the consequences of the risk event occurring
60
Q

Describe an approach to evaluate the risk to a life insurer of an extreme equity market movement.

A

Financial stress testing. This involves subjecting assets and liabilities to extreme market movements.

This can be achieved by assuming lower equity values / changing key assumptions.

Asset correlations and volatilities should be considered.

2 Types of stress testing:

  • to identify weak areas in the portfolio and investigate the effects of localised stress situations
  • to gauge the impact of major market turmoil affecting all model parameters, while ensuring consistency between correlations while they are being stressed.
61
Q

What are the risks arising from a motor insurance contract? (9)

A
  • Claim amounts are higher than expected
  • Claim frequency amounts are higher than expected
  • Moral hazard
  • Expenses are higher than expected
  • Business volumes are too high
  • Business volumes are too low
  • Business mix is not as expected
  • Operational risks
  • Lack of past data
62
Q

How to mitigate the risk:

Claim amounts being higher than expected

A
  • Use reinsurance
  • Monitor amounts and reprice if necessary
  • Review the business mix / risk classification
63
Q

How to mitigate the risk:

Claim frequency higher than expected

A
  • monitor claim frequency regularly and reprice if necessary

- use reinsurance

64
Q

How to mitigate the risk:

Moral hazard

A

Tighten the policy wording and introduce exclusion clauses

65
Q

How to mitigate the risk:

Expenses higher than expected

A
  • Look for cost savings / improvements in efficiency

- Monitor expenses and expense inflation and reprice if necessary

66
Q

How to mitigate the risk:

Business volumes too high

A

Cap the amount of business written.

67
Q

How to mitigate the risk:

Business volumes too low

A
  • Look at competitiveness of premium rates and reprice if necessary
  • Look at different agents / brokers / tied agents
68
Q

How to mitigate the risk:

Business risk is not as expected

A
  • Avoid cross subsidies in the pricing basis

- Monitor the mix carefully

69
Q

How to mitigate the risk:

Operational risks

A
  • Auditing
  • Data checks
  • Monitoring
70
Q

How to mitigate the risk:

Lack of past data

A
  • Use reinsurer expertise or industry data

- Monitor experience frequently early on and reprice if necessary

71
Q

List actions that a non-financial company would include as part of its risk management process (10)

A
  • Risk identification
  • Risk measurement
  • Risk financing
  • Assessing the company’s risk appetite
  • Assessing existing control measures
  • Risk monitoring
  • Establishing a risk portfolio
  • Implementing a risk reporting process
  • Establishing clear management responsibility for each risk
  • Performing a risk assessment at a whole company level
72
Q

Risk identification

A

Recognising the risks that can threaten the income or assets of the company.

73
Q

Risk measurement

A

Estimating the probability of a risk event occurring and its likely severity.

74
Q

Risk financing

A

Determining the likely cost of a risk and ensuring that adequate financial resources are available to cover it.

75
Q

Risk monitoring

A

Regularly reviewing and re-assessing all of the risks previously identified,
coupled with an overall business review to identify new or previously omitted risks.

76
Q

Risk portfolio

A

A risk portfolio or risk register categorises the various risks to which the business is exposed, eg business, market, operational.

Against each risk would be recorded a quantification of its

  • impact
  • probability

The quantification might simply be a subjective assessment.

Alternatively, risk analysis models may generate a financial impact figure.

The product of impact and probability measures give an idea of the relative importance of the various risks.

As the project progresses beyond the risk identification and measurement stages, the risk portfolio can be extended to indicate how the risks have been dealt with, eg:

  • retained (and how much capital is needed to support it)
  • mitigated (and a revised assessment of the remaining risk)

The risk portfolio can also identify concentrations of risk and highlight the need for management action in these areas.

3. Exam 3.1 (56 decks)

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