Chapter 13, 14, 15: Risks

Question 1

List the key risks associated with using data

Answer 1

I RAP GIF

data are INACCURATE or incomplete, leading to erroneous results or conclusions
past data is not sufficiently RELEVANT for the intended purpose because data isn’t precisely comparable across companies
the data might not be in a form that is APPROPRIATE for the intended purpose
the data may be collected for a PURPOSE, so it’s not appropriate for a different purpose
chosen homogenous data GROUPS may not be optimal due to:
– the group being too small for analysis
– if the data groups merged, it may not be sufficiently homogeneous
INSUFFICIENT volume of data, which makes it not credible
past data might not reflect what would happen in the FUTURE due to:
HARD FROG
HETEROGENEITY within the group
past ABNORMAL events
significant RANDOM fluctuations
past data may not be up to DATE
FUTURE trends not being reflected sufficiently in past data
changes in the way that the data was RECORDED
OTHER changes e.g. medical, economic
changes in the balance of any homogeneous GROUPS underlying the data
There may be missing data

Question 2

Possible reasons for heterogeneity when using industry wide data

Answer 2

GPS RN P

companies operating in different GEOGRAPHICAL or socio-economic sections of the market
POLICIES sold by companies differ
SALES method may differ
coding use for RISK factor may differ
NATURE of data storage might differ
companies will have different PRACTICES

Question 3

4 other problems with using industry data

Answer 3

LEND

LESS detailed and flexible than internal data
EXTERNAL More out-of-date than internal data
NOT all organizations contribute, and those that do may not be representative of the market
DATA quality depends on the quality of the data systems of all its contributors

Question 4

What are the risks associated with the assumptions regarding future mortality

Answer 4

Model risk - the model, typically a probability distribution, chosen to represent future mortality, may not be appropriate
Parameter risk - the parameters used with the model may not adequately reflect the future experience of the class of lives insured or to be insured
Random fluctuations - the actual future experience may not correspond with the model and parameters adopted, even though these adequately reflect the class of lives insured or to be insured ( most likely to arise if the numbers to risk are not large enough for the law of large numbers to apply)

Question 5

How can an insurance company that appears solvent one day become insolvent the next day following a change in asset values

Answer 5

A fall or rise in interest rates could lead to insolvency if liabilities are valued at market rates. If assets were invested with a shorter discounted mean term than the liabilities, then on a fall in interest rates the value of the liabilities would rise by more than the value of the assets.

Question 6

What are the key things from withdrawal risk (3)

Answer 6

The financial risk that the surrender value is higher than the asset share at the time of withdrawal.
The risk to the mortality experience due to selective effect of withdrawals
The risk of increasing the per-policy fixed expenses due to the loss of business volume from withdrawals

Question 7

What are the data Issues for health and care contracts (3)

Answer 7

Smaller policy volumes (CI and LTCI) and lower incidence rates (IP and CI) limits the credibility of the data
Changes to products and markets over time limits the applicability of past insurer data
Heterogeneity of products and markets limits the applicability of industry data

Question 8

What are examples of an error in a stochastic investment model

Answer 8

The probability density function chosen is inappropriate
The time-series relationships between outcomes at different times are not specified appropriately

Question 9

What is expense risk

Answer 9

It is a risk that the actual expenses are higher than expected, including due to the effects of inflation

Question 10

What are the different types of underlying drivers for charges being lower than expected (3)

Answer 10

Investment performance risk ( If charges are fund-based)
Persistency risk ( If charges required to recoup initial expenses are not received due to high withdrawal rates)
New business mix or volume risk ( The extent that charges are linked to average size or volume of new business, and this is liwer than expected)

Question 11

What is the effects of higher selective withdrawals (3)

Answer 11

Left with a pool of higher-risk policies
Left with fewer policies to spread overheads
The financial risk that the surrender value is higher than the asset share

Question 12

What are the sources of risk to a life insurance company

Answer 12

MAGICAL FAMED VAC W

MORTALITY and morbidity rates
ACTIONS of the board of directors or staff
GUARANTEES and options
INVESTMENT performance
COMPETITION
ACTIONS of distributors
FRAUD
failure of APPROPRIATE management system and controls
MIX of new business by nature and size of contract, and by source
EXPENSES, including the effects of inflation
policy and other DATA
VOLUME of new business
AGGREGATION and concentration of risk including credit failure
COUNTERPARTIES
WITHDRAWALS

Question 13

How can a change in mix of new business be a risk to the company (2)

Answer 13

A significant change by nature or size could lead to significant change in the risk profile or capital needs of the company that were not within the resources available to it
A change in the mix by source (distribution channel) may invalidate the parameters for the mortality and expense assumptions

Question 14

How can the volume of new business be a risk to the company (2)

Answer 14

High volume
- writing too much business puts pressure on the capital and administrative requirements

Low volume
- May cause there to be less policies to spread overhead costs

Question 15

How can guarantees and options cause risk to the company (2)

Answer 15

The company is offering terms in advance of the happening of the event.

There will be risks associated with the choice of parameters and choice of model used to determine the cost to the company of doing this

Question 16

How can competition cause risk to the company

Answer 16

The need to compete in a free market, may lead the management of a life insurance company to take decisions which will increase its risk profile beyond that which can be supported by the available resources

Question 17

What are some of the decisions management can take to increase its competitiveness in the market

Answer 17

BEARS

increase BONUSES under existing contracts
on EXISITING business with reviewable charges, either do not increase the charges or reduce their rate of growth relative to what may have been originally intended
offer ADDITIONAL guarantees and options under new business contracts
REDUCE premium rates or charges under new business contracts
increase SALARIES or commissions in the respective distribution channels

Question 18

How can actions of the board of directors increase risk to the company (1:3)

Answer 18

The directors of the company may not follow the recommendations of the actuary so that it stays within its risk profile due to:
- Competitive reasons
- Strategic company goals such as maximising new business volumes or amount of funds under management
- So as to maximise shareholder earnings

Question 19

How can actions of distributors increase risk to the company
And give examples

Answer 19

The actions of distributors may be in their own interests or the interests of their client, which may give rise to financial risk to a life company.
Eg:
- encouraging business to lapse and re-enter where there are no exit penalties or there is no clawback of commission payments
- Taking advantage of loopholes in the product design

Question 20

How can failure of appropriate management systems and controls increase the risk to the company

Answer 20

The failure in controls may result in:
- Financial losses for the insurer
- Regulatory intervention
- Reputational damage

Question 21

How can counterparties increase risk to the company

Answer 21

There is a risk that the entity will not be able to fulfil their obligations under the agreement. Or they will perform them to an unacceptable standard.

Question 22

How can the legal, regulatory and fiscal environment increase risk to the company

Answer 22

This can happen if rules are changed adversely

Question 23

A change in the mix by nature might involve what

Answer 23

A change in the mix by:
- Class of business
- Type of Contract
- Contract design
- Premium Frequency

Question 24

If a life insurer prices differently for the different distribution channels, and can achieve the same level of profitability in the different channels, then is it exposed to risk of changes in the mix by source

Answer 24

No

Question 25

What are two key factors related to the distribution channel that may cause withdrawal experience to vary between channels

Answer 25

The level of financial sophistication of the customer The degree of pressure of the sale, which may be affected by who initiated the sale

Question 26

Give examples of counterparty risks

Answer 26

Reinsurer default Outsourcing arrangements (eg poor quality service) Corporate bonds held as investment (eg non-payment of coupons) Distribution arrangements

Question 27

In what categories does financial companies classify Climate risk, Explain them

Answer 27

Physical Climate risk - These are the first-order effects of environmental changes such as greenhouse emissions, pollution and land use Transition risks - refer to economic, political and market changes as a result of efforts to mitigate climate change Climate liability risks - Can arise from injured parties seeking compensation for the impacts of climate change

Question 28

What are the main aims of the insurance company

Answer 28

Maximise profits of the company, whether these go to shareholders or with-profits policyholders maximise the return that the company achieves on its available capital

Question 29

Why is the downgrading of a company’s credit rating a risk

Answer 29

Because it would lead to: - Adverse publicity - greater difficulty and cost in raising additional capital in the market and as a consequence: - the range of profitable activities may be constrained - Policyholders may be less likely to maintain or purchase policies with the insurer

Question 29

Revised premium rates are not competitive. What could cause this, and how can a company correct this?

Answer 29

MORTALITY Experience might be heavier than that of competitors, due to: - Weaker underwriting - Different target market - Different distribution channel - No smoker split So, the insurer could: - Strengthen underwriting - Change target market - Change distribution channel - Introduce differential rates for smoker splits - Could take a less conservative view in setting the mortality assumption, if this can be justified by evidence, eg from own data, industry or reinsurers, or by offering cover on a reviewable basis EXPENSES May be higher than those of competitors - Could look to reduce commission - Reduce sales costs by more efficient marketing and increasing salesforce productivity - Try to improve admin efficiency and reduce overheads - May be able to achieve lower price if total profits improved by increasing volumes WITHDRAWALS Experience may be worse than competitors - Try to improve persistency through improving sales methods and training of sales staff - Withdrawal rates may differ due to different target markets and/or distribution channels, sowe could try to change these PROFIT TARGET - May be too high relative to the market, so reprice at a reduced level of profitability - Consider how much contribution is required from this business to overheads, reducing the required contribution will reduce the price - Perhaps reduce prices and accept lower profitability ( or even losses), if the company feels that other reasons for offering competitive term assurance rates justify this, eg the need to attract sales to other types of (profitable) business, and/or provide a complete (competitive) product range OTHER - Reinsure the business more efficiently. It can be used to reduce capital requirements, and a sufficient reduction in the overall cost of capital could allow the company to reduce its premium rates

Question 29

The overall insurer risk can be measured against its primary aims, but also allowing for:

Answer 29

The capital and other resources available to the insurer The cost of failing to meet the public interest need ( to avoid insolvency) The cost of failing to meet the requirements of any other applicable legislation