Objective 4 Flashcards

Question

What are 5 ways to mitigate foreign exchange risk? (FERM16)

Answer 1

Hedge the **_net_** level (difference between two amounts) of currency exposure using: 1. Forwards 2. Futures 3. Options 4. Swaps 5. Other Derivatives

Answer 2

1. Change the capital structure (strategic, not level of capital) 2. Reduce the volume and mix of business 3. Increase UW standards (on OTC derivatives) 4. Conduct due diligence (on counterparty involved) 5. Buy credit insurance or CDS 6. Securitize assets (for risk transfer)

Answer 3

1. Allow for transfer of liquidity within and **across legal entities** 2. **Incentivize employees** to allow for liquidity risk 3. Use **investment strategy** to manage market liquidity risk 4. Allow for liquidity risk in the **product design** 5. Ensure **funding diversification**, both in the term and source 6. Gauge the firm's ability to **raise capital from each source** 7. Have a **contingency funding plan** to provide liquidity in times of stress

Answer 4

1. Use **appropriate** systems and processes 2. **Outsource** some of the processes to external organizations

Answer 5

1. Have contingency plans for an **alternative business location** 2. Ensure regular **data backup**, preferrably in a remote location 3. Ensure that key personnel and staff can **work from home** 4. **Test the contingency** plans regularly 5. Consider **consequiential loss insurance** on top of other business insurance

Answer 6

1. In-house departments **dedicated to learn** about imminent changes and disseminate them around the firm 2. Suscribe to **alert services** 3. Hire **consultants** 4. **Take action** of any proposed changes are likely to have an adverse effect

Answer 7

1. Have a dedicated **central IT** resource 2. **Backup** data and run secondary servers 3. Ensure software and security patches are **up-to-date** 4. Consider new software and how it **interacts** with other systems

Answer 8

1. Have the right recruitment procedures 2. Retain the right employees 3. Support employees 4. Identify poorly performing employees 5. Train employees for their roles 6. Maintain good relationships with any collective bodies

Answer 9

1. Make the consequences unattractive 2. Assess claims above a certain amount 3. Lower the limit for which claims are assessed in times of economic stress

Answer 10

1. Ensure that reports and assessments are checked by a competent and independent party 2. Use objective criteria in the checking 3. Compare peers' quotations 4. Ensure that the board has the skills to ask the right questions 5. Make people aware the unintentional biases

Answer 11

1. Keep managers and employees informed 2. Seek legal advice if there is any doubt over the legal status of a particular course of action

Answer 12

1. Regularly review the proesses and systems used 2. Stress test the process and the ways it fits into the broader structure if a new process is introduced 3. Use risk-focused process analysis to manage the structure as a whole

Answer 13

1. Have a rigorous, documented process for model coding, together witha clear audit trail 2. Ensure that all models are actually designed for their original use, or that there is a sound reason for putting such model to another use

Answer 14

1. Limit the data that can be input 2. Check that the dates are reasonable and valid 3. Require the data that can be accepted only if all fields are completed using valid entries 4. Re-check the data if it is transferred 5. Combine duplicated entried (de-duplication) if personal data are used for analysis

Answer 15

1. Scan possible action for potential reputational damage 2. Insitute a sound ERM framework 3. Rebuild the organization's reputation as quickly as possible if it is damaged

Answer 16

Create a comprehensive ERM framework that allows for the interaction between the different processes and the resulting risk concentrations

Answer 17

Ensure that a firm correctly positioned in its market (choose a strategy and constantly review it with the changes in industry and competitors)

Answer 18

* Determine properly the net position of the portfolio * Identify the fundamental risks * Decompose the overall portfolio into underlying risk factors * Aggregate and manage the risks on a net basis

Answer 19

1. Internal controls 2. Documentation provisions 3. Credit enhancement structures 4. Counterparty credit evaluation 5. Use of risk limits for counterparties

Answer 20

1. Oversight of informed and involved senior management 2. Documentation of policies and procedures 3. Independent risk management function 4. Independent internal audits 5. A back office with sufficient technology and systems 6. Independent check and balance system

Answer 21

1. To measure the interest rate risk exposure of an interest rate-contingent claim 2. To replicate option-embedded bonds by using a portfolio of option-free bonds 3. Used in structure portfolio management techniques 4. To quantify the interest rate bets for the manager 5. To provide a procedure to control interest rate risk exposure

Answer 22

* Significant realized losses * Unrealized losses via AOCI * A severe drop in market capitalization vs. the broader market * Falling RBC ratios

Answer 23

* Issue common and preferred equity * ISsue senior unsecured debt, surplus notes and subordinated debt * De-risk where possible * Attempt to divest business

Answer 24

1. Risk governance 2. Risk and capital measurement 3. Risk budgeting 4. Liquidity risk management 5. ALM and SAA 6. Risk reporting

Answer 25

1. Investment objectives and constraints 2. Asset universe and assumptions 3. Liability cash flow and replicating portfolio 4. Risk measures 5. Risk-return trade-offs 6. ALM and SAA

Answer 26

1. Securitization 2. Asset transfer 3. Financing 4. Risk sharing 5. Financial engineering 6. Raising capital

Answer 27

* Asset ownership * Minimal red tape * Clarity of documentation * Freedom of jurisdiction * Tax benefits * Legal protection * Isolation of financial risk * Meeting regulatory requirements

Answer 28

* Lack of transparency (monitor results and track who has the risk) * Reputational risk (credit rating subject to SPV's performance) * Signaling effect (high degree of attention to SPV) * Franchise risk (affiliated SPV affects sponsor's other relationships) * Liquidity and funding risk * Equity risk (equity tranche collapsing) * Mark-to-market risk (force sale of assets in SPV negatively impacts firm BS) * Regulation (different regulation applies to SPV)

Answer 29

* Governance * Reporting capability (firm should have the reporting capability to assess aggregate SPV exposure in comparison to other firm-wide risks) * Oversight (firm should monitor SPV activity) * Motivation (reconsider purpose of SPV) * Regulation (tighten reporting requirements) * Simplification * Consolidation * External ratings * Reintermediation

Answer 30

* Stop using SPVs through reintermediation of OBS assets back into the BS of sponsoring firm * Why is it used? * Restricting the flow of information * Moral hazard (investors) - they know banks are backing up the SPV, so they don't carefully scrutinize * Moral hazard (banks) - if fully bankruptcy remote

Answer 31

Process of providing funds or capital for payment of losses The short-term goal is to transfer the responsibility for paying losses from the entity that incurred the loss to another entity

Answer 32

1. Innovative use of risk financing techniques to structure an ART program 2. Use an alternative mechanism to finance risk

Answer 33

**_RFM_** * An RFM is a legal entity that is the means by which fund are made available to pay for losses. The legal entity has independent existence, which means it has decision-making and executive authority. **_ARFM_** * Describes the activities of the captives that finance risk outside the TRT insurance regulatory system * Note all ARFMs are captives, and not all use insurance techniques * Includes: * RPGs * Self-insurance pools * Captives

Answer 34

* Allows smaller insureds (those without the financial strength to retain risk) to buy liability insurance "in bulk" / in an effcient manner * Avoids laws in some states which prevent groups forming solely for the purpose of buying insurance * Eases handling multistate filings for rates and policy forms, encouraging risk capital to enter the market * Reduces insurance costs since it does not separately underwrites each insured entity * It does **_not assume risk_**

Answer 35

* Mechanism for joint access to coverage and claims services, and stabilize insurance costs * Operate as a mutual benefit association (unfunded pool), where the **pool** can assess members to pay losses as they occur * Pool members have joint liability * Pool members have longer-term liability and are required to post collateral * It **_does not take risks_** * Example: WC pools

Answer 36

* "Insurance company that is wholly owned and controlled by its insureds" * Must be a **licensed insurance** company * Must have risk capital since **it takes risk** * Its primary purpose is to insure the risks of its owners * The primary benefeciaries of its UW profits are its insureds

Answer 37

1. Choose to put capital at risk 2. Work outisde the commercial regulated marketplace 3. Achieve the insured's risk financing objectives

Answer 38

* The entity that takes the "risk" in return for premium * In captives, there are two types of risk takers: * The source of risk - the operating entity that undertakes activities to generate risk * The owner of risk - who bears the ultimate financial impact and is the source of capital required

Answer 39

* Captives insuring only the risks of their owners * The purpose of writing the risk is to allow the insured owner of the captive to **more effectively manage its own risks** * If there is a commercial purpose (e.g., to sell insurance to make a profit), then the captive would **_not_** be pure

Answer 40

1. Industrial insured group captive * Insure only insureds in the same industry group or with homogeneous risk * Members o the group are all sophisticated insureds 2. Reinsurance pool * Allows a group of insured from entirely different industry groups to own a captive jointly * Its purpose is to pool risk, and it does not provide direct insurance

Answer 41

* A licensed insurer with required homogeneous risk and all insureds must be owners * Purposes: * Avoid multi-state regulation * Create new UW capacity

Answer 42

* The difference between pure and sponsored, is that sponsored captives: * Are not formed by its insureds * Participants are those whose risks are underwritten * Sponsor contributes the captive's core capital * Do not pool the risks of its insureds * May keep separate underwriting account for each insured participant

Answer 43

* Those formed by an association for hte benefit of its members * Association members will have representation in the captive's board and actively participate in decisions relating to the captive's use

Answer 44

1. To support the issuance of new policies 2. To minimize fluctuations in loss experience 3. To limit and diversify individual and portfolio risks (particularly in the case of catastrophes and natural disasters)

Answer 45

1. To limit an insurer's loss experience resulting from insured risk exposures 2. To increase an insurer's underwriting capacity 3. To promote more efficient allocation of an insurer's capital 4. To facilitate an insurer's entry to or exit from a particular line of business or market segment 5. Protection for cedents against the accumulation of losses from a natural disaster or other catastrophe

Answer 46

* A commercial agreement whereby one company (the reinsurer) indemnifies another (the cedent) for insurance losses under policies of insurance issued by the cedent * Under a reinsurance contract, the cedent is protected from its own exposure to loss by transfer of the specified insurance risk to a reinsurer

Answer 47

1. A contract between at least 2 insurance companies 2. One or more underlying insurance contracts 3. A transfer of some insurance risk from the cedent to the reinsurer(s) pursuant to the contract of reinsurance

Answer 48

* Also known as "retrocessions" * The ceding reinsurer (retrocedent) redistributes some of the reinsurance risk it has assumed from its cedents through contracts with one or more reinsurers (retrocessionaires) * May also pool risks from several affiliates and purchase retro that covers such risks places by the reinsurance group on a more efficient basis

Answer 49

1. Treaty agreement (automatic reinsurance) 2. Facultative agreement

Answer 50

* Premium and losses associated with the covered risks are automatically covered by the agreement to be transferred * The reinsurer does not analyze the reinsured business on a policy-by-policy basis before accepting the risk cession * Reinsurers must rely on the cedent to make sound underwriting and claims-management decisions * Typically classified as "pro-rata" or "excess-of-loss" contracts

Answer 51

* The insurer and reinsurer share premiums and exposures to losses in an agreed proportion * Pro-rata reinsurance treaties may be further classified as either "quota share" or "surplus share"

Answer 52

* Protection against insured losses sutained above a predetermined threshold, known as the cedent's "retention" * Does not create a proportional sharing of risk * Helps stabilize the net losses (i.e., after reinsurance recoveries) in an insurer's portfolio

Answer 53

* Advantages: * Simple in design and to administer * Provides the cedent with "surplus relief" and the capacity to write more business or at larger limits * Disadvantages: * May come at a relatively high cost due to the cedent in terms of underwriting incoe and total return (as comapred to XL)

Answer 54

1. Per ocurrence XL * Protects cedent from the accumulation of multiple policy losses arising from a single event 2. Aggregate XL * aka Stop-loss reinsurance * Protect against the accumulation of losses over the effective period 3. Per risk XL * Protection above an insurer's retention on individual risks or policies

Answer 55

* Permits an insurer to decide which insured risks will be submitted to a reinsurer for consideration * The reinsurer has the opportuinity to underwrite the individual risk and may elect to accept or decline such risk * May be structured as XL or pro-rata * Reasons for using facultative: * For large or unusual risks * May be wholly or partially outside the scope of a cedent's treaty arrangements * Creates greater administrative burdens on both cedents and reinsurers because potential risk cessions must be analyzed on an individual basis rather than in advance as a book of business

Answer 56

1. Stabilizing UW results 2. Increasing UW capacity 3. Supporting entry into and exit from insurance markets 4. Promoting capital allocation among affiliates. Reasons include: * Pooling arrangements * Efficient capital allocation * Reinsurance captive in the US life insurance industry 5. Achieving risk concentration or diversification

Answer 57

1. Pooling arrangements * Insurers in a group may want to participate in joint underwriting pool, where disparate UW experiences are pooled together * Risks are allocated back to one/some participats sharing in that UW experience, each assuming its assigned portion of the pool through reinsurance 2. Efficient capital allocation * Tailor the risk or financial profile of separate legal entities within the group to address regulatory, rating agency, or managerial concerns 3. Reinsurance captive in the US life insurance industry * To manage statutory reserve levels

Answer 58

* Because of the low correlation between investment risk and underwriting risk * Alternative reinsurance solutions may be employed to protect cedents against a variety of risks, but these instruments have primarily been geared towards **property catastrophy risks (short time horizon to maturity)** allowing investors to particiapte in contracts of a few years or less and evaluate returns soon after contract expiration

Answer 59

* Cat bond * Structured debt indstrument that transfers risk from a sponsor (insurer) to investors (capital markets) under terms and conditions similar to an insurance contract * Sidecar * Temporary reinsurance vehicle that shares premiums and losses exclusively with an insurer * Primarily on a pro-rata basis, generally for business associated with catastrophe risk * Industry loss warranty (ILW) * Provides coverage for an insurer if the industry-wide insurance loss from an event satisfies a pre-determined condition * The insurer's own loss will usually also be required to trigger payment under an ILW contract * Collateralized reinsurance * Fully collateralized insurance-linked security that can be tailored to supplement the terms and conditions of a traditional reinsurance contract * The collateral, posted by investors, is equal to the coverage limits of the reinsurance net of the premium * The collateral is held in a separate account to satisfy losses due to the ceding insurer, the reinsurance premiums constitute the investor's return

Answer 60

1. Indemnity trigger * Actual incurred loss of the sponsor 2. Parametric trigger * Description of the physical characteristics of the catastrophe 3. Industry loss trigger * Amount of insured loss incurred by the industry

Answer 61

1. An insurer establishes a SPV that issues notes to investors 2. Funds raised by investors are managed by the SPV in a segregated collateral account which is available to pay the sponsoring company in the event of a loss 3. If the event does not occur, the following is returned to the investors: * premium paid to the SPV by the sponsor, * the principal on the note, and * the investment income earned thereon

Answer 62

1. Sponsor (insurer or reinsurer) establishes a company (the sidecar) for a limited purpose and duration 2. The sidecar may be financed by debt and equity through third party investors (capital markets) 3. The proceeds from the debt, equity and premiums ceded by the sponsor are placed in a trust account as collateral for losses that may arise under ceded insurance policies

Answer 63

1. Provide an element of diversification to an insurer's reinsurance portfolio 2. The collateralization of a cat bond helps reduce credit risk and enhances predictability of reinsurance costs since the bond terms typically last several years 3. Sidecar may be used to provide an additional source of reinsurance to an insurer when the reinsurance market has limited capital (e.g., following a natural disaster) and therefore allows an insurer to write more business during a time where rates are high 4. An ILW offers low transaction costs because the payout is linked to an industry loss figure, not the specific portfolio of the insurer; and thus, an ILW may offer a more affordable solution to catastrophe protection 5. Collateralized reinsurance allows non-traditional reinsurers to efficienty offer additional capacity for catastrophe loss, often on a retrocession basis

Answer 64

1. Experience studies 2. Industry information (SOA studies, Moody's default study) 3. Reinsurer experience studies 4. Consultant (experience studies, knowledge of industry assumptions) 5. Judgement (actuarial, asset managers, investment department)

Answer 65

* Base mortality assumption * Primary source: experience studies, when available * Supplemented with: similar products, reinsurance experience, industry information if necessary * Mortality imrovement and older age mortality * Significant judgement * Some industry thinking * Some experience * Ownership * Ideally set at BU for all applications, but varies * Margins vary by application but should be coordinated, ideally

Answer 66

* Base lapse assumption: * Primary source: experience when available, especially in the early durations * Supplemented with similar products and reinsurance experience for mid-durations * Judgment used for ultimate durations * Post-level term experience * Limited company and industry experience for 10-year term in durations just after level term period * Judgment * Dynamic lapse behavior * Some experience * Judgment * Ownership * Ideally set at BU for all applications * Margins may vary by application but should be coordinated, ideally

Answer 67

* Level of expenses * Should be based on total company expenses * Split by acquisition and maintenance * Removal of certain items that are truly one time in nature * Allocation of corporate and BU overhead by acquisition and maintenance * Allocation to each product, particularly for overhead * Selection of drivers * Some companies use a fair amount of rigor in determining appropriate factors although other do not * Ownership * Level is set basedon information available for each function * Driver is determined by each function * Margins and sensitivities will likely vary by application

Answer 68

* Assumptions: * Flexible premium payment * Partial withdrawal * Guarantee utilization * Loan utilization * Sources: * Some experience * Judgment * Ownership: * Need to set at product level, but may be set by each function * Margins and sensitivities will likely vary by application

Answer 69

* Types of economics assumptions: * Interest rates * Equity returns * Inflation * Spreads and defaults * Currency * Sources: * Current economic environment * Investment expert expectations * Projected based on available models * Certain items vary by purpose: * Real world vs market consistent * Investment strategy * Ownership: * Generally set at a company level for all products

Answer 70

1. Determine assumptions in scope * Model purpose * Assumption categories (type and granularity) * Level 2. Inventory current assumptions * Document current assumptions and current assumption sources * Categorize assumptions 3. Set assumption using current and experience * Experience * Credibility blend * Reflect relevant information / techniques 4. Develop governance process * Document process & assumption source * Approval from independent committee * Set up experience review process * Implement formal procedure for assumption review * Communicate & store assumption

Objective 4 Flashcards

(98 cards)