1
Q
Categories of risk
A
2
Q
3 examples of credit-linked event
A
- Bankruptcy
- Rating downgrage / upgrade
- Failure to pay
3
Q
The principles of good lending relate to (4)
A
- Character and ability of the borrower (is he trustworthy?)
- Purpose of the loan
- Amount of the loan
- Ability of the borrower to repay
4
Q
Difference between marketability and liquidity
A
- Marketability is how easy it is to convert an asset into cash
- Liquidity is a measure how quickly the asset can be converted into cash at a predictable price
- call deposit at a bank is very liquid
- long-term government bond is marketable but not liquid since the market value is volatile
5
Q
Consequences of mismatching (2)
A
- Higher liquidity risk
- reinvestment risk
6
Q
Categories of business risks (4) and examples
A
- Underwriting risk
- inadequate underwriting standards and therefore taking on risks at an inadequate price
- Insurance risk
- Insurer suffering more claims than anticipated
- Financing risk
- investing in a business that fails to be successful
- Exposure risk
- A reinsurer having greater exposure than planned to a particular risk event
7
Q
Main claim risk for an insurance company
A
- Mortality
- Longevity
- Morbidity
- Medical advances (diagnosis, cures, etc.)
- loose policy wordings
- Accumulation of risks and catastrophes
- anti-selection and moral hazard
8
Q
Main claim risks for a general insurance company
A
- Claim frequency
- Claim amount
- Claim inflation
- Claim volatility
- Claim delays
- Claims handling
- Loose policy wordings
- Accumulation of risks and catastrophes
- Anti-selection and moral hazard
9
Q
Define operational risk
A
Operational risk refers to the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.
10
Q
Operational risk can arise from: (4)
A
- Inadequate or failed internal processes, people or systems
- The dominance of a single individual over the running of a business (dominance risk)
- Reliance on third parties to carry out various functions for which the organization is responsible
- The failure of plans to recover from an external event
11
Q
Examples of defined benefit pension schemes (3)
A
- Final salary schemes: benefits are based on earnings in the last three years prior to retirement
- Career average scheme: benefits are based on earnings over career, possibly revalued
- Fixed benefit scheme: fixed amount for each year of service
12
Q
Examples of defined ambition schemes (2)
A
- A cash accrual scheme where benefits are defined as a lump sum rather than as a pension
- A defined contribution scheme offering a defined benefit underpin e.g. the benefit will not be less than 1/100th of final salary for each year of service
13
Q
3 key benefit risks for a defined contribution scheme
A
- Investment returns being lower than expected, or expense charges higher
- Annuity purchase terms poorer than expected
- Members’ needs not being met, either due to design or inflation erosion of value
14
Q
6 key benefit risks for a defined benefit scheme
A
- Inadequate funds due to underfunding (insufficient funds set aside)
- inadequate funds due to sponsor insolvency
- inadequate funds due to asset liability mismatching
- illiquid assets
- risks that the benefit promised is changed, e.g. by the state
- members’ needs not met, either due to design or inflation erosion of value
15
Q
Further benefit risks for both, DB and DC schemes
A
- default by sponsor
- failure by sponsor to pay contributions/premiums in a timely manner
- takeover of the sponsor
- decision by the sponsor that benefits will be reduced
- inadequate communication by sponsor / provider of assets and liabilities
16
Q
The overall level of the contributions for a defined benefit scheme depend on (5)
A
- The amount of the promised benefit
- The probability of individuals being eligible to accrue the beneftis
- The probability of individuals being eligible to receive the benefits
- The effect of inflation on the level, or the real level, of the benefits
- The investment return achieved on the contributions (net of tax and expenses, if appropriate)
17
Q
Contribution risks for defined benefit schemes
A
- Future contributions unknown and depend on
- the amount of the benefit
- eligibility to accrue benefits
- eligibility to receive benefits
- inflation
- investment returns net of tax and expenses
- Extra contributions may be required to meet a shortfall, resulting in liquidity risk or excessive contributions
18
Q
Contribution risks for defined contribution schemes (3)
A
- Unafforadable contributions
- Insufficient liquidity to make the payments in a timely manner
- Contributions may be linked to an inflationary factor, introducting an inflationary risk
19
Q
Other word for “timing” of the investment return
A
Incidence of the return on investments
20
Q
10 key investment risks for a benefit scheme
A
- Uncertainty over the level and incidence of income
- Uncertainty over the level and incidence of capital
- Reinvestment risk arising from mismatching assets and liabilities
- Default risk
- Tax and expenses
- Benefits are not appreciated due to poor investment returns
- Inflation erosion
- Opportunity cost of the capital
- Liquidity risk
- Lack of diversification
21
Q
Define risk classification
A
Risk classification is a tool for analyzing a portfolio of prospective risks by their risk characteristics, such that each subgroup of risks represents a homogeneous body of risk.
E.g.
- male/female
- smoker/non-smoker
22
Q
3 criteria that a risk must satisfy in order for an insurer to be preprated to take on the risk (insurability)
A
- Policy holder must have an interest in the risk being insured (to distinguish between insurance and a wager (Wette))
- A risk must be of a financial and reasonable quantifiable nature
- Insurer need to be able to assess the risk and set an appropriate premium
- The amount payable by the insurance policy in the event of a claim must bear some relationship to the financial loss incurred
- If the claim amount is too small, the policyholder is unlikely to deem the insurance worthwhile, if it is too large, this will encourage fraud and moral hazard
23
Q
6 additional desirable criteria for a risk to be insurable
A
- Individual risk should be independent
- the probability of the event occuring should be relatively small
- large number of similar risks should be pooled to reduce variance
- There should be a limit on ultimate liability undertaken
- Moral hazard should be eliminated as a far as possible
- there should be sufficient existing data / information in order to quantify risk
24
Q
Define risk management
A
Risk management is the process of ensuring that the risks to which an organisation is exposed
- are the risks to which it THINKS it is exposed
- and tho which it is PREPARED to be exposed
25
The risk management process consists of (5)
* risk identification
* risk measurement
* risk control
* risk financing
* risk monitoring
26
Risk management process - risk identification
Recognition of the risks that can threaten the income and assets of an organisation
* high level preliminary analysis
* brainstorming with experts
* desktop analysis
* risk register or risk matrix
27
Risk management process - risk measurement
measuring the probability and severity of a risk
28
Risk management process - risk control
Mitigation to reduce the probability / severity of a loss
29
Through risk managment a provider will be able to
* 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 managemed
* price products to reflect the inherent level or 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
30
When faced with a risk each stakeholder can choose wheter to (5)
* avoid the risk
* 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 risk to another party
31
Risk management process - risk financing
Determining the likely cost of a risk
... and ensuring the availability of adequate financial resources to cover the risk
32
Risk managment process - risk monitoring
Regular review and reassessment of risks together with an overall business review to identify new / previously omitted risks
33
Main weakness of VaR
Does not quantify the size of the "tail"
34
Expected shortfall
35
Calculate 95% VaR
36
Conditional Tail VaR
Expected shortfall divided by the shortfall probability
CA1
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