Extreme Events – Specimen Answer A.8.2(c)
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Q. Summarise the main risks
to which the following types of entity might be most exposed (and which it
would be prudent to provide stress tests for if you were a risk manager for
such an entity): (c) A life insurance company
Market risk. Many lines of business in life insurance can be heavily
exposed to market risk. However, in many cases much of this risk may be borne
by policyholders rather than shareholders (if any). For example, with
unit-linked business the benefits payable to policyholders may rise and fall as
the underlying asset values rise and fall, although there may also be
guarantees that may not be fully hedged and the future revenue streams the firm
earns on in-force policies may be reduced if asset values decline.
Credit risk. Some elements of life insurance can create material credit
exposures, e.g. credit risk in reinsurance contracts that are not
collateralised or otherwise passed through to policyholders.
Liquidity risk. Life insurers have historically been viewed as less
exposed to liquidity risk than most other financial services entities, if anything
being seen as likely providers of liquidity rather than likely consumers.
However this is not necessarily the complete picture, see e.g. Liquidity
Risk – Its Relevance To Actuaries).
Insurance risk. The nature of insurance involves the assumption and
pooling of risk. Many life insurance contract types, e.g. unit-linked savings
vehicles, in effect repackage most of the risks and pass them back to
policyholders. But some life insurance contract types, e.g. mortality or
disability protection business and arguably annuity business may involve a
greater proportion of the risk implicit in the contracts remaining with the
shareholders (if any). Insurance risk can come in many different forms, many of
which may be largely unhedgeable except via (re)insurance contracts.
Operational risk. Like other financial services organisations, life
insurers are also exposed to operational risks. Given their often substantial
interaction with members of the public, and given how life insurance business
is often sold, they have perhaps been more exposed than most other financial
services entities to mis-selling risk. Some of this risk may reflect changing
expectations regarding standards of care that an insurer might owe to its
P.S. Similar types of risk (but in other guises) usually
arise with other types of financial services entities, which may be one
contributory factor in the increasing popularity of the discipline of
Enterprise Risk Management.
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