Extreme Events – Specimen Answer A.8.2(c) – Answer/Hints

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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


         i.            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.


       ii.            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.


      iii.            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).


     iv.            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.


       v.            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 customers.


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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