Bảo hiểm - Chapter 4: Advanced topics in risk management

Chapter 4Advanced Topics in Risk ManagementAgendaThe Changing Scope of Risk ManagementEnterprise Risk ManagementInsurance Market DynamicsLoss ForecastingFinancial Analysis in Risk Management Decision MakingOther Risk Management ToolsThe Changing Scope of Risk ManagementToday, the risk manager’s job:Involves more than simply purchasing insuranceIs not limited in scope to pure risksThe risk manager may be using:Financial risk management Enterprise risk managementThe Changing Scope of Risk Management Financial Risk Management refers to the identification, analysis, and treatment of speculative financial risks:Commodity price risk is the risk of losing money if the price of a commodity changes Interest rate risk is the risk of loss caused by adverse interest rate movementsCurrency exchange rate risk is the risk of loss of value caused by changes in the rate at which one nation's currency may be converted to another nation’s currency Financial risks can be managed with capital market instrumentsExhibit 4.1 Managing Financial Risk—Two ExamplesExhibit 4.1 Managing Financial Risk—Two ExamplesThe Changing Scope of Risk ManagementAn integrated risk management program is a risk treatment technique that combines coverage for pure and speculative risks in the same contractA double-trigger option is a provision that provides for payment only if two specified losses occurSome organizations have created a Chief Risk Officer (CRO) positionThe chief risk officer is responsible for the treatment of pure and speculative risks faced by the organizationEnterprise Risk ManagementEnterprise Risk Management (ERM) is a comprehensive risk management program that addresses the organization’s pure, speculative, strategic, and operational risksStrategic risk refers to uncertainty regarding an organization’s goals and objectivesOperational risks are risks that develop out of business operations, such as product manufacturingAs long as risks are not positively correlated, the combination of these risks in a single program reduces overall risk Nearly half of all US firms have adopted some type of ERM programBarriers to the implementation of ERM include organizational, culture and turf battles The Financial Crisis and Enterprise Risk ManagementThe US stock market dropped by more than fifty percent between October 2007 and March 2009The meltdown raises questions about the use of ERM Only 18 percent of executives surveyed said they had a well-formulated and fully-implemented ERM programExhibit 4.2 Timeline of Events Related to the Financial CrisisThe Financial Crisis and Enterprise Risk ManagementAIG mentions an active ERM program in its 2007 10-K ReportRiskiness of the Financial Products Division was not fully appreciatedThe division was issuing credit default swapsA credit default swap is an agreement in which the risk of default of a financial instrument is transferred from the owner of the financial instrument to the issuer of the swapThe default rate on mortgages soared and the company did not have the capital to cover guaranteesThe lessons learned by risk managers from the financial crisis will influence ERM in the futureInsurance Market Dynamics Decisions about whether to retain or transfer risks are influenced by conditions in the insurance marketplaceThe Underwriting Cycle refers to the cyclical pattern of underwriting stringency, premium levels, and profitability“Hard” market: tight standards, high premiums, unfavorable insurance terms, more retention“Soft” market: loose standards, low premiums, favorable insurance terms, less retention One indicator of the status of the cycle is the combined ratio:Exhibit 4.3 Combined Ratio for All Lines of Property and Liability Insurance, 1956–2008*Insurance Market DynamicsMany factors affect property and liability insurance pricing and underwriting decisions:Insurance industry capacity refers to the relative level of surplusSurplus is the difference between an insurer’s assets and its liabilities Capacity can be affected by a clash loss, which occurs when several lines of insurance simultaneously experience large lossesInvestment returns may be used to offset underwriting losses, allowing insurers to set lower premium ratesInsurance Market DynamicsThe trend toward consolidation in the financial services industry is continuingConsolidation refers to the combining of businesses through acquisitions or mergersDue to mergers, the market is populated by fewer, but larger independent insurance organizationsThere are also fewer large national insurance brokeragesAn insurance broker is an intermediary who represents insurance purchasersCross-Industry Consolidation: the boundaries between insurance companies and other financial institutions have been struck downFinancial Services Modernization Act of 1999Some financial services companies are diversifying their operations by expanding into new sectorsCapital Market Risk Financing AlternativesInsurers are making increasing use of capital markets to assist in financing riskSecuritization of risk means that insurable risk is transferred to the capital markets through creation of a financial instrument:A catastrophe bond permits the issue to skip or defer scheduled payments if a catastrophic loss occursAn insurance option is an option that derives value from specific insurance losses or from an index of values.A weather option provides a payment if a specified weather contingency (e.g., high temperature) occursThe impact of risk securitization is an increase in capacity for insurers and reinsurersIt provides access to the capital of many investorsExhibit 4.4 Catastrophe Bonds: Annual Number of Transactions and Issue SizeLoss ForecastingThe risk manager can predict losses using several different techniques:Probability analysisRegression analysisForecasting based on loss distributionOf course, there is no guarantee that losses will follow past loss trendsLoss ForecastingProbability analysis: the risk manager can assign probabilities to individual and joint events The probability of an event is equal to the number of events likely to occur (X) divided by the number of exposure units (N)May be calculated with past loss dataTwo events are considered independent events if the occurrence of one event does not affect the occurrence of the other eventTwo events are considered dependent events if the occurrence of one event affects the occurrence of the otherEvents are mutually exclusive if the occurrence of one event precludes the occurrence of the second eventLoss ForecastingRegression analysis characterizes the relationship between two or more variables and then uses this characterization to predict values of a variable For example, the number of physical damage claims for a fleet of vehicles is a function of the size of the fleet and the number of miles driven each yearExhibit 4.5 Relationship Between Payroll and Number of Workers Compensation ClaimsLoss ForecastingA loss distribution is a probability distribution of losses that could occur Useful for forecasting if the history of losses tends to follow a specified distribution, and the sample size is largeThe risk manager needs to know the parameters of the loss distribution, such as the mean and standard deviationThe normal distribution is widely used for loss forecastingFinancial Analysis in Risk Management Decision MakingThe time value of money must be considered when decisions involve cash flows over timeConsiders the interest-earning capacity of money A present value is converted to a future value through compoundingA future value is converted to a present value through discountingRisk managers use the time value of money when:Analyzing insurance bids Making loss control investment decisionsThe net present value is the sum of the present values of the future cash flows minus the cost of the projectThe internal rate of return on a project is the average annual rate of return provided by investing in the projectOther Risk Management ToolsA risk management information system (RMIS) is a computerized database that permits the risk manager to store and analyze risk management dataThe database may include listing of properties, insurance policies, loss records, and status of legal claims Data can be used to predict and attempt to control future loss levelsRisk Management Intranets and Web SitesAn intranet is a web site with search capabilities designed for a limited, internal audienceA risk map is a grid detailing the potential frequency and severity of risks faced by the organizationEach risk must be analyzed before placing it on the mapOther Risk Management ToolsValue at risk (VAR) analysis involves calculating the worst probable loss likely to occur in a given time period under regular market conditions at some level of confidenceThe VAR is determined using historical data or running a computer simulationOften applied to a portfolio of assetsCan be used to evaluate the solvency of insurersCatastrophe modeling is a computer-assisted method of estimating losses that could occur as a result of a catastrophic eventModel inputs include seismic data, historical losses, and values exposed to losses (e.g., building characteristics)Models are used by insurers, brokers, and large companies with exposure to catastrophic loss