Australian School of Business

Actuarial Theory & Practice A - Weeks 12/13

Review and revision

Anthony Asher 2016

Operational Risks
What are the causes, the data sources, and the most likely statistical
distribution that could be used for:
Internal Fraud - misappropriation of assets, tax evasion, intentional
mismarking of positions, bribery?
External Fraud- theft of information, hacking damage, third-party theft and
forgery?
Employment Practices and Workplace Safety - discrimination, workers
compensation, employee health and safety?
Clients, Products, & Business Practice- market manipulation, antitrust,
improper trade, product defects, fiduciary breaches, account churning?
Damage to Physical Assets - natural disasters, terrorism, vandalism?
Business Disruption & Systems Failures - utility disruptions, software
failures, hardware failures?
Execution, Delivery, & Process Management - data entry errors, accounting
errors, failed mandatory reporting, negligent loss of client assets?

2/16

Other risks
What would be covered by strategic risk?

How would you measure it?

What distribution would you use?

What type of risk is lapse risk?

How would you measure it?

What distribution would you use?

What type of risk is regulatory risk?

How would you measure it?

What distribution would you use?

Would you classify the following risks in categories above or previous slides?

3/16

Implementation risk
Contagion and related party risk
Competition risk
Legal and judicial risk
Technology change risk
Extreme events risk
Social attitudes risk
Environmental change risk

Discussion Topic 1
What are the major risks in PI contracts and how would you manage these?

4/16

Discussion Topic 2
How are policy conditions, underwriting and claims related?

5/16

Assignment comments 1

Data: Library Bloomberg

Big banks vs other banks and insurers
Need to take a longer term perspective
o Commodities high only after 2000
o Major bank crises in (1893, 1931, 1977?, 1993)
o Retailers, Telstra

Comparisons industry or international

o ROE vs COE adjusted for risks and losses
o Tobins Q
o Jensens alpha

6/16

Assignment comments 2

Economic (monopoly) rents are unethical:

o
o
o
o

Regulation
o
o
o
o

Serve no social purpose (not deserved)

Undermine trust, as they exploit customers/suppliers
Distort the political process
Allow for excessive remuneration/undermines equality & fairness

Barriers to entry excessive capital, complexity

Empower consumers disclosure, freedom of movement
Consumer protection unconscionable conduct
Limit product design, prices

A picture worth a thousand words

o Check numbers; label axes and lines
o Clearly allowing for red/green colour blind and printing without colour

7/16

Risk and reward

How do utility functions measure the trade-off?
Can you have utility free trade-offs?
What is the difference between risk aversion and ambiguity aversion?
What are background risks?

8/16

Risk relevance
How do you measure the size of a risk?
What are the biggest risks for:
Retail banks?
Investment banks?
Life insurance companies?
General Insurance companies?
Health insurance companies?
Defined contribution superannuation funds?
Defined benefit superannuation funds?
Financial conglomerates?
Mines?
Manufacturing companies?

9/16

Discussion questions 3 - 5
How would you decide whether to have a high return/ high
risk investment strategy and a low return/ low risk
strategy?
How would you decide how much reinsurance to hold?
If you were a general insurer and just suffered a heavy
underwriting loss as a result of an extreme event so that
both profit and capital were down, would you then
increase reserves as well and exacerbate the loss?

10/16

Sample question 1
You are the CFO of a mobile phone operator in Australia.
What are the main financial risks faced by the company?
How would you use the actuarial control cycle to determine
the value of different groups of clients and to monitor
changes in value?
How would you determine the economic capital
requirements of the company?

11/16

Sample question 2
QANTAS has a frequent flyer program where customers
accumulate points when they buy tickets from QANTAS,
and also when they use QANTAS branded credit cards and
buy from some QANTAS partners. The number of points
required for different flights is changed from time to time
mainly to increase the number required and points expire
after a number of years. Points can be used for flights from
QANTAS and their partner airlines. How would you use the
actuarial control cycle to manage the frequent flyer
program? [13]

12/16

Sample Question 3
Extreme risks are difficult to model as their frequency is low
and their severity high. In assessing these risks, financial
institutions can use their own data, external data (collected
from the industry) and expert opinion, or a combination of
these sources. In estimating the extreme risk of an
administration organisation to whom the administration of a
superannuation fund has been outsourced, which source(s)
would you consider more appropriate than the other(s) and
set out your reasons for your conclusion

13/16

Sample Question 4
You are approached by the Helicopter Pilots Association to
issue a contract insuring all member pilots for $1 million if
they are killed or permanently disabled whilst flying a
helicopter.
Set out with reasons whether you would use heavy (a lot of
questions) underwriting or light (very few questions)
underwriting.
Set out with reasons the type of reinsurance program you
might establish for this business.

14/16

Sample Question 5
A general insurer is proposing to issue a new contract to
insure superannuation fund trustees that are licensed in
Australia by APRA against breach of their licence
conditions. This type of contract has not been issued in
Australia previously.
Outline the major risks faced by the insurer in issuing this
contract and how you would manage these risks.

15/16

Sample Question 6
You are an actuarial consultant who has been asked to write a report for the
trustees of a large industry superannuation fund in Queensland. The fund
currently only offers allocated pensions and level term annuities, which are
underwritten by a life insurance company. The report is to explain the need to
introduce an inflation linked life annuity product for their retiring members and
how the fund might go about introducing such a product. Set out what you
would include in your report.

16/16