ACST3059 cheat sheet

.docx

School

Macquarie University *

*We aren’t endorsed by this school

Course

3059

Subject

Finance

Date

Apr 27, 2024

Type

docx

Pages

Uploaded by MagistrateExplorationMole139 on coursehero.com

What do you think are the advantages and disadvantages from the customer perspective of level premiums compared to the Australian YRT approach? Level premium rates are higher during the early years of the policy, but lower after the policy has been in-force for some years. So the advantage of YRT is to maximise the amount of cover that can be purchased for a given premium at the start of the policy when the cover is most needed. By contrast the disadvantage of YRT is that premiums may become unaffordable at older ages when the cover is still needed. What are the main risks that life insurance companies face in offering such policies and how might these risks be managed? Claims risks: Claims risks are mis-pricing, statistical variations, and selective lapsing Mis-pricing can arise because of a failure to anticipate health trends e.g. increase in mental illness claims for DI Industry pricing for new business is often more attractive than for renewing existing policies so healthy lives can take out a new policy while unhealthy ones stay with their existing products resulting in a worsening claims experience over time. Risk management: Reinsurance, good claims and underwriting, engaging customers w.g. health rewards Lapse risks: Life companies need policies to stay in-force for a number of years to recover up-front costs including commissions Early lapses result in losses because the costs cannot be recouped. Early lapses can result from churning by planners or from premiums becoming unaffordable Risk management: Reinsurance, tight monitoring and control of churning by each planner Expense risks Management expenses may exceed to expense allowances in the premium rates for existing business Risk management: tight expense control Readings - Facing increasing pressures in health care budgets due to ageing population, chronic illness and disease conditions, enhancing technologies -PHI reduces public contribution to hospital expenditure ad provides Australian with choice but it is heavily regulated -A key regulatory feature of PHI is community rating , which is to charge the same premium regardless of their health status. -Adverse selection profile - The introduction of Medicare led to a decline in PHI coverage due to an adverse selection spiral. Lower- risk individuals dropped out, leading to higher average risk profiles and premiums. -Limitations of PHI – it cannot cover for the services Medicare’s cover for such as GP. -Another problem is second tier default benefit: It allows hospitals without contracts to get paid 85% of what insurers pay other hospitals for similar care. -Restriction – need to get ministerial approval to adjust premium. This creates incentives for “gaming” to charge high premium for it to get accepted -Proposed long term solution involves “managed competitions. Idea like – leaving Medicare and choosing only PHI or having both to create a new health plan. -Transition to Ex Ante Risk Equalization which involves calculating and adjusting payments between insurance companies based on the expected health risks of their policyholders. The goal is to prevent insurance companies from avoiding or selecting healthier individuals, which can lead to imbalances in risk pools and unfair competition In relation to Australia’s banks, what do you think is meant by “ efficiency” ? Australian banks borrow from customers and make loans to other customers This process should be as simple and cost-efficient as possible Cost efficiency relates to the costs of the banks and the costs to customers in dealing with the banks Competition between banks can help to improve efficiency Loans should be allocated to customers who use the funds for the greatest economic benefit for Australia Australia is a net importer of capital. Efficiency means that the banks have ready access to overseas funding on attractive terms Why is there a concern about resilience regarding loans? One risk to banks is that individual customers may default on their loan repayments This can be managed by good loan underwriting, capping LVRs and insurance for customers with high LVRs. And the bank has the security of the asset The main resilience risk is a systemic issue, e.g. economic recession, that leads to increased loan defaults at a time of falling property prices Best defence here is a strong capital position to absorb the losses and allow the banks to continue operating A strong capital position should also allow the banks to be able to continue raising funds (including from overseas) to continue making loans even during the difficult economic conditions How can a mutual bank, that is, a bank without shareholders, demonstrate that it is “ resilient ”? Shareholder banks raise capital from shareholders and price their products to generate a return on capital for their shareholders Mutual companies meet capital requirements through building retained earnings. Customers are charged for a contribution to the build-up of retained earnings as the business grows over time. Fairness passing through interest rate reductions in banks: Bank lending rates are dependent on their borrowing rates which depend on their funding sources – see slide below Funding from Australian sources should relate to the RBA interest rates, But wholesale funding from overseas does not link directly to RBA, Banks need to consider borrowing rates as well as lending rates , In setting mortgage interest rates there are considerations other than funding costs – see slide below, Perceptions of fairness might be enhanced by more transparent disclosures from banks Why do you think Australian superannuation funds “seek greater diversification in sources of risk and return” by investing overseas?  The objective of greater diversification is a higher return for a given risk level or the same return at a lower risk level  This helps members remain comfortable with a long term investment strategy that inevitably has some years of negative returns  While there is some correlation between international markets, they are not 100% correlated  The Australian investment markets are small by world standards and narrow e.g. Australian share index is 50% financial services and lacking in global technology exposure  If investments are all Australian then in the event of a long term recession in Australia, some fund members would lose their jobs as well as value in their super Suggest five (5) steps an Australian superannuation fund might take to ensure “ strong investment governance”.  Trustee Board with independent directors with appropriate experience including in this context investment experience  Trustee receives quality advice on investment strategies, choice of investment managers etc.  The Trustee establishes clear investment mandates for the investment manager (s) consistent with the expectations of members  The Trustee monitors the performance of investment managers including returns and risks, retaining key people, mandate breaches etc.  The Trustee monitors the major investment risk exposures e.g. illiquidity, currency exposure, single asset exposure etc.  The Trustee communicates clearly to members the risks and expected returns and mandates for each investment fund to enable members to make appropriate choices What actions would you suggest other Australian banks should take when the regulatory breach becomes public knowledge? Check that their bank is not guilty of the same breaches of regulations as the bank in the question. Make a thorough review of compliance with all aspects of the AMLTF regulations and deal with shortcomings. Be proactive in communicating the bank’s position to stakeholders – once an issue become high profile all banks will be questioned and there is little benefit in hiding / delaying any bad news. The regulatory breach may result in substantial fines payable by the bank. If the bank were a mutual organisation with no shareholders what issues do you see in paying those fines?  Firstly all regulations must be complied with.  If the regulations are unduly onerous it is open to the bank to lobby for changes.  Use technology to comply with regulations at the lowest long-term cost.  Data analytics can also help in this area to identify potential problem areas for more detailed review. The financial services industry is less than 10% of the Australian economy but represents as much as half of the market capitalisation of companies listed on the ASX. Explain this apparent anomaly. 1. Global Reach: Many Australian financial services companies, especially the largest banks and insurers, have a significant international presence. They conduct business in multiple countries, which means a substantial portion of their revenue and profits is derived from overseas operations. These global operations can greatly inflate their market capitalization compared to their contribution to the domestic economy. 2. Diversification of Services: Financial services companies offer a wide range of financial products and services, including banking, insurance, asset management, wealth management, and investment banking. This diversification allows them to generate revenue from various sources, both domestically and internationally, making th em more resilient to economic downturns. 3. Size and Dominance: Australia's financial sector is characterized by a few large and dominant institutions, often referred to as the "Big Four" banks. These institutions have substantial market capitalization due to their size, brand recognition, and market share. Their size alone can significantly influence the overall market capitalization of the ASX. 4. Investor Attraction: Financial services companies are often viewed as stable, dividend-paying entities with established track records. This attracts a wide range of investors, including institutional investors, retail investors, and foreign investors, who are willing to pay a premium for these stocks. Positive investor sentiment can drive up market capitalization. Outline the rules that apply to both industries in underwriting / accepting new customers and explain why regulators have taken such different approaches to these industries. Underwriting / acceptance Life Insurance  Life insurers are allowed to underwrite new customers for health, occupation and financials (larger cases)  Life companies can accept or reject new customers  Price discrimination must be based on actuarial / statistical evidence Private health insurance  Community rating see slide below Rationale  Life insurance customers choose their own sum insured. This would be an unacceptable level of selection against the insurer if insurers are not allowed to underwrite  Competition should reduce the level of unfair price discrimination. If the industry is overcharging for a particular risk type, it is open for one company to profit by targeting this group  So life insurance companies compete to attract good risks and avoid cross-subsidies between customers  PHI benefits are limited to a reimbursement of a part of hospital costs so there is less anti-selection potential (although members can choose from different levels of cover or no cover)  The government wants PHI to be available simply for those who choose  Customers with high claims are pooled through a “reinsurance” pool Loss ratio  The ratio of incurred claims divided by earned premiums  Adjusted for reinsurance premiums and recoveries  Adjustments to derive NPAT: Management expenses 9including brokerage, Investment earnings (on shareholder funds and technical reserves), Income tax Low inflation environment  For long tail business outstanding claims liabilities are large for the reasons given in the slide below.  The liabilities are calculated by actuaries who make assumptions about the level of inflation and superimposed inflation in the period until the claim is assumed to be settled.  If actual inflation is lower than expected, then the liabilities set up will prove to be too high (other things being equal) and current year profits are increased by releases from the prior year reserves Compare and contrast the roles of banks and super in the Australian financial system. Main point is that bank deposits are mostly short term while super contributions are locked in until retirement This influences lending / investing activities with the potential for super funds to make long term e.g. infrastructure investments This is mitigated by ability of members to switch funds Compare and contrast the liquidity risks faced by banks and superannuation funds respectively. Banks borrow short and invest long e.g. mortgage loans are not easy to liquidate quickly. So liquidity is a major risk for banks which must be managed by a robust liquidity management framework Liquidity risks for super funds should be easier to manage because there is an ongoing inflow of new contributions. Compare and contrast the risk-based capital requirements for banks and superannuation funds respectively. Banks carry significant credit, market, and operational risks so capital requirements are large Super funds pass credit and market risks to customers so the remaining risks are mainly operational. APRA requires super funds to hold an operational risk reserve generally of 25 bps of FUM Compare and contrast the levels of uncertainty in estimating the liabilities you identified in bank and GI balance sheet Bank liabilities The deposit and accrued interest for any customer or lender are known precisely at a given date. Therefore very little uncertainty GI liabilities Some claims can be estimated accurately e.g. claims value finalised and due to be paid in the near future RBU claims have been reported so some information is available about each claim Compare and contrast the liquidity risks faced by banks and general insurance companies respectively. For banks Banks borrow short and invest long e.g. mortgage loans are not easy to liquidate quickly. So liquidity is a major risk for banks which must be managed by a robust liquidity management framework Extreme risk for banks is a run on the bank sparked by e.g. speculation about the financial position of the bank For GI companies Not such a significant problem because premiums are received before claims are paid GI companies need to keep some liquid assets to cover normal variations in claims requirements Week 1 Purpose of the financial system The purpose of the financial system is to facilitate sustainable growth in the economy by meeting the financials needs of its users. To achieve this it must be efficient, resilient and fair. Purpose of the banking system - Banks allocate funds from savers to borrowers in an efficient manner. Funds should be allocated to achieve maximum economic benefit for the community Purpose of insurance industry – provide products which enable individuals and business to manage risk Purpose of superannuation industry – to provide retirement income. The key aspect are: ageing population, size and growth and long term capital. Advantages of the Australian Approach (Self-Regulation): Industry Expertise: Actuaries are experts in their field, and self-regulation allows them to develop standards and guidelines that are specific to the unique challenges and intricacies of actuarial work. Flexibility: Self-regulation can be more flexible and responsive to changes in the profession and the market. It allows the profession to adapt quickly to new practices and technologies. Professional Autonomy: Actuaries can maintain a sense of professional autonomy and ownership over their standards and disciplinary processes. Disadvantages of the Australian Approach (Self-Regulation): Conflict of Interest: Self-regulation may create conflicts of interest, as the profession is responsible for policing itself. This could lead to leniency in disciplinary actions or lax standards. Lack of Independence: Critics argue that self-regulation may lack the independence required to hold actuaries accountable for ethical or professional misconduct. Public Trust: Some may question whether self-regulation truly protects the public interest and maintains public trust in the profession. Advantages of the UK Approach (Independent Authority): Independence: An independent authority is more likely to be free from conflicts of interest and external pressures, making it better equipped to make objective decisions in the public interest. Credibility: An independent authority can enhance the credibility of the profession by demonstrating a commitment to rigorous oversight and adherence to high standards. Consistency: Regulatory decisions and standards are likely to be consistent and uniform when handled by an independent authority. Disadvantages of the UK Approach (Independent Authority): Less Industry Specific: An independent authority may lack the industry-specific knowledge and expertise that actuaries possess, potentially leading to regulations that are less tailored to the profession. Bureaucracy: The involvement of an external authority may introduce bureaucracy and slower decision-making processes. Cost: Establishing and maintaining an independent regulatory authority can be costly, and these costs may be passed on to the profession and, indirectly, to clients. 5 steps for good governance  Overall key is good checks and balances, decisions made collectively  Set a governance framework with continuous improvement, clear corporate structure, clear roles for Board and management, create good governance culture  Select Board of directors with appropriate skills, diversity and independence, Chairman should be independent, directors should collectively represent all shareholders, good policy for managing any conflicts  Appropriate Board committees made up of people with relevant skills, committee chairmen should be different from Board chairman, clear charters, may include audit, risk, remuneration  Strong senior management team capable of challenging CEO, especially CFO, CRO, AA, internal audit  External review to challenge senior management e.g. external audit Code of conduct Professional Conduct - An actuary must act with integrity, honesty and due care and in a manner that enhances the reputation of the profession • Advice not knowingly false, misleading or deceptive • Scope for honest differences of opinion between actuaries Professional Experience • CPD – actuaries must maintain their professional knowledge and skills • Passing the exams is only the first step! • Actuaries must have the knowledge and skills to give advice in a particular area Impartiality • Actuaries must exercise independent professional judgment and give impartial advice • Actuaries may adopt an advocacy position if this is clear to all parties • Actuaries must not act if there are unreasonable constraints placed on the advice Conflicts of Interest - Conflicts may relate to an actuary’s personal interests, interests of his / her firm and duties to another client • Ideally conflicts are avoided • Sometimes OK to act with full disclosure to all parties • Remuneration must be disclosed to principal

Week 3 – superannuation and banking Superannuation: The key stakeholders: Trustee, employer and members. DC Risks  Failure to Comply with Investment Mandates: DC plans often offer a range of investment options for participants to choose from. There is a risk that participants may not fully understand their investment choices or may deviate from their chosen investment strategy, leading to suboptimal returns and potentially falling short of retirement goals.  Unit Pricing / Crediting Rate Risks: In DC plans, participants' contributions are invested in various funds, and their account balances grow based on unit pricing or crediting rates. Fluctuations in market values or interest rates can impact these rates, affecting the growth of participants' retirement savings.  Business Continuity Risks: DC plans are administered by plan sponsors, which can be organizations or employers. Business continuity risks, such as financial instability or changes in management, could impact the plan's administration, leading to disruptions or uncertainties for participants.  Fraud Risks: Fraudulent activities, such as identity theft, unauthorized access to accounts, or misappropriation of funds, can jeopardize participants' retirement savings and erode trust in the plan.  Outsourcing Risks: Many DC plans involve outsourcing certain administrative functions, like recordkeeping or investment management. While outsourcing can offer efficiencies, it introduces risks related to the reliability, security, and performance of third-party service providers.  Regulation / Compliance Risks: DC plans are subject to various regulations and compliance requirements, including contribution limits, vesting rules, and reporting obligations. Non- compliance can result in penalties, legal liabilities, and reputational damage.  Liquidity Risks: Participants may have the ability to withdraw or borrow from their DC accounts. While this flexibility can provide access to funds in emergencies, it also poses the risk of participants depleting their retirement savings prematurely. Defined benefits – the classical control cycle Membership data  CA  choose the model  choose the assumptions  calculate employer contribution  monitor experience Governance of superannuation Trustee Structure: Trustee Boards: Superannuation funds typically have trustee boards responsible for overseeing the fund's activities, investments, and compliance with regulations. Independent Directors: Many funds have independent directors on their boards to ensure unbiased decision- making and protect the interests of members. Fiduciary Duty: Trustees have a fiduciary duty to act in the best interests of fund members. Investment Governance: Investment Strategy: Funds must have a well-defined investment strategy aligned with the fund's objectives and risk tolerance. Risk Management: Effective risk management is essential to ensure the security of members' investments. Diversification: Funds often diversify their investments across various asset classes to spread risk. Member Engagement: Communication: Funds should regularly communicate with members, providing information about account balances, investment options, fees, and fund performance. Education: Offering financial literacy and retirement planning resources helps members make informed decisions. Compliance and Regulatory Oversight: Regulatory Compliance: Superannuation funds must adhere to the Superannuation Industry (Supervision) Act and other relevant regulations. Prudential Oversight: The Australian Prudential Regulation Authority (APRA) oversees prudential standards and financial stability. Issues for superannuation industry  “Endless” Regulatory and Tax Change: Frequent changes in regulations and tax laws can create complexities for both superannuation funds and their members. Adapting to these changes requires continuous adjustments to operations and member communication.  Governance Issues / Independence: Ensuring effective governance and independence within superannuation funds is crucial for maintaining member trust and making decisions that prioritize members' best interests.  Occasional Fraud (Trio Capital) / Industry Levy: Instances of fraud, like the Trio Capital case, highlight vulnerabilities in the industry. The government's introduction of an industry levy helps fund compensation and protects members' interests.  APRA Focus on Member Outcomes: The Australian Prudential Regulation Authority (APRA) has been actively emphasizing the importance of member outcomes, aiming to ensure that funds focus on delivering value to members in terms of returns, fees, and services.  Royal Commission Findings: The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry identified conflicts of interest and fee overcharging, particularly in retail funds. This has prompted the industry to address these issues and improve transparency.  COVID-19 and Member Withdrawals: The COVID-19 pandemic led to a government initiative allowing members to access a portion of their superannuation early. While this provided financial relief to some, it raised concerns about the long-term impact on retirement savings. Base 1: Under the Basel framework, credit risk for mortgages typically falls into a risk-weight category of 35% to 50%. The specific risk weight depends on factors such as the loan-to-value (LTV) ratio, the borrower's creditworthiness, and any additional risk mitigants. A risk weight of 50% indicates that banks need to hold capital equivalent to 50% of the outstanding mortgage amount to cover potential losses. Base 2: credit risk 35% to 100% depends on: •Documentation of Borrower's Income: The accuracy and adequacy of documentation regarding the borrower's income play a role in assessing the credit risk. Higher-quality documentation reduces the risk of default. Mortgages with well-documented borrower income might attract a lower risk weight and therefore require less capital. •Property Valuation Method: The method used to value the property associated with the mortgage impacts the loan's risk. Accurate and conservative property valuations reduce the potential loss in case of default. Mortgages backed by properties with reliable valuations might have lower risk weights and capital requirements. •Loan to Value Ratio (LVR): The LVR compares the loan amount to the property's value. A higher LVR implies a larger loan relative to the property's value and increases the risk of default. Mortgages with lower LVRs, indicating a higher equity contribution, might receive lower risk weights. •Mortgage Insurance: Mortgage insurance reduces the lender's risk in case of borrower default. Mortgages with mortgage insurance coverage might have lower risk weights, reflecting the lower overall risk. •In Arrears or Not: Loans that are in arrears (behind on payments) pose higher credit risk. Mortgages that are up-to-date on payments are generally considered lower risk and might receive favorable risk weightings. Governance Board of Directors: Independence: Boards should have a sufficient number of independent directors who are not involved in the day-to-day operations of the bank to ensure objective decision-making. Expertise: Directors should possess the necessary skills and experience to oversee the bank's activities, including risk management, finance, and compliance. Oversight: Boards are responsible for setting the bank's strategic direction, approving major policies, and monitoring the performance of senior management. Risk Management: Risk Culture: Banks should foster a risk-aware culture where all employees understand and take responsibility for risk management. Risk Committees: Banks often have dedicated risk committees on their boards responsible for overseeing risk management practices. Stress Testing: Regular stress testing and scenario analysis help banks assess their resilience to adverse economic conditions. Compliance and Regulatory Oversight: Regulatory Compliance: Banks must adhere to all relevant banking laws and regulations and maintain robust compliance programs. Regulatory Reporting: Accurate and timely reporting to regulatory authorities is crucial for transparency and accountability. Ethical Conduct and Corporate Responsibility: Ethical Standards: Banks should establish and enforce ethical standards and codes of conduct for employees and management. Corporate Social Responsibility: Banks are increasingly expected to consider environmental, social, and governance (ESG) factors in their operations and lending practices. Internal Controls: Internal Audit: Banks should have internal audit functions to assess the adequacy of internal controls and risk management processes. Segregation of Duties: Separation of duties within the bank helps prevent conflicts of interest and fraud. Variable rate mortgage pricing RBA rates and funding costs  capital requirement  choose the model  choose the assumptions  set mortgage interest rates  monitor experience Assumptions in pricing variable rate mortgages • Funding costs • Establishment and maintenance costs • Cost of loan defaults, payment delays • Loan repayment behaviour • Cost of capital • Profit margin required Recent issues for banking  Murray Committee of Inquiry - "Unquestionably Strong" Requirement: The Murray Financial System Inquiry, also known as the Murray Committee of Inquiry, was conducted in Australia to examine the overall stability and efficiency of the financial system. One of the key recommendations from the committee was the implementation of the "unquestionably strong" capital requirement for banks. This refers to the need for banks to hold a sufficient amount of capital to ensure their stability and ability to withstand economic shocks.  Compliance Breaches (e.g., AUSTRAC): The Australian Transaction Reports and Analysis Centre (AUSTRAC) is responsible for monitoring and regulating financial transactions to prevent money laundering and terrorism financing. Several Australian banks have faced compliance breaches related to AUSTRAC regulations. These breaches can result in significant fines and reputational damage for the banks involved.  Exit from Life Insurance/Advice: Some banks have been divesting from certain non-core businesses, such as life insurance and financial advice services. This is often part of a strategic shift to focus on core banking activities and streamline operations.  Royal Commission - Poor Value and Service: The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, commonly known as the Banking Royal Commission, was a major inquiry in Australia that uncovered widespread misconduct and poor practices within the financial sector. The commission's findings highlighted instances of poor value and service provided to customers by various financial institutions.  COVID-19 and Loan Repayment Deferrals: The COVID-19 pandemic had a significant impact on the economy and individuals' ability to repay loans. Many banks offered loan repayment deferrals to customers facing financial hardships due to the pandemic. This was a measure to provide temporary relief to borrowers, but it also had implications for banks' cash flow and risk management. Week 2 Insurance company structure:  Board of Directors and Senior Management: Board of Directors: The governing body that oversees the company's strategic direction, policies, and major decisions. Senior Management: The top executives responsible for managing the company's day-to-day operations and implementing the strategies set by the board.  Underwriting: The process of evaluating insurance applications, assessing risks, and determining the terms and pricing of insurance policies. Underwriters use various factors to evaluate risks and decide whether to provide coverage.  Claims: This department handles customer claims, which involve assessing the validity of claims, processing claims payments, and managing interactions between policyholders and the company in the event of covered losses.  Business Support & Development: This department focuses on expanding the company's market presence and improving its operations. It might involve identifying new business opportunities, partnerships, and strategies for growth.  Finance, Investment, and Treasury: Finance: Manages the company's financial operations, including budgeting, financial reporting, and managing financial risks. Investment: Oversees the management of the company's investment portfolio to ensure prudent and profitable investments. Treasury: Manages the company's cash flows, liquidity, and financial assets.  Actuarial and Risk Management: Actuarial: Utilizes mathematical and statistical models to assess risks and determine pricing for insurance products. Actuaries play a key role in setting insurance premiums and reserves. Risk Management: Identifies, assesses, and manages various types of risks that the company faces, including operational, financial, and regulatory risks.  Sales and Marketing: This department is responsible for promoting and selling insurance products to potential policyholders. It involves market research, developing marketing strategies, and maintaining relationships with agents and brokers.  Human Resources and Policy: Human Resources: Manages employee recruitment, training, benefits, and overall organizational development. Policy: Develops and enforces company policies and procedures, ensuring compliance with regulations and ethical standards Recent issues to life insurance  . Bank Sales of Life Insurance Subsidiaries: Many banks in various countries, including Australia, have divested their life insurance subsidiaries to overseas groups. This trend has led to a reduction in the number of Australian- owned life insurance companies, potentially impacting market competition and customer options.  Regulatory Changes: Regulatory changes can have significant effects on the life insurance industry. These changes can impact product offerings, distribution channels, pricing, and overall business models. Reduced sales volumes due to regulatory changes can also affect profitability and market dynamics.  Poor Claims and Lapse Experience: Losses reported by life insurance companies resulting from poor claims and lapse experiences can be detrimental to their financial stability. Claims experience that deviates from projections or policies lapsing earlier than expected can lead to financial strain and necessitate adjustments in pricing and product design.  Sustainability of Disability Income Products: Disability income products are designed to provide financial support to policyholders in case they are unable to work due to disabilities. However, the sustainability of these products can be challenged by factors such as changing customer needs, rising claims costs, and regulatory changes. Ensuring the long-term viability of these products while meeting customer needs can be complex.  Pandemic Impact (2020-2022): The COVID-19 pandemic has brought unprecedented challenges to the insurance industry, including life insurance. Insurers had to grapple with uncertainties related to claims related to the pandemic, changes in customer behavior, and financial market volatility. There might have been increased claims for life insurance policies due to pandemic-related deaths, and changes in the way insurers operate due to remote work and digitalization. Recent issues for GI  Availability and Affordability: Ensuring that insurance coverage remains available and affordable to a wide range of customers is an ongoing concern. Balancing risk assessment with accessibility can be challenging, particularly for high-risk areas or industries.  Climate Change Effects: Climate change has led to more frequent and severe weather events, impacting insurance claims due to increased property damage and other related losses. Insurance companies are facing challenges in accurately assessing and pricing climate-related risks.  Increased Claims Due to Climate Change: The effects of climate change, such as more frequent and severe storms, wildfires, and flooding, have resulted in increased claims for insurance companies. This has financial implications for the industry as it needs to address these growing claims.  Digital Disruption: The insurance industry is undergoing significant digital disruption, with advancements in technology affecting distribution channels, customer engagement, underwriting, and claims processing. Insurers need to adapt to these changes to remain competitive. Recent issues for the reinsurance industry Financial Reinsurance (HIH, Zurich): Financial reinsurance, which includes transactions like those undertaken by HIH Insurance and Zurich, has been a source of concern. These transactions involve complex financial instruments and accounting practices, and issues may arise when they are not properly disclosed or understood. Regulatory authorities have been scrutinizing such practices to ensure transparency and compliance with accounting standards. Delays in Reported Claims (Asbestosis): Delays in reported claims, particularly those related to long-tail liabilities like asbestos-related claims (asbestosis), have been a challenge for the reinsurance industry. These claims can take many years to materialize, making it difficult to estimate and reserve for potential liabilities accurately. Excess of Reinsurance Capacity - Competition from Catastrophe Bonds: The reinsurance industry has faced increasing competition from alternative capital sources, such as catastrophe bonds and insurance-linked securities (ILS). These vehicles provide alternative risk transfer mechanisms, often at competitive rates. This excess capacity has put pressure on traditional reinsurance pricing and profitability. Competing in the Direct Market: Reinsurers have increasingly entered the primary insurance market, competing directly with insurers. This blurring of lines between reinsurers and insurers has created challenges related to market positioning, underwriting discipline, and risk management. Recent Catastrophe and Disability Claims: Catastrophic events, including natural disasters like hurricanes and wildfires, have led to significant claims for both primary insurers and reinsurers. Additionally, an increase in disability claims has put pressure on the reinsurance industry, particularly given the ongoing challenges of accurately assessing and pricing long-term disability risks. Pandemic 2020-22: The COVID-19 pandemic has been one of the most significant challenges to the reinsurance industry. It created uncertainties and complexities in assessing and managing risk. Key pandemic-related issues include business interruption claims, event cancellation coverage, and potential future pandemic risk. To elaborate on the COVID-19 pandemic: Business Interruption Claims: Insured businesses sought coverage for financial losses due to pandemic-related closures. The interpretation of policy wordings, legal disputes, and regulatory responses have created uncertainty and financial exposure for insurers and reinsurers. Event Cancellation Coverage: The cancellation of major events, such as sports events and conferences, led to substantial claims under event cancellation policies. These claims have highlighted the need for reinsurance companies to carefully assess and manage their exposure to such risks. Future Pandemic Risk: Insurers and reinsurers are now reevaluating their pandemic risk management strategies, including the development of new products, better risk modeling, and enhanced stress testing to prepare for potential future pandemics. In response to these challenges, the reinsurance industry continues to evolve, with a focus on risk modeling and analytics, innovation in products and coverage, and a more comprehensive understanding of emerging risks like pandemics. Regulatory bodies also play a critical role in ensuring the industry's resilience and adherence to prudent risk management practices. Recent issues for the PHI industry Commonwealth Government Policy to Reduce Payments to PHI: The Australian government has been implementing policies to reduce its subsidies and payments to the private health insurance industry. These policies include measures to slow the growth of premium increases and to limit the range of treatments covered by insurance. These changes can impact the affordability and attractiveness of private health insurance for consumers. Insurers Developing Preventative, Health Maintenance, and Cost Control Programs: Private health insurers are increasingly focusing on preventative health programs and initiatives aimed at improving policyholders' health and controlling healthcare costs. These programs may include wellness initiatives, telehealth services, and partnerships with healthcare providers to offer cost-effective care. Risk Equalisation Needs Flexibility to Respond to Changes in Hospital Benefits: Risk equalisation is a mechanism in Australia's private health insurance system designed to ensure that insurers are compensated for taking on higher-risk policyholders. The industry has been discussing the need for greater flexibility in risk equalisation arrangements to respond to changes in hospital benefits and the cost of healthcare services. Increased Public Spending on Public Hospitals and Dental Services: Public spending on public hospitals and dental services can impact the demand for private health insurance. If the public healthcare system provides comprehensive and timely services, some individuals may question the need for private health insurance, potentially leading to a reduction in PHI membership. Week 5 Community rating Community rating is a principle in health insurance that requires insurers to charge the same premium to all applicants, regardless of their health status or other risk factors Fund cannot refuse new members – waiting periods to deter short term “hit and run” members – they can impose waiting periods for certain benefits, such as hospital coverage. This is to deter people from joining a fund just to get coverage for a specific procedure, and then leaving the fund after the procedure is done. Funds must renew insurance irrespective of claims history – they need to renew regardless of how many claims were made in the past. This is to make sure there is no discrimination against the people who are sick and need medical attention Members can change funds (for similar benefits) without serving a new waiting period Premium rates must not discriminate by Health status (including previous hospitalisation) Lifestyle choices Age, race or gender Other risk factors What do you think are the advantages and disadvantages of community rating for PHI? Why does it work at all? Advantages:  Ensures everyone has access to affordable health insurance: This is because premiums are not based on health status, so everyone pays the same regardless of their risk. This can help to prevent people from being denied health insurance or charged higher premiums because of their health status.  Prevents discrimination: This is because premiums cannot be based on health status, lifestyle choices, age, race, gender, or other risk factors. This can help to ensure that everyone is treated fairly and equally when it comes to health insurance.  Makes it easier to shop around for the best plan: This is because premiums are the same for everyone, so people can compare plans based on other factors, such as coverage, benefits, and customer service. Disadvantages:  Can be expensive for healthy people: This is because healthy people are subsidizing the cost of insurance for sicker people. This can make it difficult for healthy people to afford health insurance.  Can lead to adverse selection: This is when healthy people choose not to buy health insurance because they know they will have to pay the same premiums as sicker people. This can lead to an increase in premiums for everyone.  Can be difficult to manage: This is because insurers have to pool the risk of a large group of people, which can be difficult to do accurately. This can lead to insurers making losses or charging higher premiums than necessary. Reinsurance Premiums certified by actuaries Define product benefits  analyse experience  review competition  choose the assumptions  calculate premiums  government approval Why buy reinsurance?  To make efficient use of capital: Reinsurance can help insurers to free up capital that can be used for other purposes, such as investing or issuing new policies.  To smooth earnings volatility: Reinsurance can help to smooth out the volatility of an insurer's earnings by transferring some of the risk of large claims to the reinsurer.  To limit the impact of catastrophic events: Reinsurance can help to limit the impact of catastrophic events, such as hurricanes or earthquakes, on an insurer's financial performance.  To limit risk concentration: Reinsurance can help to limit the risk concentration of an insurer's portfolio by spreading the risk across a wider range of reinsurers.  To support growth / increase business capacity: Reinsurance can help insurers to support growth by providing them with the capacity to underwrite more business.  Tax efficiency: Reinsurance can sometimes be used to achieve tax efficiency, such as by transferring the risk of a loss to a reinsurer in a different tax jurisdiction.  Technical support: Reinsurance can provide insurers with technical support, such as expertise in assessing and managing risk. The benefits of such arrangements for the direct insurer include:  Reduced risk: The direct insurer can reduce its risk by transferring a portion of the risk to the reinsurer. This can help to protect the direct insurer from financial losses in the event of a large claim.  Improved capital management: The direct insurer can improve its capital management by transferring some of the risk to the reinsurer. This can free up capital that can be used for other purposes, such as investing or issuing new policies.  Increased capacity: The direct insurer can increase its capacity by transferring some of the risk to the reinsurer. This can allow the direct insurer to underwrite more business and grow its market share. The benefits of such arrangements for the reinsurer include:  Spreading of risk: The reinsurer can spread its risk by taking on a portion of the risk from a number of different direct insurers. This can help to protect the reinsurer from financial losses in the event of a large claim.  Earnings diversification: The reinsurer can diversify its earnings by taking on a portion of the risk from a variety of different types of policies. This can help to protect the reinsurer from fluctuations in the insurance market.  Access to new markets: The reinsurer can gain access to new markets by taking on a portion of the risk from direct insurers in other countries. This can help the reinsurer to grow its business and expand its global reach. Risk for reinsurers:  Little data for pricing risks: Reinsurers often have limited data on the risks that they are insuring. This can make it difficult to accurately price the risk and set premiums that are fair to both the reinsurer and the direct insurer.  Low claims frequency: Reinsurers typically earn premiums over a long period of time, but they may only pay out claims infrequently. This can make it difficult for reinsurers to generate enough cash flow to cover their expenses and make a profit.  High claims severity: When claims do occur, they can be very large. This can put a strain on reinsurers' financial resources and make it difficult for them to meet their obligations to the direct insurers.  Delays in reporting claims: Reinsurers may not be notified of claims as soon as they occur. This can delay the settlement of claims and make it difficult for reinsurers to manage their risk.  Reliance on direct insurer for underwriting standards and quality of the business: Reinsurers rely on direct insurers to underwrite their risks properly and to provide quality business. If the direct insurer does not underwrite the risks properly, the reinsurer could be exposed to losses. Life insurers are exposed to pandemic risk (such as Covid-19). Reinsurers do not provide protection against such catastrophe events. Why is this?  The risk is too unpredictable: Pandemics are rare and unpredictable events. This makes it difficult for reinsurers to accurately assess the risk and set premiums that are fair to both the reinsurer and the direct insurer.  The potential losses are too large: When a pandemic occurs, the potential losses can be very large. This could put a strain on reinsurers' financial resources and make it difficult for them to meet their obligations to the direct insurers.  The risk is not insurable: Some experts believe that pandemic risk is not insurable. This is because it is a systemic risk, meaning that it could affect a large number of people and businesses at the same time. This could make it difficult for reinsurers to spread the risk and manage their exposure  Availability and Affordability: Ensuring that insurance coverage remains available and affordable to a wide range of customers is an ongoing concern. Balancing risk assessment with accessibility can be challenging, particularly for high-risk areas or industries.  Climate Change Effects: Climate change has led to more frequent and severe weather events, impacting insurance claims due to increased property damage and other related losses. Insurance companies are facing challenges in accurately assessing and pricing climate-related risks. Catastrophe risk modelling control cycle Define hazard, location  analyse the data  choose the model  likelihood and PML  calculate premiums  monitor experience Concerns of a regulator about catastrophe modelling: Catastrophe models are used to set the retention levels of direct companiesIf the models understate the risks, the reinsurance cover may prove inadequate and imperil the solvency of the insurerAll models have their limitations so insurers should understand the limits of the models they are using.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help