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Marshall: Risk margin assesment

Study Strategy

Checklist

  1. Be able to explain why we need a risk margin
  2. Know how to prepare a portfolio by segmenting into homogenous, credible classes
  3. Be able to list and define the three main components of risk
    • Independent risk
      • Know and be able to define the two components
      • Be able to explain how to model this risk
    • Internal systemic risk
      • Know and be able to define the three components
      • Be able to estimate risk using a balanced scorecard approach
      • Know the potential risk indicators and which component they fall under
      • Be able to analyze a CoV mapping for reasonability
    • External systemic risk
      • Know and be able to define the components
      • Be able to describe how to quantify risk
  4. Be able to describe where we are likely to see correlation in our analysis
  5. Know why internal systemic risk correlation occurs
  6. Be able to describe the impact of higher/lower correlations on the CoV
  7. Be able to consolidate CoVs for each class, liability and risk type into a single CoV
  8. Be able to describe when it might be appropriate to use the LogNormal vs the Normal distribution
  9. Be able to calculate the risk margin as both a percent and in dollars
  10. Be able to describe the types of additional analysis that may need to be performed
    • Sensitivity testing
    • Scenario testing
    • Internal benchmarking
    • External benchmarking
    • Hindsight analysis
  11. Be able to explain when a review of the process should be done

My Notes

The framework talks about the following stuff

Portfolio

We have to segment the portfolio into groups (classes) for the risk assessment analysis with enough granularity to balance the homogeneity of data with the amount of data within each group (class), to keep them credible.

We may or may not use the same coverage groups as segmented while setting reserves, because

  1. These groups may not have enough credibility of their own
  2. The cost of analysis at such high granularity while using these segments is too high to justify the improvement it brings.

Internal Systematic Risk

  • Three components: SPD
    1. Specification error is the error that arises due to the inability of our model to perfectly model the insurance process
    2. Parameter selection error is the error that arises because the model cannot adequately measure all predictors of the future claim cost outcomes or trends in the predictors
    3. Data error is the error that arises due to lack of credible data
      • Also, inadequate knowledge of the portfolio analyzed
      • …of the pricing, underwriting and claims management processes

External Systematic Risk

Five LOBs

  • Remember PW-MLA-B
  • Property; Workers Comp; Medical Malpractice; Liability; Auto; Builder's Warranty
  1. Legislative risk
    • WC: limit benefit limits or items requiring coverage \(\implies\) increase risk
    • Med: increase max payouts or statute of limitations \(\implies\) more claims
    • Liability: change in law \(\implies\) large number of open claims
    • Auto: impact coverage limits \(\implies\) larger risk
  2. Event risk

Internal Benchmarking

Determine the reasonability of CoVs for the three sources of risk:

  1. Independent risk:
    • Larger the book: smaller the CoV
    • Longer the tail: larger the CoV
    • Premium Liabilities & Outstanding Claims Liabilities1
      • CoV PL \(\gt\) CoV OCL (long-tailed lines)
      • CoV PL \(\lt\) CoV OCL (short-tailed lines)
  2. Internal Systematic Risk
  3. External Systematic Risk

Please have a look at the different lines of businesses and what length of claim-runoffs they have (length of tails)

Line of Business Tail Classification Est. Average Payment Lag Primary Drivers of Tail Length
Homeowners Short 0.5 – 1.5 Years Primarily first-party property damage. Damage is usually visible and quantifiable immediately.
Auto Physical Damage Short < 1 Year Repairs to vehicles happen quickly. Claims are usually reported and settled within months.
Personal Auto Liability Medium 2 – 4 Years Involves third-party bodily injury. Settlement is delayed by medical recovery and legal negotiations.
Commercial Auto Liab. Medium-Long 3 – 6 Years Higher limits and more complex legal disputes (e.g., trucking accidents) extend the settlement window.
General Liability Long 5 – 10+ Years "Long-tail" due to latent injuries, product defects, or complex litigation (e.g., professional malpractice).
Workers' Compensation Very Long 7 – 30+ Years Statutory requirement to pay for lifetime medical care and indemnity for permanent disabilities.

  1. Premium Liabilities are those liabilities for unearned exposures (for claims that haven't yet occurred, but if they do as future events, the company shall be liable to cover for them), they are associated with event risk. Whereas, Outstanding Claims liabilities refer to those for which exposures have already been earned and we know the claims associated to those liabilities (as events or accidents that have already occurred) ↩

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