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large number of policyholders withdraw their funds Having examined the risks originating from financial
simultaneously. markets, we now turn to the unique risks inherent in the
o An accumulation of large claims resulting from a business of insurance itself.
catastrophic event, such as a natural disaster.
3.0 Core Risk Category: Insurance Risks

2.4 Credit Risk Insurance risks are those that arise directly from the core
Credit Risk is the potential for financial loss resulting from a business of underwriting and managing insurance policies.
borrower's or counterparty's failure to meet its contractual These risks are fundamental to the insurance model and are
obligations. For an insurance company, this risk manifests in driven by the potential for deviations between actual
several key areas of its operations: experience-in areas such as mortality, policyholder behavior,
1. Corporate Bonds: Insurers invest in corporate bonds and expenses-and the assumptions used to price products.
to achieve higher yields than government securities. This Effective management of these risks is critical to
exposes them to the risk that the bond issuer may underwriting profitability. The following sections detail the
default on scheduled interest payments or the principal primary types of insurance risk.
redemption amount.
3.1 Mortality and Morbidity Risk
2. Bank Deposits: Significant cash holdings are often
placed with commercial banks. In a distressed financial Mortality Risk is the risk that actual claims are higher than
situation, regulators could limit or restrict withdrawals, the expected claims that were projected during the product
preventing the insurer from accessing its funds when pricing phase. This variance can result in either a loss or a
needed. profit. For example, if a product was priced assuming 5
deaths would occur in a given year, but 7 actual deaths
3. Reinsurance: Insurers transfer a portion of their risk to occur, the company must pay two excess claims for which
reinsurance companies. This creates a counterparty risk, no premium was collected, resulting in a direct underwriting
where the reinsurance company could default on its loss. Similarly, if only 4 deaths occur, the company realizes
obligation to pay claims due to its own poor financial an underwriting profit equivalent to the value of one claim.
condition.

2.5 Mitigation Strategy: Asset and Liability A key concern within this category is the phenomenon of
"Early Claims"-claims that occur within the first two to three
Management (ALM)
years of a policy's inception. These are primarily attributed
Asset and Liability Management (ALM) is the primary to two factors:
strategic framework for managing the financial risks
Anti-selection: The tendency for individuals who
detailed above, particularly interest rate risk. The core
believe they are at a higher risk to be more likely to
function of ALM is to coordinate the management of an
purchase insurance.
insurer's assets and liabilities to optimize financial
performance and control risk exposure. Non-disclosure: The failure of policyholders to disclose
pre-existing or serious medical conditions to the insurer.
Key ALM practices include:
1. Frequency: ALM is a dynamic process, with formal Two key metrics are used to measure and monitor mortality
reviews conducted quarterly to align with the Assets risk:
and Liability Committee meeting schedule. A/E Ratio: This is the ratio of "Actual Claims" to
"Expected Claims." A ratio greater than 1 signifies that
2. Duration Matching: A central technique involves the portfolio's mortality experience is worse than
matching the duration of the company's asset portfolio
anticipated at pricing. Conversely, a ratio less than 1
to the duration of its liability portfolio. This strategy indicates a better-than-expected experience and
helps neutralize the net impact of interest rate
potential underwriting profit.
changes, as a change in the value of liabilities will be
offset by a similar change in the value of assets. Reinsurance Experience: The ratio of reinsurance
claims received to the reinsurance premiums paid
3. Other Methods: Additional management techniques
include cash flow matching and the calculation of serves as a vital indicator of portfolio health. Persistently
economic capital required to cover potential losses from poor reinsurance experience presents a twofold risk:
first, the potential for future increases in reinsurance
interest rate risk.
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