 Hi everyone, it's MJ the fellow Actree and in this video, I want to go through an exam question That seems very relevant at the moment. I mean here we are. We're literally talking about pandemic stemming from unknown viruses So before we get into it, this paper was set all the way back in 2010 You know things were a lot simpler back then and it's for the subject enterprise risk management Now, I know a lot of the actual exams have been cancelled because of corona But enterprise risk management because it's a specialist subject It's still gonna go ahead and you're gonna be writing it online. So Using the shutdown the lockdown the social distancing whatever is called in your country to focus and to study and to yeah Let's let's all make sure we can pass this exam. So what I want to do in this video is go through this corona virus exam question Now the question starts off quite easy. I mean that is very much book work Question two, isn't that difficult? It requires a little bit of thought and the question three is a little bit tricky But let's start with question one Well question one is very much book work question two is saying how is the corona virus? I'm just gonna call it the corona virus instead of pandemic How's the corona virus going to impact a life insurer and then part three is saying since we don't have any Information on this virus. How can we use our model in reverse to try and gain insights? So like I said, these are the three parts of the question So what I've done is I have written out some of my some of my answers And I thought let me show them to you because very very important for this exam is your layout You know, especially now that it's gonna be an online exam and you're gonna be typing you want to set your work out Almost how I'm doing it where you have what I call structured lists So you use bullet points and you use indentation It makes it nice and neat for the examiner and you're almost basically telling them each little point should be a mark So first question is explain what is meant by stress testing sensitivity analysis and scenario testing What I like to do for a question like this is have a general for each I like to just say, you know, these are techniques to analyze deterministic models. I'm just stating what they are I'm saying why we use them We use them so that we can see if our strategy is alright if we need to redesign it And then I say, you know, if we do redesign it, we need to redo this analysis kind of talk about how this is a Continuous thing that needs to be done And I mean just by having that general statement You could end up getting a nice solid mark for saying it and of course ending sounds always good to have a little bit of examples So the right example I give on why you want to redo the testing after you've done it and change your strategy is Because maybe your previous strategy was managing one risk, but not the other one Now you've changed it to manage this other risk and you've left that previous risk vulnerable And so that's why you would want to redo testing after you've done it Anyway, let's look at stress testing sensitivity analysis and scenario testing stress testing Essentially, you're changing one parameter at a time by a large amount and seeing how the output changes We're doing this to see how robust our strategy is to an extreme movement And like I said, it's always nice to give examples if you want to get those extra marks So here we can say well, what if inflation was to triple You know, would we still meet our investment objectives and because it's an example I can make it very specific to say investments I can also want to give maybe a little bit of a weakness of each of these tests So the weakness of stress testing is sometimes we don't know how likely the extreme movement is And so we require subjective judgment to determine the extent of the stress I mean inflation to triple that does sound incredibly extreme But we have observed specifically in Zimbabwe and Venezuela, hyperinflation is a thing But how likely is it going to happen for our life insurer in whatever country it's based in? This is the weakness of stress testing we don't know Then we have something called sensitivity analysis Here again, we're only changing one parameter at a time But this time we're doing it by just a small amount and we want to see how the output changes So we're testing to see how reactive the output is to each parameter For example, if inflation was to increase by just say 1% or 0.01% You know, what would we expect our return of our investments to do If they decrease by more than 1% then well, we can say Okay, this strategy is very very sensitive to inflation Of course, there is a weakness It is unlikely that a small movement in a parameter will change by a small amount in isolation Because like let's say inflation was to drop a little bit We could see an increase in foreign currency exchanges Or we could see an increase in assets that hedge inflation or something like that So that's why in order to do sensitivity analysis We do something called scenario testing Where we change a few parameters at a time in a coherent way And see how the output changes Important that you tell the examiner that you're changing these parameters In a coherent way Coherent means a logical and consistent way You're not just taking random parameters and randomizing them And saying, oh, what's going to happen You're actually setting a possible scenario Where you don't want to have inflation and interest rates increasing at the same time That might be unrealistic You want to maybe do it in a way that they're coherent And we do scenario testing to test possible future realities For example, if a pandemic was to strike It would cause a few parameters to change And we can see, you know, would the investment strategy be robust if the scenario occurred? Of course, the weakness here is that there's an unlimited number of possible scenarios So how does one balance their time testing the plausible and extreme scenarios? Now look, this question was only for three marks So in order to get your full marks You needed to list six points because you're getting half mark per point So you want to have six points in total And at least one for each of these things I think, you know, the change in a few parameters, change in one parameter You know, those statements you definitely want to have And then you want to maybe fill up the rest so that you have six points But this question could very well have been worth eight marks in the exam I've seen it, it pops up quite often in these exams So very, very important that you know your book work very, very well Okay, let's get to the other part of the question Where part two says A life insurer company specializes in writing term assurance and income protection Specifically on the health side for business It is concerned, sorry A life insurer company specializes in writing term assurance and income protection business It is concerned about the impact that a pandemic event could have on its business And it is developing a series of pandemic scenario tests to evaluate its exposure A critical fact in developing a pandemic scenario Is the recognition that the single event could trigger losses from many different risks List six different risks that should be included in the test And explain how these risks could result in losses from a pandemic Now what I'm doing is I'm telling the examiner This is now my answer I'm saying I'm going to give you both answers at once I'm going to give you the risk And I'm going to give you the explanation And again, look at how I'm doing structured lists So just focus on how I've structured the answer I'm making a point I'm giving my risk And then I'm indenting it And I'm giving a explanation I'm now using the number bullets Instead of just the picture bullets Because I want to make sure that I have six points In the exam you give six Because this is the memo I've gone in and I've included 12 Okay, just so that I can be a little bit more exhaustive Than the solutions that they provide you with these exams But one of the big things that I've seen when I've been marking some of the students Is they'll maybe take mortality and morbidity risk And they list it as two separate risks Which I would rather combine them Because together they're an actuarial risk There's the probability that your claims are going to increase Well, anyway, let's read through it So I've combined mortality and morbidity risk as one But like I said, some of the students have split this up into two And I'm worried about doing that because you can only list six risks So you want to try and pack in or impress the examiners With six risks as possible You're going to see I'm a little bit sneaky How I've thrown in a few other risks within my explanations But let's go through mortality and morbidity risk I think this is the main risk, okay The idea here is that term assurance pays out If a person dies within a specific period And income protection pays out If a person gets sick within a specific period The pandemic will increase the frequency claims for both products And may even increase the severity of the income protection As people may stay sick for longer This depends very much on the nature of the disease Thus the firm can expect to make more benefit payments Which will impact profits and reserves negatively The big thing here, and this is like I said I gave this to some students to do And the one thing that they said Is that it would increase all claims severity Sometimes with term assurance the benefit is defined It's fixed So you could only see a severity increase on the income protection But what you're going to see with the term assurance Is an increase on the frequency of claims And then very important to link it back That this is going to have a negative impact on profits Because that's kind of what the question is asking Results and losses from the pandemic Then another one is operational risk, okay The increase in claims will put the workload stress on the employees You know, so employees are going to have to like Figure out and do a lot more Some of the employees might themselves be sick Also a lockdown might force employees to work from home So there's going to be more work less staff And less communication Which means we can see our operational mistakes will increase We're also going to have much higher dependency On communication and other IT systems And so a failure in one of these Is going to lead to an even longer period of disruption You can imagine if your computer fails And you're working at home You don't have the IT person to say Hey, can you turn it on and off again You know, there's going to be these Knock-on effects of working at home And operational risk can be expected to increase Although very difficult to translate that into a model Because this is one of the things about operational risk It's very difficult to quantify So that is something that you want to just be mindful of When looking at your model Now, because this is enterprise risk management You always want to try and look at it A little bit of an upside risk Although the question is focusing on the losses So I'm being sneaky by introducing an upside risk But you're going to see how I'm going to tie it in And how it could actually end up being a loss So what I'm saying is There's potentially some upside business risk With the pandemic More people might demand insurance out of fear People are like, oh, I don't need insurance Suddenly everybody's getting sick around them They're going to be calling up and say Hey, Mr. Broca, I need as much cover as I can get Although we want to link this up with being a negative risk And what we could see is something called anti-selection risk As the most vulnerable people to the disease Will be the ones most likely to apply for the insurance So let's say you've got a normal insurance business And you give out insurance according to Search and underwriting principles And now this coronavirus hits And it's infecting, let's say, all the old people All the old people are now going to be calling in And wanting to buy insurance And you might need to update your underwriting rules In order to factor in this coronavirus How it affects the older people more Maybe change your premiums But you need to do this at a time When your staff are already under so much stress Just handling the current claims Now to try to make them change the underwriting point of view You know, it's going to be difficult And you don't exactly want to turn away business Because we're going to see later that you're going to have a liquidity problem So you want to try and get as many premiums as you can into the business But now this is a terrible thing about humanity Is some people never let a good crisis go to waste And so we might see an increase in fraud People might try to use the pandemic to their advantage And pretend to be sick in order to either get off work And then claim the income protection benefit And they might think, oh, because these insurers are overloaded with claims That they're just going to be allowing them all through And they can just submit a claim And because specifically with, say, coronavirus There's not enough tests to test everybody And there's a shortage You know, they might just say, I'm sick And the claim writers might say, well, we can't actually test it Let's just pay this person out So we could see fraud could increase However, an insurer might need to combat this With stricter claim analysis However, that's going to cause even more demand on the employees Who are already currently stressed and overloaded With dealing with just the number of claims Now you're telling them to spend more time on each claim They might say, hold on, I myself am also sick So like I said, crazy, crazy, crazy Then there's also the market risk A pandemic is likely to cause panic in the market And shock asset prices Okay, we're seeing this The stock market is dropping like 10% every day Then it's up 5% Then it's down 20% It's just chaos It's absolute chaos And we're seeing equities getting smacked And property Real estate investment trusts are getting destroyed Why? Because they're locking down shopping centers And people thinking, how are they going to get rent? And, you know, is there any future? So we're seeing these asset prices fall, fall, fall, fall Look, we are seeing the dollar is rising Because people see it as a safe haven But with everyone selling equity and selling property And trying to hold dollars What we're seeing is this demand in dollars Increasing the price of the dollar Which is then stuffing up the exchange rate For all the other local currencies So we're seeing currently the rent here in South Africa D value relative to the dollar Just because demand for the dollar has increased So overall coming back to the question The life insurance might see a decrease in reserves At a time that they need at most You can imagine, all these claims are coming through And the money that you've set aside And you've put in the stock market To try and make some money And you've just lost money there So you've lost money on the market Now you're going to lose money with claims It's not a fun place to be in But fortunately there's re-insurance But that could also be another source of risk Okay, because this is the idea The life insurer is not going to be the only one Impacted by the pandemic Think about it, this coronavirus is worldwide So all these multiple insurers all around the world Might start claiming from their re-insurer Now re-insurers are global organizations And they think, oh they're diversified across the world You know, what's the likelihood That everyone's going to claim at the same time They're like, oh it's very low Coronavirus is like, mm-hmm, think again So what we're going to see is the re-insurer Is going to be incredibly stressed And this means there's a small counterparty risk Before, I mean normally re-insurers Are really highly rated But this is going to stress them as well So there is now this counterparty risk That the re-insurer might not be able to handle all the claims And this is going to leave the life insurer To deal with all the risk by themselves So this is another thing that could freak everybody else Is we could see a failure of a re-insurer So now this comes down to solvency risk With markets crashing and claims increasing The insurer's risks are going to be stressed To such a point that they might actually fall Below the required solvency And this is going to hurt profits Because it means there's going to be no retained earnings For this year, for the life insurer All that extra money or profit that they might have made Will be going to the reserves Any future profit in the long run Some of that is going to be going into trial And you know, refill the reserves That have been heavily depleted Look, two little bit of positives to pick in And this is something that the ruin models Don't necessarily take into consideration Regulators might be more lenient during the pandemic They might not say, oh, you've fallen below the solvency ratio That's it, we're taking away your license We're shutting your business down They will be very lenient, I think, during these situations And I mean, we are seeing this happening now Government is providing bailouts Because if they don't, then the economy might just collapse And then it's, we basically become Mad Max situation Or they don't write Mad Max situation in the exam Where were we, yeah So government might provide a bailout If the situation gets extreme So that's a little bit comforting Of course, let's maybe talk about this political risk And you know, this impact it'll have on, let's say, the economy So speaking of government, lockdowns and other extreme measures Might be put in place That could lead to social instability And damage to the economy Now, a recession might result in high unemployment And so people might start lapsing on their insurance And again, we're going to see anti-selection at play As the healthiest people are going to be the ones most likely to lapse You can imagine if I'm a healthy young person And coronavirus has shut down everything So I've now lost my job I might say, you know what? I'm not going to pay for health insurance anymore Because I might believe that maybe the disease only infects all people That's one of the rumors going out there So we might see the healthiest people Or the people less likely to get infected by the pandemic lapsing And that's going to be really detrimental to our book in the long run So again, we can see how anti-selection and lapse risk Is going to be popping up when government starts taking action Now we could even see moral hazard You know, people who are covered Especially with, say, income protection one They might not respect social distancing And other safety recommendations As they feel that if they get sick They won't have to work And they're still going to get paid And we're seeing this from some people There's some people out there who underestimate this pandemic You know, there's that guy at spring break He's like, oh, nothing's going to stop me from partying Or I think there was even someone here in South Africa Who got arrested because on Friday night During the lockdown, he was having a party with 100 friends Saying, you know, oh, this is nothing more than the common flu And we might see people's behavior Specifically those who have income protection Might say, I don't need to obey social distancing Because I'm covered And this might actually increase the rate of the pandemic So there is even a moral hazard that we could be seeing in Then coming in, we could even see a reputational risk I mean, this pandemic will cause chaos People will look to institutions for stability Now if this life insurer delays paying our claims Because they either can't afford it Or they're waiting on their reinsurer Or they just don't have the manpower to process the claims Then the public's going to get quite upset with them And especially now with social media They're going to say, hey, this company's not paying up my claim Then somebody else, Mary Jane's going to be like, oh, they're not paying up my claim Corrin's going to be like, they're not paying up my claim John's going to be like, yo, why aren't they paying up my claim And they could become this whole social media storm That can damage the company's brand And if there's a decrease in their reputation This is going to hurt future business in the long run So amongst all this chaos There might even be this liquidity risk So to try to boost the reserve The insurer might be forced to sell its less marketable assets Like let's say shopping centers At a fraction of its previous price And this lack of liquidity is being caused by all the claims And what we're going to see is that if this liquidity risk isn't settled Because they're using all the money to pay the claims They might not have enough money to pay their staff At a time when they need them most So you can imagine your employees are working super super hard And now you might get to a situation where you say, oh, listen here guys We can't pay you for this month Do you think they're going to continue working the following month And you can imagine the operational disaster That will then cause Then finally, this one is very actuarial Is there's also going to be a liability risk If the pandemic slows down the economy The central bank might take action and lower the interest rates We've seen that share in South Africa I think it's happened in the US as well Interest rates have been cut But now what this means is that your future long-term liabilities And look, we're dealing with term assurance So the liabilities aren't that long But you could have a term assurance that say 20 years So it will still be significant But these future long-term liabilities will increase As they're going to be discounted at a lower rate And this is going to put even further stress On the insurer's solvency position And long-term profit and loss You can imagine your solvency is how much reserves you have For how much potential liabilities Now not only your current liabilities Manifesting themselves with higher claims But your future liabilities are also increasing Because of this reduction in the discount rate Which means the time value of money doesn't reduce it as significantly And you're getting to the stage where you know People might be lapsing and doing all of these things It's absolutely chaos So in summary, in your scenario testing You might want to increase claim frequency You want to increase claim severity You want to maybe increase claim payment delays Increase cost from operational mistakes How you exactly do that is a little bit difficult Increase lapse rates Increase new policy rates Increase cost from fraud Moral hazard in the election Decrease asset values Increase probability wrencher of failing Decrease interest rates Which will increase your liabilities Now this pandemic We know it's going to cause these shocks and these movements But by how much we don't really know And this is where you really want someone Who's been working in the business for 40 years And where experience plays a big role Essentially this was for six marks Was this for six marks? I put down the marks I think this was six marks So you wanted to get three marks for listing your six risks And three marks for explaining How each risk could result in a loss Look, I did mention 12 And I'm sure there's a whole bunch more So let me know in the comment section below If you're thinking of some other risks And also give the explanation That it's being caused from this pandemic The final question was probably the hardest one It says much of the risk from a pandemic Stems from currently unknown viruses and diseases Meaning that the additional impact on mortality and morbidity Cannot be estimated with any degree of accuracy As such, the usual approach of building a model To forecast losses based on inputs Does not work because the inputs are not known Accordingly, the life insurer company Has decided to use this model in reverse It'll choose a total loss amount And then analyze the inputs and processes That would produce it Now we are told to explain the insights That the insurance company should gain From using the model this way So this is a hard question Because we've been taught to build models From what's your assumptions What's your input, your calculations You get your output, you have your conclusion This question is saying, you can't do that Because we don't know what the inputs Are going to be from this virus We don't have enough information You're going to have to use this model in reverse It's not saying that's in the notes This is not a book work question This is a higher order question Fortunately, it's only for two marks So, I mean, if you're stressed for time This is the exam question that you skip But if you've got the time And you're going for that 100% You can give it a go But essentially, using the model in reverse You're basically saying What is the worst total loss that we could handle So you kind of say What is the worst case scenario A little bit of a scenario analysis You're saying, okay, we can handle 100 billion loss Our reserves used to be 200 billion But markets has halved it How much of a total loss can we handle And once we have this total loss We can reverse engineer the model To see, well, what input would have caused that So we can see What is the maximum number of claims That we could handle within a given severity And what is that? Is that like 80% of our book? Is it 90% of our book? Is it 100% of our book? If we can handle 100% of our book Then we're fine If we can only handle 10% of our book And we're dealing with a pandemic Then maybe it's time to start freaking out We can also look at how much stress Could our investment strategy for our reserves take We can see, well, okay If we've got 200 billion Is it foreseeable that we lose 100 million Well, if we've got 90% in the US dollar We're going to be fine If you've got 90% in a CFD For some super risky share That's not even in the top 500 Then you have a little bit of a problem Although regulation probably means That you're not that reckless And then you could also look at a combination Of various claims, reserve stress, other factors And to see what are possible scenarios That cause your company to be absolutely ruined And then once you have that information You can say, okay, how do we use this information To make ourselves more prepared It might be too late to make a different investment strategy Or depending, let's say, if you're a life insurer And the pandemic's really crazy in the overseas markets You might have a little bit of a window But normally you might not have enough time To change your investment strategy Or you might change it a little bit too late But I guess better late than never You could look at various reinsurance treaties Assuming that the reinsurers are still open for business And that they haven't been ruined by the pandemic But you can also look to changes to how we handle claims And other operational activities So you could say to all your employees Listen here, we're going to take two weeks To pay out every single claim And in normal situations regulator might be like Whoa, you're not treating customers fairly But you might need to say, listen here We need to give ourselves this delay If we're in order to stay alive You know, the model might show that If we can just delay claims by two weeks This might lower liquidity risk by a significant amount And like I said, regulation becomes very, very interesting During this time It's a reason why you want to have such a good relationship With the regulator So if this ever occurs You can explain to them This is the extreme action we're taking Even though it might go against traditional rules So you might want to look at that Also you can look at your expenses And just cut out things that are not essential You know, you no longer need to be stocking The Nespresso machine with that high quality coffee You can go back to Jacob's coffee You know, you can cut out all these Unessential expenses And really streamline the business Maybe look at, you know, if we had to cancel all bonuses Although you might not want to freak out Your star activities at a crisis where you need them most So it's important to understand What the residual impact is going to be Of each of these things Anyway, I think I have I think that's enough for two mocks And I see I have been speaking for quite a long time This is a question that should have taken you What, it's six mocks plus two mocks plus three mocks So I think that's, if my maths is correct That's 11 mocks in total So you're looking at spending 20 minutes on this question Maybe even less 18 We did give a little bit of a higher explanation In this video So hence why it's a little bit longer But hopefully this has helped you in a way to What I want you guys to focus on Is how I've answered the question Remember my structured lists And yeah, I think otherwise If you do the book work and you think things through You're going to be fine in this exam Anyway, thanks so much for watching And like I said, let me know If you came up with any other risks In the comment section below Cheers