2-managing-event-risk.pptx

8/16/2019 2-MANAGING-EVENT-RISK.pptx

1/38

MANAGING EVENT RISKS

Damodaran/ch.10


2/38

Contents

1. Reclassi!in" ris#s rom a ris#mana"ement $ers$ecti%e

&. E%ent ris#s

'. (h! sho)ld *e mana"e e%ent ris#s+

,. The -enets o ins)rance

. The eecti%eness o ins)rance. The ins)rance mechanism

2. Sho)ld cos. ins)re or not+


3/38

1. Reclassi!in" Ris#s3

Ris#s

Non4ins)ra-le

ris#s

Ins)ra-leris#s

All others 5ieNon4lie


4/38

1A6 Ins)ra-le Ris#s

• Ins)ra-le ris#s are those ris#s or *hichsol)tions are $ro%ided -! the ins)ranceind)str!

• There ma! standard $rod)cts *idel! a%aila-lein the ins)rance mar#et 7 s)ch $rod)cts s)itthe re8)irement o man! clients

• 9r there ma! -e c)stomised $rod)cts not

*idel! a%aila-le in the ins)rance mar#et 7s)ch $rod)cts s)it the re8)irement o s$ecicclients


5/38

1A6 Ins)ra-le Ris#s3

• T!$icall! ins)ra-le ris#s ollo* thela* o lar"e n)m-ers : theeconomies o scale

• ;eca)se s)ch ris#s ollo* the la* olar"e n)m-ers their $ro-a-ilities can-e estimated rom a lar"e sam$le the lar"er


6/38


• D)e to these characteristics s)ch ris#s can-e mana"ed $rota-l! *hen handled inlar"e n)m-ers 7 lar"e $ortolio o ris#s

• This has "i%en rise to the de%elo$ment othe ins)rance ind)str!

• Ins)rance cos. handle ris#s in lar"en)m-ers


7/38


• 5ie ris#s re$resent a relati%el!homo"eneo)s class o ris#s

• Non4lie ris#s re$resent a relati%el!

hetero"eneo)s class o ris#s• These t*o classes o ris#s re8)ire dierent

techni8)es to mana"e

• ?ence dierent cos. s$ecialise in handlin"

these ris#s

• Generall! e%ent ris#s -elon" to ins)ra-leris#s


8/38

1;6 Non4Ins)ra-le Ris#s

•

Non4ins)ra-le ris#s are those ris#s or *hichsol)tions are not $ro%ided -! the ins)ranceind)str!

• There ma! -e man! $arties *ho *o)ld -enet

rom $rotection rom s)ch ris#s

• ?o*e%er the ins)rance ind)str! has notdesi"ned sol)tions or s)ch ris#s

•

This is -eca)se ins)rance cos. cannot e@$loits)ch ris#s $rota-l!

• Sol)tions or s)ch ris#s ha$$en o)tside theins)rance ind)str!


9/38


• Non4ins)ra-le ris#s t!$icall! consisto contin)o)s ris#s

• S)ch ris#s occ)r contin)o)sl! o%ersmall inter%als o time 7 orei"ne@chan"e ris#> interest rate ris#>commodit! $rice ris#> stoc# mar#et

ris#s 7 mar#et ris#• ?ence there is no need to estimate

their $ro-a-ilit!


10/38


• Mana"in" s)ch ris#s in%ol%es selectin" thea$$ro$riate hed"in" techni8)e

• T!$icall! instit)tions *hich are e@$osed to

s)ch ris#s enter into hed"in" contracts*ith each other

• There are instit)tions *hich act asintermediaries in arran"in" s)ch contracts

• Mar#et ris#s can -e mana"ed )sin"hed"in" tools and non4hed"in" tools


11/38

1C. 9ther Ris#s3

• (here sho)ld *e classi! theollo*in"+

1. Credit ris#s

&. 9$erational ris#s


12/38


13/38

&. E%ent Ris#s

• Ins)rance cos. "enerall! ha%estandard $rod)cts to co%er se%eralt!$es o e%ent ris#s

• Standard $rod)cts are a%aila-le orsome o the common t!$es o e%entris#s

• Since standard $rod)cts are oered-! man! ins)rance cos. the! tend to-e com$etiti%el! $riced


14/38

&. E%ent Ris#s

• Some o the e%ent ris#s are %er! rare$henomena

• ;eca)se the! are rare it is e@tremel!

dic)lt to estimate their li#elihood oocc)rrence

• ?ence the correct $rice or ins)rance

$rotection *o)ld -e dic)lt to determine• So standard ins)rance $rod)cts or s)ch

ris#s are "enerall! not a%aila-le


15/38

&. E%ent Ris#s

• Moreo%er there *o)ld -e %er! e*$arties *ho *o)ld see# $rotection roms)ch ris#s

• ?ence ins)rance $rod)cts or s)ch ris#stend to -e %er! e@$ensi%e

• Also the ins)rance $rod)cts or s)ch

ris#s are c)stomised or s$ecic clients• There *o)ld -e e* ins)rance cos. *hich

*o)ld oer s)ch c)stomised sol)tions


16/38

'. (h! Sho)ld (e Mana"e E%ent

Ris#s+

• Generall! the ma"nit)de o im$act o e%entris#s is so hi"h that the aected $art!*o)ld -e com$letel! nanciall! destro!ed

•Most o the -)siness


17/38

'A6 (hat is Ins)rance+

Ins)rerFs Bers$ecti%e6

• It is the -)siness o e@$loitin" ris#s orearnin" $rots

• Since the $henomenon o ris# is*ides$read : aects indi%id)als :instit)tions in %ario)s orms> there is ano$$ort)nit! to do -)siness

• Ins)rance cos. do not oer $rotection rome%er! ris# 7 the! oer $rotection roms$ecied ris#s onl!


18/38

'A6 (hat is Ins)rance+

Ins)redFs Bers$ecti%e6

• It is essentiall! a contract o indemnit!

• This contract can -e -o)"ht or a $rice 7

the ins)rance $remi)m

• ;! $a!in" the $rice the ins)red can -)!com$ensation or the ris# rom the

ins)rer• In order to "et the co%er it has to

com$l! *ith the T:C o the ins)rer


19/38

,. The ;enets o Ins)rance

•

Ins)rance does not eliminate the ris# -)ttransers it rom the ins)red to the ins)rer

• Ins)rance cos. ha%e e@$ertise in mana"in"$ortolios o ris#s : the! "ain rom

di%ersication -enets *hich the client cos.cannot do

• Ins)rance cos. ha%e the e@$erience :

e@$ertise to e%al)ate ris#s : handle them>*hich the client cos. do not ha%e

• Ins)rance cos. also $ro%ide related ser%ices%i. ins$ection : saet! *hich $re%ent ris#s


20/38

,. The ;enets o Ins)rance3

• The -enet o ins)rance to the ins)redis $rotection a"ainst those ris#s *hichha%e a lo* li#elihood -)t hi"h im$act

sho)ld the! occ)r• The cost o $roc)rin" ins)rance

$rotection is an o$eratin" cost or the

ins)red co. and it red)ces its o$eratin"income : also the ta@es

• The -enet is increased sta-ilit! oincome : cash o*s o%er time

•


21/38

. The Eecti%eness o Ins)rance

•

It is eecti%e a"ainst rm4s$ecic ris#sthat aect onl! a e* rms at an! $ointo time i.e. s)ch ris#s are not*ides$read $henomena

• It is not eecti%e a"ainst mar#et ris#actors

• It is more eecti%e to )se ins)rance or$rotectin" a"ainst lar"e ris#s than smallones

• Small ris#s can -e $rotected -! a co. onits o*n


22/38

. The Eecti%eness o Ins)rance

• Ins)rance $rotection is more eecti%e

a"ainst e%ent ris#s *hich are discrete innat)re than a"ainst ris#s o acontin)o)s nat)re

•

Hor discrete ris#s the $ro-a-ilities :nancial im$act can -e estimated romhistorical data

•

E@am$les o e%ent ris#s/discrete ris#s6ood> re> nat)ral calamit!> -)r"lar!etc.

•

E@am$les o contin)o)s ris#s6 ination>


23/38

. The Ins)rance Mechanism

• Ins)rance cos. mana"e $ortolios o ris#s

• T!$icall! a $ortolio *ill -e or a s$ecic ris#

• The! "ain rom di%ersication -enets as the

$ortolio o ris#s -ecomes lar"er• Di%ersication ha$$ens -eca)se *hen more

: more clients are added to the $ortolio the

chances are that most o them *ill not -eaected -! the ris# 7 i clients are selected*isel!


24/38

. The Ins)rance Mechanism

?o* does the ins)rance co. di%ersi!+

• The ins)rance co. di%ersies alon" t*odimensions

1. It adds more : more clients to a $ortolio o as$ecic ris# 7 di%ersication *ithin the $ortolio

&. It oers %ario)s t!$es o ins)rance $rod)cts or%ario)s ris#s 7 so it -alances o)t $rod)cts orris#s o hi"her li#elihood *ith $rod)cts or ris#so lo*er li#elihood 7 di%ersication across$ortolios


25/38

. The Ins)ranceMechanism3

• ;ased on this $rinci$le the entire $ortolioo ris#s o a $artic)lar t!$e can -e di%idedinto t*o $arts6 "ood ris#s : -ad ris#s

• Good ris#s are those ins)red clients in the$ortolio *ho *ill not -e aected -! theris#

• ;ad ris#s are those ins)red clients *hich*ill -e aected -! the ris# res)ltin" inlosses or the ins)rance co.


26/38


• The ins)rer earns its re%en)es rom$remi)ms collected rom all clients 7 "ood: -ad ris#s

•

?o*e%er it has to $a! or losses onl! to the-ad ris#s


27/38


• So the lar"er the $ortolio o ris#s :the hi"her the concentration o "oodris#s therein> the hi"her *o)ld -e the

re%en)es : lo*er *o)ld -e the losses• The lar"er the $ortolio o ris#s the

"reater *o)ld -e the economies o

scale -eca)se the o$eratin" @edcosts co)ld -e s$read o%er "reater no.o clients 7 hi"her $rota-ilit!


28/38


29/38

A6 Bortolio Ris#s

The im$ortant $ortolio mana"ementris#s aced -! an ins)rance co. are6

• Ad%erse selection

• Moral haard


30/38

A6 Bortolio Ris#s

• Ad%erse selection6 It is the ris# oselectin" more -ad ris#s as clients than"ood ones

• As a res)lt hi"her $ro$ortion o clients inthe $ortolio *o)ld -e con%erted to claims

• This *o)ld res)lt in massi%e losses to theins)rance co. -eca)se the amo)nt o$remi)ms collected rom s)ch clients*o)ld -e m)ch less than the s)m ass)red


31/38

A6 Bortolio Ris#s

• Moral ?aard6 This ris# arises *hen the"ood ris#s t)rn into -ad ris#s -eca)sethe! tend to -ecome ne"li"ent :

careless> : act in a ris#! manner-eca)se the! ha%e ins)rance$rotectionJ

• The res)lt is that increasin" no. o claimsare to -e $aid -! the ins)rer res)ltin" inhea%! losses


32/38

;6 9ther Critical Iss)es

•

All ins)rance cos. *orr! a-o)t nat)ralcalamities : catastro$hes

• D)rin" a catastro$he there are *ides$readlosses o $ro$ert! : li%es

• A sin"le e%ent o catastro$he can aect theentire $ortolio o ris#s o a "eneral ins)ranceco. res)ltin" in losses arisin" o)t o claim$a!ments

• Similarl! or a lie ins)rance co. the entire$ortolio o li%es co%ered can res)lt into claims

• Man! ins)rance cos. ha%e -ecome -an#r)$t


33/38

2. Sho)ld Cos. Ins)re orNot+

• An im$ortant iss)e that cos. ace isto decide on the ris#s that the!sho)ld ins)re : those *hich the!

need not• The sol)tion to this iss)e lies in a

com$arison o the e@$ected costs o

not ta#in" ins)rance : the costs ota#in" ins)rance

6 6


34/38

6 6Betrole)m


35/38

2A6 Caselet6 ;B3

• Accordin" to ;B ins)rance cos. *ere less

ecient in assessin" s)ch lar"e : s$ecialisedris#s than ;B itsel : hence less eecti%e inad%isin" on the $rotecti%e meas)res

•

?ence the ins)rance $remi)ms char"ed ons)ch lar"e ris#s *ere not com$etiti%el! $riced

• ;B assessed lar"e losses o o%er 00 mha%e a %er! lo* $ro-a-ilit! o occ)rrence


36/38

2A6 Caselet6 ;B3

• ;eore im$lementin" the ne*ins)rance strate"! ;B *as $a!in" 11 m a !ear in $remi)ms :recei%in" & m a !ear in claims

• Ass)me that ' m o $remi)ms

: the entire amo)nt o claims*ere or ro)tine ris#s and itso$$ort)nit! cost o ca$ital is 10

'


37/38

2A6 Caselet6 ;B3

• )e 16 (hat *o)ld -e the %al)e osa%in"s made -! the chan"e in strate"!*itho)t considerin" the e@$ected cost o

not ins)rin" or the -i" ris#s+• )e &6 (hat *o)ld -e the e@$ected cost

o not ta#in" ins)rance $rotection or the

-i" ris#s+• )e '6 Is the chan"e in ins)rance

strate"! L)stied nanciall!+

'2


38/38

2A6 Caselet6 ;B3

Concl)sions6 Hor %er! lo*4$ro-a-ilit! ris#s• Ver! lar"e cos. need not -)! ins)rance :

allo* the losses to aect shareholder

*ealth• In%estors themsel%es can eliminate the

im$act -! holdin" di%ersied $ortolios

2-managing-event-risk.pptx

Documents