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Enterprise Risk Management For Insurers and Financial Institutions


Enterprise Risk Management For Insurers and Financial Institutions David Ingram CERA, FRM, PRM From the International Actuarial Association – PowerPoint PPT presentation

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Title: Enterprise Risk Management For Insurers and Financial Institutions

EnterpriseRisk ManagementFor Insurers and
Financial Institutions
  • David Ingram

From the International Actuarial Association
Course Outline

Advanced ERM Topics
  • 4.1 Governance And An Enterprise Risk Management
  • 4.2 Upside Risk Management
  • 4.4 Performance Management And Reward Systems
  • 4.4 Role Of Internal Audit
  • 4.5 Dealing With New Activities
  • 4.6 Risk Tolerance, Appetite Limits
  • 4.6 Emerging Risks
  • 4.7 Scenario Planning
  • 4.8 Risk and Loss Diagnosis
  • 4.9 Reporting and Monitoring
  • 4.10 Risk Disclosure

4.1 Governance And An ERM Framework
  • Board Committees ERM
  • Risk Tolerance Board
  • Communicating ERM with Board

Board Committees ERM
  • Existing Committees
  • Executive Committee
  • Investment Committee
  • Audit Committee

Risk Tolerance Board
Turning Tolerances into Limits
  • Question 1
  • Is Top Management Board able to articulate
    their Risk Tolerance?
  • Often the answer is no.

Determining Risk Tolerance
  • Survey Discussion
  • Analysis of Past choices Risk Levels
  • Review of Current Choices
  • External Views of Risk Return

Survey Discussion
  • Brokerage Forms Mutual Fund Companies
    Questionnaires for Individuals
  • Income Net Worth
  • Knowledge of Investments
  • Experience with Investments
  • Investment Objectives
  • Risk - Return Expectations
  • Cash Flow Needs Investment Horizon

Bank or Insurance Company
  • Information needed is the same
  • Income Net Worth
  • Knowledge of Risks
  • Experience with Risks
  • Financial Objectives
  • Risk - Return Expectations
  • Capital Needs Financial Horizon

Income Net Worth
  • Level of Income
  • Volatility of Income
  • Level of Surplus
  • Management attitudes about above
  • Preferences for losses to bypass income? Or
    dislike all losses equally?
  • Has income grown steadily? If not, is unsteady
    path seen as normal or highly undesirable?

Knowledge of Risks
  • Can Board readily articulate the top risks of the
  • Does Board have a feel for which risks are most
    significant to
  • Company Earnings?
  • Company Solvency?

Difference between Knowledge Experience
  • Knowledge Intellectual
  • Experience Emotional
  • Knowledge Read the Book
  • Experience Didnt need to read the Book
  • Knowledge Heard the News reports of Tsunami
  • Experience Was here for the storm

Difference between Knowledge Experience
  • In 1999, it was often said in the US that
    majority of investment management had no
    experience with market downturn
  • Now they all do.

Does the Board have Knowledge or Experience
  • Credit Risk
  • Interest Rate Risk
  • Equity Risk
  • Fx Risk
  • Insurance Risk
  • Operational Risk

Experience with Risks
  • What were the experiences of the company is
    previous periods of industry difficulty?
  • What were the personal experiences of top
    managers in those periods?
  • Which risks are management more likely to want to
    avoid because of past experiences?

  • In 1987, a US company had equity exposure of 50
    of surplus beginning of 1987
  • By end of 3rd Quarter, surplus had grown 15
  • In 4th Quarter, Group Health Division reported
    unexpected losses of 12 of Surplus
  • Equity market fell 23
  • Surplus dropped 25
  • Local newspaper reported 96 drop in Company

Experience with Risks
  • What kinds of losses has the company experienced?
  • Macro Market problems
  • Industry-wide problems
  • Unique Company Problems

Financial Objectives
  • Earnings, ROE, Increase in Embedded Value
  • Ratings Level, surplus ratio
  • Sales Level, Assets under management, sales
  • Risk Management

Risk Return Expectations
  • What are return expectations?
  • Do they currently vary by product Line?
  • What are seen as the drivers of the variances?
  • Business Size Age
  • Competitors Return or Prices
  • Business Risk
  • Do return expectations vary with market
  • Or do they encourage additional risk taking under
    unfavorable conditions?

Capital Needs Financial Horizon
  • Growth Rates Capital Needs of New Sales
  • Profitability of businesses
  • Current Capital Level
  • Planning Horizon
  • 1 year, 3 year, 5 year

Analysis of Past Choices Risk Levels
  • Look at historical risk levels relative to today
  • Must be careful to choose right metric for
  • Should try to choose time of most recent decision
    on risk limit
  • Assume that management is comfortable with past
    risk limits

Example Retention Limit
  • Retention limit was set at 1 M 10 years ago
  • Reduced probability of one year fluctuation gt 10
    M from 5 to 1
  • 10 M was 50 of pre-tax income
  • Now a retention limit of 3 M would produce a 1
    probability of fluctuation of 50 of current
    pre-tax income

Review of Current Choices
  • Show the risk characteristics of the current
  • For several alternate structures
  • Variability of Returns
  • Results of Stress test

Review of Current Choices
Communicating ERM with Board
  • Quantity Quality of Risks Plan
  • Regular updates
  • Changes to Environment
  • Changes to Plan
  • Losses
  • Management Responsibilities Reports
  • Unpredictable Events
  • Strategic Initiatives Risk Management
  • Strategies Risk Management

Risk Management The Board
  • 1. An advance agreement with management
  • the quantity and quality of risks that the firm
    is expected to take in the coming year and
  • how much variability management expects there to
    be in what actually happens.
  • This will naturally lead to a discussion of how
    far away from plan things can get before another
    discussion between management and the board is in

Risk Management the Board
  • 2. Regular updates in the quantity and quality
    of risks that are actually being taken by the
  • as well as the quantity and quality of risks
  • One of the major issues that banks have faced in
    the current crisis is that some of their risk
    offset programs were not as effective as
    management had expected and very large gross risk
    positions that were thought to be transferred or
    offset did become the responsibility of the bank
    when the losses started to occur.
  • Board reporting had focused only on net retained
    risks which put the board outside the discussions
    of how much gross risk was acceptable.

Risk Management The Board
  • 3. Information about the changes in the
    environment that might indicate that certain
    risks might be increasing.
  • This information would be in the form of trending
    of key risk indicators

Risk Management The Board
  • 4. Information about the continuous changes that
    management is making to the plans in response to
    the changing environment
  • as they relate to the quantity and quality of
  • Too often management appropriately changes course
    and defers mentioning that to the board. The
    lack of mention of course corrections should be
    seen as a sign of potential trouble by the board.
  • Management and the board should agree how far
    things can drift from plan before management is
    expected to both do something different and
    mention that to the board.

Risk Management The Board
  • 5. An advance discussion of losses.
  • Management and the board must recognize that the
    word risk is short for risk of loss.
  • It is uncommon to have these advance discussions.
  • When firms experiences losses, there is often a
    period of uncertainty during which no one knows
    whether this loss exceeds the tolerance of the
    board and how the board might react.
  • While it does not make sense to expect there to
    be an exact list of expected reactions, there is
    much to be gained by having this discussion
    before a real loss occurs.

Risk Management The Board
  • 6. Appointing members of top management to be
    individually assigned personal responsibility
  • for each of the major risks and
  • risk/loss aversion practices of the firm
  • a risk management best practice that is
    internationally recognized.
  • A regular update by the top management
    individuals that have been given these
    responsibilities, confirming that they have
    sufficient resources, both in quantity and
    quality, to achieve the objectives for loss
    limitation and reporting on the status of
    projects to improve capabilities.

Risk Management The Board
  • 7. A periodic discussion of the unusual and
    adverse events that might unpredictably impact on
    the firm and the ways in which management expects
    to prepare for such events.

Risk Management The Board
  • 8. When a major corporate strategic initiative
    comes to the board for notice or approval,
    discussion of the ways that this action changes
    the risk of the firm.
  • The board should know whether a headline action
    further concentrates the risks of a firm or
    whether is broadens the risk exposures.
  • If there are additional concentrations of risks,
    then it would be important to hear more about the
    additional diligence to the existing loss
    aversion actions.
  • If it is a diversifying risk, then the board
    should be hearing about the new risk/loss
    aversion actions that are contemplated.
  • Too often, management diversifies into a new risk
    and thinks that loss aversion is unnecessary
    because of diversification. The term for that
    type of risk management decision is
    de_WORSE_ification. For new risks, risk/loss
    aversion plans are particularly needed because of
    managements lower experience wit the new risk.

Risk Management The Board
  • 9. When management discusses the major
    strategies of the firm with the board
  • discussions should include recognition of the
    implications of the strategic plans on the firm's
    risks and the risk/loss aversion plans.
  • The board should be sure that the plans for
    growth of the firm reach for faster growth of
    expected profits than the rate of growth of risks.

4.2 Upside Risk Management
Strategic Risk Management
  • View of risk across all risks to make decisions
    about optimizing risk adjusted returns.
  • capability to assess trade-offs between different
    risk types
  • assessment of risk adjusted returns.
  • capital budgeting
  • strategic investment allocation.

Strategic Risk ManagementFor Life Inurers
  • Strategic trade-offs between products with
  • Credit Risk
  • Interest Rate Risk
  • Equity Risk
  • Insurance Risks
  • Based on long term view of risk adjusted
    returns of products
  • Choosing which to write, how much to retain and
    which to offset
  • Strategic trade-offs in Investment Selection
  • based on risks embedded in products
  • plus long term view of risk adjusted returns of
    investment choices

Strategic Risk Management For Non-Life (PC)
  • Strategic Trade-offs between insurance coverages
    AND investments
  • based on long term view of risk adjusted return
  • Recognizing significance of investment risk to
    total risk profile
  • Selecting which risks to write and which to
    retain over the long term
  • Some Insurers have 40 or more of their total
    capital tied to Investment risks
  • An Insurer with Strategic Risk Management will be
    able to say why they chose to take that much
    Investment risk
  • Including discussing relative risk reward of
    Insurance choices and Investments
  • Average risk reward vs. marginal risk reward
  • With consideration of diversification impact of
    Insurance vs. Investments

Tactical Risk Selection
  • Reacting to short term market conditions to
    choose which risks to take and which to retain in
    the short term
  • May use Risk Reward analysis or just combined
    ratio targets
  • Cycle Management
  • Insurance Cycles
  • Credit Cycles
  • Interest Rate Cycles
  • Equity Market Cycles
  • Choices to vary from long term strategic choices
  • Usually within a range
  • Range of variation authority

Strategic Risk Mgt
  • Companies with Superior Risk Management
    (Controls) will have low volatility of earnings
    and low incidence of losses.
  • Companies with Superior ERM will have low
    volatility of earnings, low incidence of losses
    AND Steadily improving Returns.
  • Strategic Risk Management is the UPSIDE of Risk

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4.4 Performance Management And Reward Systems

4.4 Role Of Internal Audit

4.5 Dealing With New Activities
  • New Products
  • Acquisitions
  • Other New Activities

New Product Risk Review
  • Multiple Layers of Sign-offs
  • Plan for Product
  • Go Ahead for Design
  • Design of Product
  • Go Ahead for implementation
  • Implementation of Product
  • And implementation of Measures, limits

New Product Risk Management Review Questions
  • What types of risk is the company assuming with
    this product?
  • Market, Credit, Insurance, Operational Risks
  • Short Term, Long Term
  • Ruin, Volatility
  • Specific, Systematic
  • Accounting, Market Value, Liquidity
  • Aggregation or Diversifying

New Product Risk Review2. How will these risks
be measured and monitored?
  1. By whom and using what techniques and processes?
  2. Where/how will the risk exposures be reported?
  3. What will the risk reports look like?

New Product Risk Review
  • 3 What are the risk mitigants and plans for
    managing those risks?
  • a. Product design, compensation design, control
    processes, reinsurance, hedging
  • b. Who will be responsible for the risk

New Product Risk Review
  • 4 What are the daily, weekly or monthly risk
    limits? a How are those limits determined and
    policed? b What happens when a limit is

New Product Risk Review
  • Who in Senior Executive Team is personally
    responsible for this product??
  • 6 What is the procedure for determining the
    Economic Capital/Risk Surplus required for this
    product? a Has this been demonstrated to be
    consistent with the Economic Capital/Risk Surplus
    for other company products?

New Product Risk Review
  1. What is the Risk Return profile of this product
    and how consistent is it with the Risk return
    profile of the other products?
  2. How does the product pricing reflect the risks of
    the product? a What adjustments have been made
    to the pricing to achieve risk adjusted returns
    that are appropriate as compared to the other
    company products?

  1. What training is needed for the staff that will
    be doing the risk measurement and the risk
    management processes?a. What training is needed
    for Senior Management to get a full understanding
    level on these risks?
  2. Will the companys internal and external
    financial reporting processes capture the
    appropriate risk adjusted returns for this
    product consistently with existing
    products?a Are there risks for this product
    that have significantly different characteristics
    that special consideration is needed? b Are
    there any pending studies of financial reporting
    for this product that might change the accounting
    significantly when the studies are completed?

Acquisition Risk
  • Risk Profile
  • Risk Management Processes
  • Implementation Risk

Other New Ventures
4.6 Risk Tolerance, Appetite Limits
  • Covered Twice already
  • Any Questions?

4.6 Emerging Risks
Emerging Risks Management
  • Primary Components
  • Environmental Scanning To provide advance
    signals of potential Crisis developments
  • Process for Anticipating Emerging Risks
    Development of Emerging Risk Scenarios
  • Process for Envisioning Significance of Emerging
    Risks Stress Testing Liquidity Risk Analysis
  • Process for Preparing Response to Emerging Risk
    Solutions Contingency Planning
  • Execution of Insurer in Emerging Risk Solutions
    Changes to company business and risk management
  • Insurer learning process from Emerging Risk

Objective To anticipate the next big risk
Emerging Risks Management
  • Pocess for Anticipating Emerging Risks
  • Development of Emerging Risk Scenarios
  • Terrorism, Natural Disasters, Pandemic, Man-made
    Disasters, IT Failures, Power Failures, Stock
    Market Crash, Banking Crisis, Interest Rate
    Spike, Systemic liquidity Crisis, hyperinflation,
    negative interest rates, significant negative
    economic growth, Stagflation, Price deflation,
    currency exchange rate crash
  • To the extent these are not considered under
    operational risk management.
  • To the extent that the risk are not core
    (catastrophe risk coverage)
  • Process for Envisioning Significance of Emerging
  • Stress Testing
  • Liquidity Risk Analysis

Emerging Risks Management
  • Process for Preparing Response to Emerging Risk
  • Liquidity Crisis planning
  • Reputation Risk planning
  • Crisis Response Rehearsal
  • Contingency Planning
  • 5. Execution of Company in Emerging Risk
  • Company learning process from Emerging Risk
  • Environmental Scanning
  • to provide advance signals of potential Crisis

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4.7 Scenario Planning
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4.8 Risk and Loss Diagnosis
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4.9 Reporting and Monitoring
Risk Management Constituencies
  • Management
  • Board of Directors
  • Shareholders
  • Securities Analysts
  • Investment Firms
  • Regulators
  • Rating Agencies
  • Distributors

External Auditors Creditors Reinsurers Business
Partners Parent Company Customers Employees
Internal Risk Position Reports
  • Asset
  • Duration, Convexity, Greeks, Liquidity, VaR,
    Performance Attribution, OAS
  • Liability
  • A/E analysis, Embedded Value analysis
  • ALM
  • Scenario Testing, Mismatch Risk, Transfer Pricing
  • Operational Risks

4.10 Risk Disclosure
  • Risk Management Discussion Disclosures in
    Annual Report
  • Aegon (ND) 6 pages
  • AIG (US) - 12 pages
  • Swiss Re (SW) 5 pages
  • Manulife (CA) 10 pages
  • Nedcor (SA) 30 pages (Bank)

Aegon Disclosures
  • Sensitivity Analysis
  • Fx
  • Equity Return Assumptions
  • Equity RE returns
  • Interest Rates
  • Exposure Limits
  • Credit Name limits
  • Derivative Exposure
  • Other
  • Bonds by Sector

AIG Disclosures
  • VaR
  • Market Risk VaR by Major Business Segment for
    Interest, Fx, Equity and Combined High, Low and
    average for year
  • Fair Value sources
  • Counterparty Credit Summary by quality by
  • Note AIG operations include trading market
    making in Fx, Commodities Metals. Much of
    disclosures relate to that activity.

Manulife Disclosures
  • Discussion of
  • RM Structure
  • Policies Process
  • Risk Measurement
  • Risk Limits
  • Sensitivity Tests
  • Interest Rate
  • Equity Market Value
  • Fx
  • Liquidity Stress
  • Exposures
  • Seg Fund Guarantees
  • Credit

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