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Management of Asset Risk - II CM - 19 Risk & Capital Management Seminar - 9 July 2002

I N S U R A N C E A S S E T M A N A G E M E N T. Management of Asset Risk - II CM - 19 Risk & Capital Management Seminar - 9 July 2002. Types of risk. Do I have the correct strategy? Model Risk Strategic Allocation Can I implement the strategy? Process Risk Tactical Allocation.

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Management of Asset Risk - II CM - 19 Risk & Capital Management Seminar - 9 July 2002

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  1. I N S U R A N C E A S S E T M A N A G E M E N T Management of Asset Risk - II CM - 19 Risk & Capital Management Seminar - 9 July 2002

  2. Types of risk • Do I have the correct strategy? • Model Risk • Strategic Allocation • Can I implement the strategy? • Process Risk • Tactical Allocation

  3. Agenda

  4. Measures of Risk • Five axioms of coherence • Relevance • Monotonicity • Subadditivity • Positive Hemogeneity • Translation

  5. Measures of Risk • Variance/Standard Deviation • Well known • Symmetric

  6. Measures of Risk • Probability of Ruin • Ease of explanation • Ease of calculation • Similar to VaR • Ignores severity • Single point

  7. Measures of Risk • Value at Risk • Use in Capital Markets • Ignores severity • Single point

  8. Measures of Risk • Expected Policyholder Deficit • EPD • Reflects whole distribution • Difficult to explain • No parallels • Almost option price to policyholders

  9. Measures of Risk • Tail Value at Risk • Reflects whole distribution • Difficult to explain • No parallels

  10. What is risk? • Companies have more than one measure of risk • What is the chance that my surplus will decline? • What is the chance that I will have to pay more taxes? • What is the chance that my income will decline two years in a row? • What is the chance that my leverage ratio will be greater than 3? • Risks can work against each other • Determine all of the company’s risks in a qualitative manner

  11. Risk #1 Portfolio B Portfolio A

  12. Risk #2 Portfolio B Portfolio A

  13. Customized Risk Measures • Control volatility of returns • Risk: Standard Deviation of Total Return • Reward: Mean Total Return • Short-Term Hurdle Rate • Risk: Probability 2 Year return < -10% • Reward: Total Return • Long-Term Hurdle Rate • Risk: Probability 5 year return < 6% • Reward: Total Return

  14. Customized Risk Measures • Distribution of assets • Risk: Standard Deviation of Terminal Assets • Reward: Mean Terminal Assets • Limit Losses • Risk: Probability of Unrealized Losses in any year • Reward: Mean Terminal Assets • Budget cash flows • Risk: • (-1)(Paid Dividends)3 if Paid Dividends <= 0 • 0 if Paid Dividends > 0 • Averaged over all scenarios and years • Reward: • Sum Paid Dividends over all years • Averaged over all scenarios

  15. Customized Risk Measures

  16. Conditional Asset Allocation • What do you do if there is a catastrophe? • Force catastrophe into Model • Re-calculate allocation • Plan transition

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