Risk Assessment and Management Seminar

1. Session 1Risk Assessment and Management Regional Training Seminar IAIS-ASSAL San Salvador, El Salvador, 22-25 November 2010 Takao Miyamoto, IAIS Secretariat

2. Agenda • Enterprise Risk Management (ERM) • General Framework • Risk Management Process • Risk Identification • Risk Assessment & Measurement • Planning & Execution • Final Remarks 1

3. Enterprise Risk Management (ERM) Governance and an Enterprise Enterprise Risk Management Framework Risk Management Framework Feature 1 Risk Management Policy Risk Tolerance Statement Feedback Loop Own Risk and Solvency Assessment (ORSA) Feedback Loop Economic and Regulatory Capital Continuity Analysis Role of supervision Role of supervision 2 Feature 8

4. Process • Risk management policy • How all relevant & material risks are managed • Relationship between risk tolerance limits, regulatory capital, economic capital & processes/method for monitoring risks • Investment policies • Asset-liability management (ALM) • Relationship between pricing & product development • Risk tolerance statement • Both quantitative & qualitative • Level of risk to which insurer is willing & able to be exposed 3

5. Process • Own Risk and Solvency Assessment (ORSA) • Self-assess all reasonably foreseeable & relevant material risks • Translate risk identification into capital needs • Include long-term continuity assessment • Role of Supervision • Assess adequacy & soundness of insurer’s framework & processes • Take appropriate actions when necessary • Should not take “one-size-fits-all” approach – nature, scale & complexity of business & risks 4

6. Agenda • Enterprise Risk Management (ERM) • General Framework • Risk Management Process • Risk Identification • Risk Assessment & Measurement • Planning & Execution • Final Remarks 5

7. Risk Identification Typical category Features Underwriting (Insurance) • Risks assumed through insurance contracts insurers underwrite • Line of business: fire, marine, automobile, earthquake, death, injury etc. • Types: pricing, product design, claims, economic environment, policyholder behavior etc. Credit • Inability or unwillingness of counterparty to fully meet contractual financial obligations • Source: default, downgrade, migration, spread, settlement, sovereign etc. • Relatively smaller for insurers compared to banks 6

8. Risk Identification Typical category Features Market • Volatility & uncertainty of market value of assets/liabilities • Variables: stock price, interest rate, foreign exchange rate, commodity price etc. Liquidity • Obliged to procure funds (e.g. by liquidating assets) under unfavorable terms as financial obligations fall due • In worst case, unable to settle financial obligations Operational • Risk of loss resulting from inadequate or failed internal process, people, system, external events etc. 7

9. Example 8 (Source) The Geneva Association “Systemic Risk in Insurance”

10. Risk Assessment & Measurement • Two factors in assessing impact of risk • Frequency (likelihood/probability of occurrence) • Severity (loss size in case accident occurs) • Risk map – more intuitive/simple method • Useful for classification • Most risks may not be so simple as to be classified this way Example High • Earthquake Severity • IT system trouble • Daily share price change Low Low High 9 Frequency

11. Risk Assessment & Measurement • Quantitative/Statistical method • Mean (1st order), Variance/Standard Deviation (2nd order), Skewness (3rd order) etc. • Value at Risk (VaR): possible maximum loss over a specific time horizon (e.g. 1 year) at specific confidence level (e.g. 99%) • Tail Value at Risk (TVaR): average VaR beyond a specific confidence level Probability Mean VaR (e.g. 99%) TVaR (e.g. 99%) 10 Loss

12. Risk Assessment & Measurement • Mismatch between models & real world • Model risk • Parameter risk • Need to • Validate & understand limitations of models • Complement use of models • Stress testing • Measure financial impact of stressing risk factors • Also, reverse stress testing • Scenario analysis • Consider financial impact of combination of circumstances based on scenarios 11

13. Planning & Execution Two concepts • Risk (Loss) control • Intended to change characteristics of risks themselves • e.g. insurers conduct promotional activities against car theft (=> reduce frequency of car theft) • e.g. insures ask installation of sprinklers (=> mitigate severity of fire) • Risk (Loss) finance • Financial preparation for loss resulting from existence of risk • Necessary regardless of risk control activity 12

14. Tools of Risk Management - Overview Risk Management Risk (Loss) Control Risk (Loss) Finance Frequency Severity X Retain Prevent Mitigate Transfer Avoid Reduce Exploit (Expand or Diversify) 13

15. Risk Control Strategy Features Avoid • Avoid underwriting certain product line or market segment • Because it is (unlikely to be) unprofitable, too risky, lower priority area • But does not mean no cost – opportunity cost exists Reduce • Take lesser amount of particular risk • Because risk amount is approaching insurer’s appetite & capacity Exploit (Expand or Diversify) • Particular risk may work as hedge to overall risk exposures • Possibly intentionally take particular risk for diversification effect 14

16. Risk Finance Strategy Features Retain • Simply retain particular risk • Because insurer is confident to manage risk and has capacity • May need outside finance: borrowing, commitment line, new capital etc. Transfer • e.g. reinsurance (traditional) • e.g. derivatives, securitisations (ART: alternative risk transfer) • But create another risk (counterparty credit risk) 15

17. Example – Reinsurance Insurer or another reinsurer Reinsurer (ceded) Reinsurer (ceded) Reinsurer (ceded) Insurer (retained) Insurer (retained) Insurer (retained) • Advantages • Reduce and control risk profile • Manage/Stabilise financial result • Create new capacity • Gain product expertise • Gain underwriting advice Shared in fixed proportion (amount changes) Amount over specified level is ceded (proportion changes) With upper limit 16

18. Example - Securitisation • Cat (catastrophe) bond • Use capacity of capital market (from insurer’s perspective) • Diversification due to low correlation with other asset classes (from investor’s perspective) 17 (Source) Munich Re “Insurance-linked securities (ILS) market update”

19. Agenda • Enterprise Risk Management (ERM) • General Framework • Risk Management Process • Risk Identification • Risk Assessment & Measurement • Planning & Execution • Final Remarks

20. Final Remarks • Risk management does not exist in isolation • Link risk management with • Corporate objectives • Business strategy • Day-to-day operations • Capital management • Current circumstances • Serve for enhancing strategic decision-making 19

21. ¡Muchas gracias! www.iaisweb.org takao.miyamoto@bis.org 20