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Risk Appetite, Tolerance and RBC

Risk Appetite, Tolerance and RBC. What do they mean?. Is it all the same?. Risk Appetite Risk Tolerance Risk Bearing Capacity. What is it?. Risk Appetite Propensity to take risk Risk Tolerance Ability to take risk Risk Bearing Capacity Absolute financial measure to survive risk.

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Risk Appetite, Tolerance and RBC

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  1. Risk Appetite, Tolerance and RBC What do they mean?

  2. Is it all the same? • Risk Appetite • Risk Tolerance • Risk Bearing Capacity

  3. What is it? • Risk Appetite • Propensity to take risk • Risk Tolerance • Ability to take risk • Risk Bearing Capacity • Absolute financial measure to survive risk

  4. Risk Appetite • Totally subjective • Based on perceptions • Personal • May be measurable or not • May change very regularly as environment changes

  5. Risk Tolerance • Still Subjective • Measurable • Criteria need to be identified • Criteria need to be agreed • Must take note of business dynamics

  6. Risk Tolerance • Measured in terms of “deviation from business objectives” • Prioritised according to criticality to company • Both upside and downside are identified and measured (each with own identity) • KPI’s

  7. Risk Tolerance Dimensions • Enterprise • Business unit • Region • Product line • Brand • Customer

  8. Risk Tolerance Dimensions • Time • Risk type • Change • Value • Outcome • Objective

  9. Risk Tolerance Dimensions • Reward • Interest • Asset • Value • Action • Change Agents • Influence

  10. Risk Tolerance Dimensions • Time • Probability • Position • Information

  11. Reward • Strategic goals • Financial targets • Production targets • Marketing & sales targets • Organisational objectives • Business objectives

  12. Interest • Shareowners • Suppliers • Customers • Employees • Authorities • Communities • Business Partners • Industry Bodies

  13. Assets • Dynamic assets • Value based assets • Legal assets • Human assets • Physical assets • Product based assets • Intellectual assets • Financial assets • Static assets

  14. Value • Financial value • Strategic value • Competitive value • Time value • Replacement value

  15. Action • Incoming corporate actions • Corporate financial actions • Corporate process actions

  16. Change Agents • Competitive • Financial • Fiscal • Operational • Intellectual • Legal

  17. Change Agents • Reputation • Social • Human • Environmental • Natural • Technological • Political

  18. Influence • Accumulation • Aggregation • Arbitrage • Background • Complexity • Correlation • Criticality • Cycles • Dependency

  19. Influence • Diversification • Duration • Interdependency • Liquidity • Proximity • Reliability • Tolerance • Volatility • Vulnerability

  20. Time • Cyclical factors • Seasonal factors • Timing • Regional cycles • Duration • Simultaneity

  21. Probability • Likelihood • Statistical probability • Correlation • Volatility • Aggregation • Timing • Relative frequency

  22. Position • Flexibility • Liquidity • Crisis response • Contingencies • Control/influence

  23. Information • Value at risk • Earnings at risk • Cash flow at risk • Yield curves • Risk capital • Stability ratios • Liquidity ratios

  24. Some examples • % of Revenue • % of EBITDA • % of Adjustable earnings • % of Debt Service cover headroom • % Leverage

  25. Some examples • Employee safety • Staff Turnover • Management turnover • Environmental incidents • Machinery breakdown incidents • Ethics (fraud, bribery incidents) • Training as % of Revenue • Employee engagement scores • Average machinery age • R+D spend as % of turnover

  26. Risk Bearing Capacity • Definition: • RBC is a prediction of the enterprise’s ability to endure losses and the effect such losses may have on the enterprise’s value and /or its ability to continue with its activities • RBC is a monetary value which is used as a yardstick, measuring the maximum loss the enterprise can endure, without exposing it to the point where its existence and survival is under threat, given an equivalent loss.

  27. RBC Methodologies • Net Working Capital • Net Working capital = Current Assets – Current Liabilities • 25%

  28. RBC Methodologies • Quick Asset Value • Quick Asset Value = Current Assets – Inventory • Quick assets = trade debtors +bank account • 25%

  29. RBC Methodologies • Coverage Ratio • Coverage ratio : Times-interest-earned ratio • How many times the enterprise’s operating income covers its debt-service charges • T-I-c-v= earnings before interest and tax – interest expenses • 10%

  30. RBC Methodologies • Annual Cash Flow Generated • Annual Cash flow Value = Annual cash flow-interest paid annually on long term debt • 10%

  31. RBC Methodologies • Surplus Cash • Surplus cash (free cash) = after ops activities, interest, taxes, dividends and before investment • 10%

  32. RBC Methodologies • Total sales • Total sales from income statement • 5%

  33. RBC Methodologies • Net Income • Net Income = Profits after tax and interest • 10%

  34. RBC Methodologies • Retained Earnings • Earnings after dividends • 10%

  35. RBC Methodologies • Fixed Assets • Total value of Fixed Assets • 5%

  36. RBC Methodologies • Distributable Reserves • = Accumulation of profits retained and reinvested • 10%

  37. Risk Tolerance Value • Pick a selection of RBC values • Some may be negative or not applicable at all • Select as many as possible • Calculate the Average

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