Enterprise Risk Management

Transcription

1 Enterprise Risk Management Southeastern Actuaries Conference Rebecca Scotchie June 2011 ERM is 2 1

2 Agenda What is ERM? Why is risk management important? ERM maturity model/evolution of ERM ERM Framework Risk governance Risk Appetite policy North American CRO Council Emerging risks Economic capital 3 ERM is A framework of methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. the discipline by which an organization in any industry assesses, controls, exploits, finances and monitors risk from all sources for the purpose of increasing the organization s short- and long-term value to its stakeholders. a process, affected by an entity s board of directors, management and other personnel, applied in a strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity goals. 4 2

3 ERM is Process Organized, systematic way of managing risks Not once and done activity Process steps integral to how organization operates Enterprise (all) Not just financial or insurance risks (or individual risks) Applies broadly to all things threatening achievement of enterprise objectives Portfolio context Strategy/goals Value creation Risk is not limited to downside, includes opportunities Risk management includes risk acceptance and seeking Stakeholders Who we create value for Who we manage risk for Includes policyholder, employees and shareholders 5 Why is risk management important? Regulatory developments Rating agency views Convergence of financial products & markets Economic Capital Just good practice Financial Crisis Very large enterprises/ groups Board attention public s demand for assurance 6 3

4 ERM maturity model / evolution of ERM +Performance measurement. + Facilitate pricing Risk-adjusted > profitability + Accounting Capital.. + Economic Capital (Risk) > Manage reserves. + Regulatory Capital and capital + Value at Risk (VaR). + Stress Test & Scenario Analysis > Risk analysis + Identify, Avoid, Monitor > Limit management Effective Enterprise Risk Management Infrastructure 7 ERM Framework 1. Corporate Strategy Corporate strategy is starting point for risk philosophy and enterprise risk management strategy 2. Risk Culture & Governance Strong risk culture and properly designed governance structure frames entire risk management program Tone at the top (Board responsibilities, management understanding) 3. Risk Identification & Prioritization Consistent and ongoing development of profile of sources of risk Don t forget operational and emerging risks 4. Risk Appetite & Limits Risk appetite policy describes types of risks willing to take and amount of enterprise risk exposure in pursuit of goal 5. Risk Management & Controls Accept, manage, minimize, or avoid risks 6. Risk Reporting & Communication 8 4

5 WHO 7/20/2011 ERM Framework: Risk governance 1 st line of defense 2 nd line of defense 3 rd line of defense All employees Risk Committees & CRO Internal Audit & Control Frontline business management Compliance External Audit Audit Committees CRO can t be everywhere at all times Multi-layered risk control system (3 lines of defense) Board of Directors plays active role Direct responsibility for strategic risk Receives ERM report regularly from CRO Committee structure: Audit, Finance, Human Capital, Regulatory Compliance Audit committee of Board of Directors oversees entire ERM governance 9 ERM Framework: Risk appetite policy Policy surrounding types and amounts of risks we re willing to take in pursuit of goals Good business practice Documented risk appetite is becoming an expectation among regulators and rating agencies Insurers should demonstrate that they have operated their business within their stated risk tolerances No prescriptive checklists of required content Common practices emerging; according to the Towers Watson s 2010 Global ERM Survey: Balance sheet solvency is principal focus of current risk appetite metrics 66% use regulatory capital and 62% include economic capital measures 35% use GAAP or IFRS earnings volatility Use of risk limits focused on market (79%), credit (76%), and insurance (65%) risks. Operational risk limits are less common 37% of participating companies. 10 5

6 ERM Framework: Components of risk appetite policy Components Most significant risk categories Risk strategy and principles Starts with corporate strategy, forming foundation Principles are embedded in risk management strategy / efforts Business and company scope Statement: Broadly describes types and amounts of risk company is willing to take to achieve business and strategic objectives Sets boundaries for risk taking activities Links earnings, capital and operational processes together Limits and controls Monitoring and reporting 11 North American CRO Council Professional association (CROs) that seeks to develop and promote best practices in risk management for NA insurance industry Initial agenda: Global developments associated with harmonization of regulatory capital requirements across jurisdictions Providing guidance to NA regulatory bodies on effective methods for evaluating risk management and solvency monitoring standards Promoting the development and assessment of capital requirements leveraging company-developed risk models Producing industry-leading research on emerging risks Working groups/committees US regulatory developments Rating agency developments International developments FSOC and federal issues Emerging risks 12 6

7 Emerging risks Definition: New or evolving risk which is characterized by uncertain probability or frequency of occurrence, momentum, or magnitude, but which could have a significant impact on risk profile or long term value of the industry. Examples: Changes in regulatory environment General economic trends Inflation/stagflation Privacy breaches Potential changes in tax law Policyholder behavior in extreme scenarios Changes in financial reporting Failure to identify asset bubbles, or fraud Geopolitical risk Pandemic/health crisis Social media Climate change 13 Economic capital (EC): The catalysts of development of EC are both external and internal To be completed External Regulators Solvency II: Principles-based economic capital framework for solvency capital requirement Bermuda: New framework to gain Solvency II equivalence NAIC: Solvency Modernization Initiative (SMI) Rating agencies A.M. Best S&P Internal Inform internal capital allocation model, which attempts to consolidate view of regulators, rating agencies and company Capital which maintains regulatory requirements and level required to target specific rating and align with our view of the risk Assist in planning for impact of business decisions Provide quantitative criteria for risk appetite Support ALM Support corporate development activities 14 7

8 Introduction to economic capital Economic capital is: Capital required to provide a specified level of security to policyholders that benefits will be paid An internal calculation of the capital required, based on the company s view of risk, with calculations based on economic principles A calculation to assess risk There is no global consensus as to how to define or calculate; techniques vary between regulators, rating agencies, geographies, accountants, etc Two main approaches have emerged Liability run-off approach One year mark-to-market approach 15 Liability run-off approach EC is based on the amount of initial assets needed to cover liabilities at a required confidence level projected over the lifetime of the business For each scenario examined, the minimum amount of assets required to satisfy all liabilities by the end of the projection is determined Scenarios are rank ordered to form distribution of the required initial asset amounts EC is a function (e.g., VaR or CTE) of the distribution for a given confidence level less some measure of the liabilities Typically implemented using an integrated stochastic model, although other implementation approaches are possible Principles-based approaches to reserves and capital being adopted in the U.S. by NAIC (e.g., C-3 capital) use a liability runoff approach 16 8

9 One-year mark-to-market approach EC is based on the amount of assets needed to remain solvent over a oneyear time horizon at a required confidence level, measured on a mark-tomarket basis Opening assets and liabilities projected for one year Mark-to-market value of net assets calculated and discounted to valuation date Tail distribution of the PV of mark-to-market net assets is developed by repeating under different conditions EC measure(s) (e.g., VaR, CTE) calculated from tail distribution In practice, stochastic and stress testing implementation approaches are used With stress testing, a limited number of stress scenarios are run, which have been calibrated to give results in the relevant tail of the capital distribution Stochastic approaches are becoming more common, but are usually more complex, particularly for business with financial options and guarantees Approach began in the banking industry and is soon to be the basis for insurer solvency regulation across Europe (currently in U.K. and Switzerland, expanding under Solvency II) 17 Unum s economic capital project: Project plan Unum s EC project is divided into several stages: Pilot Rollout Enhancement Stress tests for main risks, including insurance, credit, and market Preliminary correlation matrix/conventional wisdom re: diversification benefits Use current modeling capabilities 3 products only Crude documentation Limited ability to quickly repeat process Additional risks and/or refined stress tests More formed views for diversification benefits Expanded modeling capabilities Unum US Improved documentation Increased ability to repeat process Additional risks and/or refined stresses tests, consider stochastic modeling Final views on diversification benefits Enhanced modeling capabilities Unum Group Economic Capital manual Smooth running process, easily to replicate Accepting this pace and not seeking perfection has prevented us from getting bogged down, allowing us to make headway faster and better. 18 9

10 How do we interpret the calculation? Potential extra capital needed Allocated capital Economic Capital Risk Margin Statutory Reserves Best Estimate Liability Assets Liabilities Potential extra capital = Total asset requirement (BEL+RM+EC) - MVA backing statutory reserves and allocated capital 19 Questions? 20 10