Enterprise Risk Management (ERM)

Transcription

1 Southeastern Actuaries Conference Enterprise Risk Management (ERM) November 16, 2007 ING. Your future. Made easier.

2 Agenda ERM Are you doing it? Definition of ERM What is it? Industry Overview What is going on? Primary Components of ERM What are they? Rating Agency Perspective What do they think? Economic Capital (EC) What is it and what are we (ING) doing? Questions & Open Discussion What can we learn from each other? Insurance - Banking - Asset Management 2

3 Insurance - Banking - Asset Management 3

4 Are You Doing ERM? How much risk is your company taking (provide a value)? Is your company taking more risk or less risk than a year ago? How do you know? Has your investment risk increased or decreased during the past three months? How do you know? How much investment risk is your company taking relative to your underwriting risk? How do you know? Do you have the right amount of capital to support the risk your company is taking? How do you know? If you do not have answers to the above questions, then more than likely you are not doing ERM! Insurance - Banking - Asset Management 4

5 Definition of ERM In its Overview of Enterprise Risk Management, the Casualty Actuarial Society describes Enterprise Risk Management as: the discipline by which an organization in any industry assesses, controls, exploits, finances and monitors risk from all sources for the purposes of increasing the organization s short- and long-term value to its stakeholders. Similarly, COSO defines ERM as: 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. Insurance - Banking - Asset Management 5

6 Definition of ERM Differences between ERM and Traditional Risk Management (TRM) Scope and Comprehensiveness ERM covers ALL risks and is applied across the entire organization TRM was more focused on risk mitigation, while ERM also includes strategic opportunities (e.g. optimizing results on a risk-adjusted basis) TRM looked at risks individually, typically by experts in those areas (i.e. silos) ERM takes advantage of diversification benefits of looking at interactivity of risks Leads to the possibility of holding less capital There is now a lot more focus on operational and reputation risk and their potential impact Insurance - Banking - Asset Management 6

7 Industry Overview The activity around ERM has increased significantly over the past year or two and can be attributed to several drivers: Regulation Sarbanes-Oxley Solvency II SEC and NYSE requirements Rating Agencies Public Business scandals Post 9/11 Opportunities for Management Achieve business goals rather than just minimize downside potential Insurance - Banking - Asset Management 7

8 Industry Overview Education / Resources SOA - Society of Actuaries Sponsors the ERM Symposium CERA Certified Enterprise Risk Analyst RIMS Risk and Insurance Management Society Risk Maturity Model An online resource that provides guidelines and best practices for developing and maintaining effective risk programs Allows companies to evaluate risk culture competency, identify gaps, and determine areas for improvement PRMIA Professional Risk Managers International Association PRM Professional Risk Manager GARP Global Association of Risk Professionals FRM Financial Risk Manager Insurance - Banking - Asset Management 8

9 Industry Overview Insurance - Banking - Asset Management 9

10 Primary Components of ERM Establishing an ERM framework and risk governance Risk identification Risk assessment Risk response Incorporation into performance measurement / management External risk reporting Insurance - Banking - Asset Management 10

11 Rating Agency Perspective Rating agency s evaluate the risks of a company and their ability to manage those risks Standard & Poor s Enterprise Risk Management (ERM) evaluation criteria Part of the rating process since October 2005 Evaluate ERM quality in five areas Risk management culture Risk controls Extreme risk management Risk and economic capital models Strategic risk management Classifications Excellent, Strong, Adequate, Weak Insurance - Banking - Asset Management 11

12 Economic Capital (EC) I. What is Economic Capital? Why use it? II. EC measurement and risk management in ING III. Conclusions Insurance - Banking - Asset Management 12

13 EC as part of the total balance sheet Excess Capital Economic Capital Market Value Surplus = Available Capital Market Value of Assets Risk margin Guaranteed liabilities Market Value of Liabilities Economic Capital is the amount of assets that is needed in addition to the market value of liabilities to guarantee payment of all liability cash flows at a x% confidence level in a determined period of time. Insurance - Banking - Asset Management 13

14 Economic Capital Best Estimate Market Value Surplus Economic Capital Market Value Surplus in 1 year 99.95% Insurance - Banking - Asset Management 14

15 Why Stakeholders are Converging to EC A common system is required for all users Regulators Rating Agencies Creditors Risk versus Capital Senior Management Risk versus Return Shareholders Analysts Regulators demand that risks are well managed (to avoid taxpayer bail-outs) Depositors/policyholders expect safety of their savings and investments Rating agencies will only give high ratings to institutions able to measure and manage risk Shareholders have entrusted the board with their capital They don t want to lose it They expect a decent return on it They don t want any surprises They penalise volatility Capital Adequacy Capital Efficiency Insurance - Banking - Asset Management 15

16 Discussion Points I. What is Economic Capital? Why use it? II. EC measurement and risk management in ING III. Conclusions Insurance - Banking - Asset Management 16

17 Capital models in ING Until % EU Requirement ING Capital Model (ICM) still factor based 2006 and onwards - Economic Capital 150% EU Capital Requirement ING Capital Model Requirement Economic Capital Statutory Reserves Statutory Reserves Market Value of Liabilities Insurance - Banking - Asset Management 17

18 A Continual Improvement Process Management Control Measurement 1999/2000 Start EC Pilots 2006: MC Pricing targets Full migration of EC, MVaR, Focus on auditable, efficient risk and value reporting processes Risk governance EV profit in incentive plans 2005: Board & ALCO approval to further implement EC Input in MTP: MVaR limits EV profit in strategic planning process 2004: EC results used to calibrate ICM 2007 Objectives Auditable, efficient risk and value reporting processes (ECAPS) Confirm usage of MCEV for internal management; consideration for valuation tool for external purposes: to be decided, considering model stability and (credit) spread recognition. Leverage ECAPS to change the way that actuaries view our business (risk management) Pre 1999: strong foundation in current and future assumption setting and cash flow projection experience around Embedded Value calculations. Insurance - Banking - Asset Management 18

19 How is Economic Capital Calculated? Assets, Liabilities, and Surplus at Market Value EC = Change in Market Value Surplus under 1 in 2000 worst case occurrences during next year 1 in 2000 correlates to risk profile of AA rated company Required Capital = Sum of Individual Required Capitals based on Risk Type Credit and Transfer Risk Market Risk Business Risk Operational Risk Insurance (Life and Non-life) Risk less Diversification Effects Total combined risk capital < sum of individual risk capitals Diversification exists across risk types and business units Insurance - Banking - Asset Management 19

20 Risk types correspond to a possible economic loss CREDIT RISK Unexpected Loss Earnings Deviation due to variations in Credit Losses RISK Earnings Deviation Total Economic Risk Inter-risk diversification TRANSFER RISK Unexpected Transfer Loss MARKET RISK Value at Risk BUSINESS RISK Residual Earnings Deviation OPERATIONAL RISK Event Loss Deviation LIFE Risk Mortality Deviation Non-Life Risk Claims Deviation Earnings Deviation due to inability to repatriate funds - immaterial for insurance Earnings Deviation due to changes in the Market Price or Liquidity Earnings Deviation due to changes in Operating Economics (e.g. Volume, Margins or Costs Earnings Deviation due to One-off Losses unrelated to Volume, Margins and Costs Earnings Deviation due to unexpected changes in mortality rates Earnings Deviation due to changes in morbidity and P&C claims Insurance - Banking - Asset Management 20

21 EC Competitive Advantages ING s Rating Best Practice Risk Management will be essential part of rating review process Rating will influence share price and provide us with cheaper capital Analyst s View Pricing Pricing on EC will better reflect risks in our products EC will identify unprofitable products or markets Exploit opportunities with EC pricing Vs. statutory Lobbying opportunities globally Solvency II Capital Improved consequences risk management improves view Analysts will recognise our pro-activeness Managing our business on EC will benefit all our stakeholders Insurance - Banking - Asset Management 21

22 Capital use - Managing market risks GOAL: Objectively measure and actively manage market risks Measure Objectively quantifying the market risks taken by ING Group Measure equity, interest rate, foreign exchange, real estate, and credit spread risks as well as credit risk- all adjusted for risk diversification Manage Provide framework for optimal management of market risks in insurance (MVaR covers 60% of total Economic Capital for ING Insurance) Optimal allocation of scarce resources through allocation of limit space Optimal determination of investment mix: business units to decide within limits Making risks (i.c. risk-return) comparable throughout ING Group by creating a level playing field Insurance - Banking - Asset Management 22

23 How to get it right? EC Application Software Auditability Timeliness Consistency Functional Improvements Clear control procedures and documentation leading to auditable EC reporting Large increase in automated processes Supports auditable Risk Dashboard reporting Timely quarterly reporting in line with financial calendar Standardised methodology and reporting format Comparable assumptions and results across entities Improved methodologies, particularly on market risk calculations, diversification and aggregation of risks Expandable to support MCEV performance analysis and reconciliation Replicating portfolio for ALM interface Market Risk Analysis Faster Group wide impact of analysis of specific risks Increased analysis & communication move from getting the numbers to using the numbers Insurance - Banking - Asset Management 23

24 ECAPS Overview Via Intranet ECAPS Tool Scenario Generator Replicating Portfolio Economic Capital (EC) Calculation Reporting Business Unit (BU) Focus on providing asset/ liability data and non-market risk EC Insurance - Banking - Asset Management 24

25 ECAPS - improvements Old Method Best Possible Cash Flow Models Simplified Market Shocks Very Simplified Aggregation Techniques Overall Approximation Error New Method Best Possible Cash Flow Models Simplified Portfolio Representation Advanced EC & Aggregation Current methodology tries to measure individual liabilities very accurately, but makes big approximations for Market shocks (e.g. single factor for term structure, etc.) Diversification / aggregation (e.g. simplified covariance matrix, Gaussian Copula) New methodology uses replicating portfolios to capture asset and liability risk profiles Much more accurate EC market shocks & diversification possible due to Monte-Carlo method Insurance - Banking - Asset Management 25

26 Discussion Points I. What is Economic Capital? Why use it? II. EC measurement and risk management in ING III. Conclusions Insurance - Banking - Asset Management 26

27 Summary Alignment of external, regulatory and internal move to enhanced risk measurement through EC will facilitate: Improved understanding of risks and therefore avoiding costly mistakes that may hurt the solvency of the insurer Better risk management in insurance companies Provide more transparency for the external world Senior executives will be able to make better informed decisions about risk and capital, and ultimately improve the risk-adjusted business performance of the company INCREASE TOTAL SHAREHOLDER RETURN Insurance - Banking - Asset Management 27

28 Questions & Open Discussion Thoughts on ERM The evolvement of ERM to-date What are you seeing now? Where you think this will lead to in the future? Challenges Opportunities Questions / Comments Insurance - Banking - Asset Management 28