2013 Canadian Insurance Financial Forum

Transcription

1 2013 Canadian Insurance Financial Forum Understanding Managing and Mitigating Investment Risk Presented by: Jim Falle EVP & CFO Aviva Canada Inc. Date: May 22 nd, 2013 Understanding Managing and Mitigating Investment Risk Overview Why Bother Managing Investment Risk? Risk Management Framework How does the Management of Investment Risk fit in? Economical Capital Modelling Overview Risk Appetite Investment Management Process Strategic Asset Allocation Why does any of this matter? War Gaming Sensitivities Q & A 1. 1

2 Why Bother? The Wacky & Ever changing world we live in! $CAD - $.65 USD $1.03 USD October 1987 Black Monday Market 23% in 1 day Inflation rates +5% in 1 year -3 times post 1950, twice in 70 s Interest rates +2% in 1 year 80 s 1981 first mortgage rates 18.25% Q4 2008, Q % market correction in Q4 Corporate A Spreads > 400 BP s $1 Trillion - $1,000,000,000,000 Lehman Brothers Bailout of GM & Chrysler Too big to fail? European crisis 2013? SIFI S U.S. Fiscal cliff European crisis Leafs!! 2014?? 2. Why Bother? G of C Rate S Corporate A Spreads 3. 2

3 Why Bother? TSX Composite S&P Why Bother? Having a Plan is a complete waste of time. However planning is invaluable Winston Churchill 3

4 Risk Management Framework Three Lines of Defense for the Management of Risk 6. Governance and Risk Management Risk Management Framework 7. 4

5 Purpose of ORSA & DCAT and Integrated Approach 8. Economic Capital Modelling Required Economic Capital (REC) to cover Insurance Risk Pricing Reserving Catastrophe Financial Risk Market Interest Rate Equities Credit Risk Inflation Currency Operational Risk REC calibrated to 1:200 / 99.5% level consistent with the Company s risk appetite REC is accumulated and then co-variance relief applied to arrive at the net REC Risk appetite set for each individual risk It is better to be approximately right than precisely wrong!! 9. 5

6 Core Risks of a General Insurance Company It is important to understand the relative size of each risk on a stand alone basis as well as in relation to the other risks of the company Interest Rate Up Interest Rate Tilt Reinsurance Credit Structured Settlements Inflation Currency Rate Preferred Equity Property Available Economic Capital Required Economic Capital Underwriting Reserving Latent Credit Broker Investments Operational Catastophe Expenses Closure Cost Key: Insurance Risks Credit Risks Market Risks Operational Risks 10. Governance and Risk Management Overarching Risk Appetite Statements Risk Appetite Statement Philosophical statement that sets the tone with respect to the Company s approach to the delicate balance between risk and reward. High level statement as to how this is to be achieved. Capital Target Measure Liquidity Target Measure Economic Capital Sufficient capital to withstand a 1:10 year stress while still retaining sufficient capital to withstand a 1:200 year stress to the balance sheet. Often expressed as a ratio of AEC/REC. Statutory Capital Maintain MCT of at least X% to ensure solvency capital exceeds 150% following a 1:10 year stress. Maintain sufficient cash and liquid assets to meet short term net cash flows and unexpected requirements under a 1:10 year stress event Franchise value Qualitative statement as to how to protect the franchise value through the lens of key stakeholders (Shareholders, Customer, Regulator) 11. 6

7 Steps Leading to the Investment Strategy and Management Process Strategic Plan Scenario Stress Testing Risk Appetite Statement Strategic Asset Allocation Process 12. Strategic Asset Allocation Process Conducted at least annually or more frequently if required (market or stress event) Evaluates existing and potential investment strategies that enable the overall strategy of the Company and safeguards the capital in accordance with the Risk Appetite Framework Risk/Return evaluated using Efficient Frontier analysis through the lens of Economic Capital and MCT Set of Strategies, Action Plans, and parameters to manage the Investment Portfolio 13. 7

8 Why does any/all of this Matter? Importance of investment income to the industry Using 2012 year-end data A 1% change in investment income = $1.2 billion $1.2 billion in underwriting profits equates to a 3.8% impact on COR 14. Why does any/all of this matter? MCT interest rate required capital 2012 and beyond Year Interest Rate Shock Industry Required Capital $ millions Impact on Industry MCT % 2012 Actual.5% % 2013 Est..75% 1, % 2014 Est..75% 1, % 2015 Est. 1.25% 1, % Est. The estimated figures are indicative of the impact on the industry provided there were no material changes in ALM activity or hedging in the industry 1/200 The economic capital requirement calibrated at 1:200 or 99.5 th percentile would be closer to a 200 BP interest rate shock! 15. 8

9 Why does any/all of this Matter? Asset Liability Matching Fundamental Question Is this important or not to your company? We calculate effective duration of policy liabilities and then manage the Investment Portfolio so that effective duration of the assets backing policy liabilities are as closely matched as possible Means to protect earnings and capital from significant swings in interest rates You need to know the impact of ALM decisions on the earnings and capital of the Company 16. Why does any/all of this Matter? War Gaming Scenarios Sudden spike in inflation of 5% 200 BP sudden rise in interest rates (parallel shift) 200 BP sudden widening of Corporate A credit spreads Significant catastrophe at 1:200 level, 1:500 level What event or series of events cause the Company to fail 1:200 = 99.5 th percentile =.5% chance of financial ruin 17. 9

10 Outcome of War Gaming Exercise Playbooks developed to address 5 questions 1. What? 2. So what? 3. Now what? 4. Then what? 5. Who? Management and Board are more explicitly aware of the resilience of the balance sheet and capital Significantly improves / promotes a risk aware culture 18. Monitoring What Matters Ongoing Monitoring of Key Sensitivities To monitor the impact on the earnings and capital position we recalibrate the following on a quarterly basis and monitor them at least on a monthly basis 10 BP move in interest rates 10 BP move in credit spreads frequency by 10 BP severity by 1% Impact on normal CAT events Capital consumption ratios Material changes in any of the above items can have a significant impact on the management of the Investment Portfolio

11 Questions? 11