Session 3B: Stress Testing from Macro-environment, to Scenario to Impacts and Decision. Moderator: Dariush A. Akhtari, FSA, MAAA, FCIA

Transcription

1 Session 3B: Stress Testing from Macro-environment, to Scenario to Impacts and Decision Moderator: Dariush A. Akhtari, FSA, MAAA, FCIA Presenters: Ricky Power David Wicklund, FSA SOA Antitrust Disclaimer SOA Presentation Disclaimer

2 ERM Symposium - Stress Testing: from Macroenvironment, to Scenario, to Impacts and Decisions Ricky Power, FSA, FIA, CERA Ricky.Power@Moodys.com 2017

3 Agenda What is Stress Testing? Where Would I get Stress Testing Scenarios? Examples Creating Scenarios: Macroeconomic and Market variables Assessing Frequency and Severity Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 2

4 What is Stress Testing? Stress testing of financial institutions is designed to gauge the impact of changing financial situations on the balance sheet. Broadly speaking there are 3 types of stress test: 1. Sensitivity Test typically smaller changes to a single variable (often instantaneous) 2. Scenario Test would usually involve simultaneous changes to a number of variables, possibly to emulate a possible future state of the economy. 3. Reverse Stress Test this type of stress testing tries to identify the situation(s) where the financial institution would fail (insolvency, breach risk appetite etc.). Single/Multi Factor Sensitivity Single/Multi factor Single/Multi period Scenario Multi Factor Single/Multi period Stress Ref 1: Adapted from International Actuarial Association Stress Testing and Scenario Analysis July 2013 Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 3

5 Where would I get Stress Testing Scenarios? Sources: 1. Business Plan (Finance Department) 2. Historical what if 2008 happened again? 3. Economists - Internal/External Research and Forecasting 4. Regulatory (Prescribed): 1. CCAR (FED - Comprehensive Capital Analysis and Review) 2. ORSA annually over the business plan horizon and different stress scenarios Considerations: 5. Applicability 6. Data Availability 7. Understandability: Results discussed by the board Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 4

6 Example Stress Testing Scenarios 1. CCAR - Baseline, Adverse, and Severely Adverse 2. Slower Near Term Growth bad Brexit, strong dollar, less exports 3. Stronger Near Term Growth better Brexit, stronger EU, more exports 4. Moderate recession Brexit contagion, EU recession 5. Protracted Slump Ref 2: Moody s Analytics Forecasts with Alternative Scenarios (August 2016 Views) 6. Below Trend Long Term Growth 7. Stagflation - persistent high inflation combined with high unemployment and stagnant demand in a country's economy. 8. Next Cycle Recession 9. Low Oil Price 10. Baseline Oftentimes stress scenarios include a mix of both financial and macroeconomic variables Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 5

7 6 Linkage Between Macroeconomic and Financial Variables» Capital markets are an objective barometer / driver of macroeconomic conditions.» Trading prices of financial products signal expectations for the future state of the economy. Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 6

8 The roles of Economists and Actuaries Narrative selection Economists Backtesting Variable selection Econometrics vs Stochastics Results Target setting Actuaries Correlation Variable expansion Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 7

9 Market/Macroeconomic Variable Framework Equity returns Property returns Alternative asset returns (e.g. commodities) Corporate bond returns Credit risk model Initial swap and government nominal bonds Nominal short rate Nominal minus real is inflation expectations Exchange rate (PPP or interest rate parity) Index linked government bonds Real short rate Realised inflation and alternative inflation rates (i.e. Medical) Foreign nominal short rate and inflation Unemployment f(real Short, Nominal Short, Equity, Spreads, Unemployment[t-0.25]) Unemployment Claims f(unemployment, Equity, GDP) GDP f(real Short, Nominal Short, GDP[t-0.25]) Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 8

10 Frequency and Severity Severity Frequency Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 9

11 10 Macroeconomic Forecasting Example GDP» Based on econometric modelling Gross Domestic Product Growth distribution 15% -5% Baseline Strong Rebound Moderate Recession Protracted Slump Below Trend Long Term Growth Stagflation Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 10

12 11 Accessing Frequency» Econometric forecasts overlaid with stochastic distribution Gross Domestic Product Growth distribution 50 to to to to % -5% Baseline Strong Rebound Moderate Recession Protracted Slump Below Trend Long Term Growth Stagflation Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 11

13 Accessing Severity Capital & Solvency Projection» Forward looking analysis of solvency & capital requirements.» Potentially complex depending on the nature of assets and liabilities» Data and calculation intensive nxn more than the initial solvency calculation.» Significant expert input scenarios, calibration, approximation methods etc Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 12

14 Accessing Severity Calculating solvency capital along the path U.S statutory reserving and capital often prescribes a CTE calculation approach Proxy techniques such as curve fitting and LSMC can prove useful» Stochastic real world scenarios with deterministic root behaving similarly to risk neutral / real world nested stochastic Capital calculation Multi timestep capital projection Ref 3: Moody s Analytics: Proxy Methods for Run-off CTE Capital Projection, October 2016 Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 13

15 References Reference 1: IAA Stress Testing and Scenario Analysis, July Reference 2: Moody Analytics Forecasts with Alternative Scenarios, August Reference 3: Proxy Methods for Run-off CTE Capital Projection, October Stress Testing: from Macro-environment, to Scenario, to Impacts and Decisions 14

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17 Integrated stress testing and forecasting ERM Symposium April 20, 2017 David Wicklund, FSA, CFA

18 Agenda Stress testing and forecasting Developing an approach Inputs Calculations Consolidation Outputs Uses Takeaways Page ERM Symposium integrated stress testing and forecasting

19 Stress testing and forecasting Industry current state Financial forecast Focus: earnings Scenarios: baseline (limited or no stresses) Uses: financial planning and analysis Process owner: finance Focus: solvency Stress testing Scenarios: deterministic stresses Uses: risk management and/or regulatory (e.g., ORSA) Process owner: risk management or actuarial Process: Redundancy and inconsistency between forecast and stress testing Inefficient and manual processes Long cycle times Current state shortcomings Use: Narrow scope Limited flexibility and ability to inform management decisions Limited reflection of legal entity and holding company dynamics Page ERM Symposium integrated stress testing and forecasting

20 Stress testing and forecasting Integrated approach potential future state Production Analysis and action Inputs Modeling Consolidation Outputs Uses In-force New business Assets Assumptions Scenarios Modeling tools Infrastructure Processes Methodologies Legal entity and business views Enterprise results Enterprise actions Financial bases Metrics Cash flow projections Risk management Strategic decision support Financial planning and analysis Regulatory Integrated approach benefits Process: Use: Consistency across uses Increased efficiency Generate comprehensive view (GAAP, stat, etc.) in one process Ability to connect with risk appetite across multiple lenses Better information to drive management decisions Page ERM Symposium integrated stress testing and forecasting

21 Developing an approach Inputs Scenarios Deterministic outer loop scenarios Inner loop scenarios Risk drivers Assumptions Inner loop vs. outer loop assumptions Assumption unlocking in stress scenarios New business New business inclusion Number of years of new business Volumes and pricing under stress Page ERM Symposium integrated stress testing and forecasting

22 Process illustration Description Developing an approach Modeling Actuarial or finance-driven Process ownership Business unit results consolidation Supporting infrastructure Finance-driven approach Actuarial-driven approach Finance-led process Actuarial led process Finance forecasting team combines results provided by business partners (e.g., actuarial, investments, expenses, tax) to complete the forecast Forecasting components (e.g., assets, liabilities, expenses) are modeled together in an actuarial modeling process Liability results (Actuarial) Asset results (Investments) Expenses (Expense team) Other (multiple) Consolidation of BU/Product forecast results (Finance) BU/Product forecast results Actuarial assumptions Non-actuarial assumptions or projections Actuarial model* BU/product forecast results * May include external asset projections. Page ERM Symposium integrated stress testing and forecasting

23 Developing an approach Modeling Asset and liability interaction Reinvestments and divestitures Asset-dependent liabilities Asset system vs. actuarial system Asset modeling system Actuarial modeling system Asset system: Asset system: Asset system: Asset system: Existing assets Reinvestments Liabilities Liability system: N/A Existing assets Reinvestments Liability system: Liabilities Existing assets Liability system: Liabilities Reinvestments N/A Liability system: Existing assets Reinvestments Liabilities Preferred approaches to capture asset and liability complexities Page ERM Symposium integrated stress testing and forecasting

24 Interest rates Developing an approach Modeling Complex actuarial balances Projecting VA reserves, AAT reserves, DAC unlocking, etc. Outer and inner loops First principles vs. driver-based approaches Asset adequacy testing Outer loop: low interest Inner loop: New York 7 scenarios Projection period Page ERM Symposium integrated stress testing and forecasting

25 Developing an approach Consolidation Aggregation Legal entities: insurance, holding company and other Business unit and/or product line Enterprise view Enterprise actions (external) Dividends and share repurchases Debt issuance Contingent capital/liquidity actions Enterprise actions (affiliated) Holding company and legal entity dynamics Capital management/transfers (dividends, injections, etc.) Internal borrowing and guarantees Page ERM Symposium integrated stress testing and forecasting

26 Developing an approach Outputs Reporting and analytics Potential outputs Financial bases: GAAP, statutory, cash flow, economic Projection horizon and time-steps Risk and return metrics Drill-down capabilities Illustrative GAAP earnings drill-down Statutory financials RBC and other capital ratios Internal economic Leverage metrics GAAP financials Cash flow statements Other performance metrics Liquidity metrics Page ERM Symposium integrated stress testing and forecasting

27 Developing an approach Uses Risk management Strategic decision support Financial planning Regulatory Stress testing as an outcomes-based risk appetite lens Multiple bases: GAAP, statutory (RBC), liquidity Multiple severities What-if analysis of potential management actions Asset mix, product mix, capital actions, new business, etc. Impact on multiple frameworks/metrics in baseline and stress Capital planning Budgeting Earnings guidance ORSA SIFI or GSII requirements Page ERM Symposium integrated stress testing and forecasting

28 Takeaways Integration there is an opportunity to integrate forecasting and stress testing into one process. Efficiency further efficiency can be gained through process redesign and/or improvement. Expanded use a more robust forecasting and stress testing process can support risk appetite and strategic decisions. No one-size-fits-all approach an effective stress testing approach can be achieved through varying processes, models and methodologies; it should be designed with the organization s characteristics and planned uses in mind. Page ERM Symposium integrated stress testing and forecasting

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