Tuesday, Oct. 27 2:30 – 4:00 p.m. Session 90 Panel Discussion Session Sponsor: Joint Risk Management Solvency II and a New Enterprise Risk Management Paradigm Moderator: Michel Rochette, FSA Presenters: Matthew G. Lantz, FSA, CERA, MAAA; Michel Rochette, FSA; David K. Sandberg, FSA, CERA, MAAA This session will provide information on the current state of the European Union’s Solvency II regulatory initiative along with ways in which its fundamentals can lead to an enhanced enterprise risk management (ERM) framework. A critical piece of Solvency II regulation will be the development of internal capital models and how they are used to manage risk and make strategic decisions. Presenters will discuss the attributes of an effective capital model and uses beyond defining regulatory capital. The session will also include a presentation of PillarOne, an open source modeling platform, as well as the modeling approach and simulation results of a partial internal model comparing Solvency I and Solvency II requirements. Finally, we will talk about how capital models and other operational improvements can lead to a new ERM paradigm, one in which the risk function within an organization not only focuses on what can go wrong, but also on what can go right - and becomes part of the strategic decision making process. Coordinator: Robert F. Wolf, ASA, CERA, FCA, FCAS, MAAA
Tuesday, Oct. 27 4:15 – 6:45 p.m. Session 92 Session Sponsor: Health Design Your Own Community Health Plan Moderator: Robert Gordon Cosway, FSA, MAAA Facilitator: Marge Ginsburg* This program offers the opportunity to participate in a novel experiential learning session. Using a computerbased program called CHAT ®, you will design a basic health plan to cover the uninsured. The catch? The money available is one-third less than typical employer-based coverage. How will you decide what coverage is important? What does society consider valuable coverage? The session will provide a broad range of perspectives in policy, economics and health care and audience participation is vital. In the midst of the current political climate related to health care, this is a relevant session for everyone, not just health care actuaries. The session will be limited to 20 participants and is free of charge. Coordinator: Beth K. Grice, FSA, MAAA
Michel Rochette, MBA, FSA 2009 SOA Annual Meeting Boston October 27th 2009
Topics ERM and Solvency II Similarities and differences between them Purpose of an economic capital model Major components of a capital model Uses of a capital model Validation issues Calibration issues Emerging issues
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Similarities Economic capital models: ERM: focus is on internal models only Solvency II: SCR approach, partial and full internal models Governance: ERM: many potential standards like COSO, SP ERM, ISO 31000 Solvency II: Pillar II with ORSA, governance and risk management functions Implementation of ERM: ERM: embedded in operations Solvency II: Use test 30/05/11
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Differences Overall goal: ERM: value creation through risk management Solvency II: risk control through capital, SCR and protection of policyholders Risk taxonomy: ERM: all risks with a focus on key risks Solvency II: specific risks as defined in Pillar I and additional risks with capital add-0ns in Pillar II Risk champion: ERM: need a CRO to oversee all processes Solvency II: actuarial function is defined and participates in setting up risk system, complemented by Audit and a risk function 30/05/11
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Differences Risk Appetite: ERM: essential as it guides firms in setting up risk limits and tolerances. Focus is on shareholders’ wealth. Solvency II: focus is on the control of the negative side of risk through capital and policyholders’ protection. Financial resources: ERM: all financial resources available to face risks: existing and contingent capital Solvency II: available capital: Tiers I, II, III Value & time framework: ERM: Economic basis, EEV, MCEV over a flexible time, twosided VAR, TVAR.. Solvency II: target IFRS, over a one-sided 1-yr VAR 30/05/11
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Purpose of an EC framework ¨ Risk management system of an insurer for the
analysis of the overall risk situation of the insurance undertaking, to quantify risks and determine the capital requirement on the basis of the company specific risk profile¨ CEA Groupe Consultatif Required capital is assessed in light of: available capital & other financial resources enterprise risk management processes strategic goals & risk appetite regulatory requirements 30/05/11
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Principles: EC development All material risks should be covered: links to ERM and emerging
risks Models must be appropriate for the scale and complexity of the firm Models must be dynamic and flexible Models must be embedded in the financial, strategic and operational processes: Use Test in Solvency II Governance of models development:
Board/top management oversight and involvement documentation of models, limitations & changes internal controls over development: auditable independent review: More than peer review
Others: consistency between valuation and EC models: valuation framework input data verifiable and controllable validation and calibration 30/05/11
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Major components
Exposure models of key risks: financial risks & underwriting risks: assets and liabilities models cash flows non financial risks: operational and business models strategic risks: strategic models Risk drivers models: ESG, catastrophic, scenarios, stochastic,
EVT, competitor, behaviour, management actions Aggregation approaches: correlation with var/cov, copulas, none Time horizon: short-term view versus run-off approach Confidence level: internal, regulatory, rating agencies Frequency of calculations: quarterly to monthly Valuation framework: economic, EV, EEV, MCEV Metric chosen: VAR, T-VAR, EVT
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Uses
Investment decisions: existing and new Product development Strategic decisions Corporate finance decisions: financial leverage Hedging strategies External events and emerging risks Regulatory proposals: CP 37 & CP 56 in Solvency II “…widely used and plays an important role in the course
of conducting an insurer's regular business, particularly in risk management. "
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Validation principles
Integrates both qualitative and quantitative elements Provides that the models were designed, work as planned
and are implemented correctly – quality assurance Analyses the predictive properties of the models: testing against experience, back testing Iterative process to assess that assumptions & data are appropriate with a certain degree of confidence: regular cycle Need independence of validation to satisfy basic risk management principles: internal and/or external reviews Must go beyond the pure regulatory ticking the box
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Validation elements
Model development, design, implementation and
operations: similar to IT systems controls in place like COBIT Review of models inputs:
assumptions & key risks continuous appropriate mathematics and methodologies data accuracy
Review of basic functioning of the models: gaps to internal standards and best industry practices model replication with a different set of random numbers stress testing and reverse stress testing: sensitivity of the results models capture business environmental changes 30/05/11
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Validation elements
Historical performance: back testing to external sources: industry studies, academic papers, regulatory and rating agencies’ capital Profit and loss attribution: comparison of actual
results to risk drivers predicted by the models. Idem to a source of earnings analysis Management oversight: has management been using the models? has management put in place processes to obtain
assurance that the models are still appropriate
Documentation and independent validation 30/05/11
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Calibration principles
For each risk drivers, should aim to calibrate four elements: level of the risk factor and its uncertainty trend of the risk inherent volatility calamity/catastrophic/tail Market conditions : impact on pro/counter cyclicality Frequency of calibration: at least annually and probably more
often for financial risks Should be performed before hedging Should be based on best assumption. No margin embedded as the purposed is to estimate required capital for the risks facing the organization Time horizon and risk measures chosen per risk category 30/05/11
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Calibration by risk
Interest rate risk: take into account the parallel , twists, inversion of the term structure QIS4 tail up shocks: 94% at 1yr – low - to 40% multipliers at 10yr interest rate volatility: usually set separately: * 1.5 Equity risk: use different calibrations for publicly-traded, private equity, hedge funds, emerging markets for publicly-traded: tail risk decline of 40% at 99.5% for hedge funds: recent decline around 20% implied equity volatility of around 35% Currency risk: usually set around +/- 20% for a well-diversified
portfolio
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Calibration by risk
Credit, counterparty & asset risk: in a total return context, spread risk anticipates future defaults and migration. No need for an explicit default model spread risk varies by type of assets, rating and currency in Q1S4, spread volatility around 30% and shocks of about 90 bps to treasuries. Probably too low given recent experience concentration risk must be assessed for default risk: recovery assumption crucial in the 30% to 40% range
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Calibration by risk
Life underwriting risk: QIS4 mortality rate increased by 15% permanent with a 2.5 additional per mille mortality catastrophe shock – debate in light of potential pandemic lapse shock depends on impact. Can go as high as 100% multiplicative longevity rate increased by a permanent 25% Operational risk: must move beyond the factor based approach to
modelling explicitly and map to insurance coverage and other internal controls Liquidity risk: can be modeled and not simply managed Contagion (systemic ) risk: Large FIs might be subject to additional capital if viewed as systematically important. Strategic risk: can deplete capital and should be modeled Reputation risk: doesn’t affect capital but value of the firm
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Correlation in the tail Correlations exist at different levels: within a risk category: Market Risk Interest rate
Equity
Interest rate
1
Equity
75%
1
FX
25%
25%
FX
1
between risk categories within an entity between legal entities for Solvency II: should probably
be zero because of the non-fungibility of capital and the non recognition of group capital support
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Correlation in the tail ď‚— Recent experience seems to indicate otherwise ď‚— According to a recent Pimco study:
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Correlation to S & P 500
Early 90s
Early 2008
2008 Meltdown % yearly loss
S & P 500
1
1
37%
High-Yield Bonds
20% -30%
80%
26%
International stocks
30% -40%
70%
45% - 55%
Real Estate
30%
60% -70%
37%
Commodities
0%
-20% -30% 37% Enterprise Risk Advisory LLC
Correlation in the tail: lessons Correlations are unstable in the tail and this what EC is
trying to determine Independent risks become dependent in extreme times:
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subprime business practices – operational risks › enhanced defaults - credit risk › market losses on securitized investments – market risk › capital problems at many FIs – liquidity risk › bankruptcies of many FIs – systemic risk › lawsuits by investors and regulators – legal risk › enhanced regulations – regulatory risk › diminished reputation for the financial industry – reputation risk and loss in value Enterprise Risk Advisory LLC
Correlation in the tail: lessons “When people start buying an asset, the act of them
diversifying ultimately makes the asset less of a diversifier .“ Pimco’s Head of analytics Rule: total diversification benefit should not be above 30% One potential approach is to use Clayton copulas which measure non-linear dependency This is difficult as we trying to assess 1 in 200 year events 30/05/11
Enterprise Risk Advisory LLC
Emerging issues EC must be a forward looking process , tied to ERM
and thus must anticipate emerging risks Risk issues and impact on EC – mostly Solvency II
liquidity premium: not allowed in the calculation of the
market consistent value of liabilities discount rate: most likely the risk-free not swap rates group support: not allowed and impact on diversification assumptions in EC calculation MVM: currently set at 6% with no diversification benefit 30/05/11
Enterprise Risk Advisory LLC
ERM: Emerging risk
Environmental risks – US based: Fiduciary Responsibility: Legal and Practical Aspects of Integrating ESG Issues into Institutional Investment – UNEP FI NAIC is requiring insurance companies with at least 500 million in annual premiums to start estimating and publishing an Insurer Climate Risk Disclosure Survey starting in May 2010. NAIC seeks to determine "how insurers are altering their risk-management and catastrophe-risk modeling in light of the challenges posed by climate change. “ › direct EC implications
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Solvency II: ORSA Pillar II requirement: Own Risk & Solvency Assessment Goal is to demonstrate “sound and prudent management
of the business and assess overall solvency needs” Useful references:
BMA paper: “opopportunity to align management and
regulatory reporting & encourage sound risk management practices within the jurisdiction” CEIOPS: explains its preliminary views on the definition and importance of the ORSA as a management tool, requirements and guidance
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Enterprise Risk Advisory LLC
CONTACT MICHEL ROCHETTE, MBA, FSA ENTERPRISE RISK ADVISORY, LLC 954-607-6969 michel.rochette@enterprise-risk-advisory.com
SOCIETY OF ACTUARIES
Annual Meeting (October 2009) Session Topic:
Solvency II and a New ERM Paradigm Session:
All Sessions
90 PD
11,894
89
Actual Attendance
9,494
68
Number of responses
5,192
35
Return rate (# of resp./actual att.)
52%
51%
Overall rating of this session
3.89
3.83
Provided you with practical technical information
4.00
4.06
Will enable you to make better business decisions
3.91
3.91
Prepared you to impact industry-wide changes
3.69
3.82
Knowledge of Subject
4.24
4.43
Effectiveness of Delivery
3.83
4.28
Expected Attendance
Overall Rating
All Sessions
1
Learning Experience
2
Indicate your level of agreement with the following. This session:
David K. Sandberg, FSA, CERA, MAAA
Number of participants indicating presenter included commercial promotion in presentation
Presenter Effectiveness1
This Session
G. Lantz, FSA, CERA, MAAA
Knowledge of Subject
4.24
4.00
Effectiveness of Delivery
3.83
3.34
0
Knowledge of Subject
4.24
3.89
Effectiveness of Delivery
3.83
3.31
Number of participants indicating presenter included commercial promotion in presentation
Michel Rochette, FSA
0
1
Moderator Effectiveness : Rate the moderator's skills in managing this session
Rate the level of audience interaction for this session (7=high, 1=low)
3.89 4.06 4.00 3.91 3.91 3.82 3.69 4.43 4.24 4.28 3.83 1
1
Number of participants indicating presenter included commercial promotion in presentation
Michel Rochette, FSA
3.83
3.81
3.51
4.96
3.97
4.00 4.24 3.34 3.83 0
3.89 4.24 3.31 3.83 0
3.51 3.81 3.97 4.96
1
The rating scale used: Excellent (5), Very Good (4), Good (3), Fair (2), Poor (1), and N/A (no value).
2
The rating scale used: Strongly Agree (5), Agree (4), Neither Agree nor Disagree (3), Disagree (2), Strongly Disagree (1), and N/A (no value).
Evaluation Tips to keep in mind when reviewing the responses: Numerical evaluations tend to give you a pretty good feeling for how well the attendees responded to the session as a whole. Scores in the range of 3 to 5 are considered successful programs. Written comments come from people who may have a strong opinion, therefore they tend to be very good or very bad. Repetitive comments that point to the same theme could be an indication of an area you may want to capitalize on in the future or work on for future presentations. Perception Solutions, Inc.
www.perceptionsolutions.com
12/17/2009
SOCIETY OF ACTUARIES
Annual Meeting (October 2009) Session Evaluation (Participants' Comments) Session
Overall Comments Regarding This Session
90PD
Sandberg - great use of visuals for PPT deck. Not enough time left for questions. Another session with packed material from each presenter. Suggest moderator coordinate with each speaker to block more time for Q&A (plus time to get to the next session/exhibit hall). Screen too low - could not see bottom half of slides. Microphone not working - cannot hear. Cannot see and cannot hear - bad combination. Sandberg presentation was very impressive! The session did a good job of relating Solvenly II to ERM best practices.
90PD 90PD 90PD 90PD
Perception Solutions, Inc.
www.perceptionsolutions.com 12/17/2009
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