4 open forum by jorge

Joint Regional Seminar 2011 Economic Capital Capital Open Forum

Jorge Noronha Chief Risk Officer ING Malaysia and Thailand

19 July 2011

Need to Manage several Balance Sheets IFRS

Local GAAP

MVBS

Local solvency requirement (RBC)

EC

Equity

MVS (=MCEV)

Equity

Free Surplus

Free Surplus

Asset

Asset Local Statutory Liability

Best Estimate Liability + Provisions for Adverse Deviations

MVA

MVL

Key question: Why is it important to understand and manage risk on the 3 b/s ?

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Risk Limit Framework Currently we have multiple Insurance limits and restrictions in place: • MVaR

• Commercial mortgages

• Issuer Limits

• Equity restrictions

• Real Estate ban

• Mortgages requirements

• Financial restrictions

• Country restrictions

• Counterparty limits

• Banned Sovereigns

• Collateral requirements

• Reinsurance credit risk limits

• RMBS and CMBS restrictions

New risk limit framework introduced at ING in 2011 will focus more on managing the full balance sheet, balancing value, earnings and capital.

The new risk limit framework is defined with three accounting views to capture adequately the risk of a 1 in 10 year event : Earnings-at-Risk (IFRS earnings view; drives Leverage Ratio) AFR-at-Risk (Market value view; drives Own Funds) Regulatory-Capital-at-Risk (Local regulatory view; drives Leverage Ratio)

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New Market Risk Limit Limits set at Business Line level Business Lines to further cascade limits to Business Unit level based on same framework.

Limits based on 1-in-10 events: Equity: -25% (incl. volatility shock: 80/30/20/10% relative shift for different tenors) Interest Rates: +/-30% (incl. volatility shock: 30% relative shift) Credit: +100bp for Corp A; %Default Loss Given Default BV for Defaults, Real Estate:-15% FX Open Position: 1-in-10 events Combined Market Risk limit of above risks In addition, Business Risk: 1-in-10 events

Three Levels: Hard limit is for which enforcement measures apply; Soft limit is for reference Hard Limit: Total Market Risk Per BL Soft Limit: Equity, Interest Rate, Credit, RE, FX and Business per BL or BU No Limit but risk exposures need to be reported: Insurance, Operational

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Managing Insurance on MV basis Separate valuation of assets and liabilities Consistency with capital markets including option/guarantee costs Reduces reliance on actuarial or management investment assumptions Clearer picture of the impact from asset/liability management choices: allows separate analysis of investment decision versus whether or not to hedge market risk

Economic risk-based pricing Clear identification of market price of individual risks enables product pricing to reflect specific risks Improved comparison across different products versus approaches which set topdown discount rates

Greater understanding of volatility of underlying value Accounting results smooth actual changing economics- this can be beneficial for some purposes, but can also hide real value changes Risk management should focus on understanding and making real value changes transparent so they can be managed appropriately Eventually accounting will reflect changes in economic value

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ING Economic Capital Framework Definition: ING Insurance economic capital is defined as the maximum loss to ING Insurance’s Market Value Surplus (MVS) within a 99.95% confidence interval based on shocks which could occur over a one-year horizon Market Value Assets

Market Value Liabilities

(MVA)

(MVL)

One year MVS Scenarios

Expected value

EC

MVS Based on total Market Value Surplus • Current balance sheet value only – no future business or future return expectations • MVL (including financial options), rather than best-estimate liabilities

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99.95% worst case Economic Capital definition • Maximum loss within a confidence interval over one year (“VaR”), consistent with Solvency II • 99.95% confidence interval consistent with AA rating, more conservative than Solvency II minimum of 99.5%

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Overview of ECAPS Project Approach Source Data

Cash flow Systems

Actuarial Analysis System

Spreadsheets

Consolidated Reporting Spreadsheets

BU 1

Improved interface, pushing boundary

Web-Based Access to Input

Improved analysis at BU, Region, and CIRM

ECAP S Tool

And Results at BU

• Available on the desktop of BU CIROs and risk professionals • Significantly reducing the number of downstream spreadsheets • Improved Analytics: based on industry market risk platform well known within ING (e.g.

Algorithmics) • Facilitating timely reporting ING Asia Pacific

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Improved methods

ECAPS Overview ECAPS Tool

Via Intranet

Scenario Generator

Economic Capital (EC) Calculation

Replicating Portfolio (X/Y)

Reporting

Business Unit (BU) • Focus on providing asset/ liability data and non-market risk EC

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A few lessons learned on EC models from crisis • Models are estimates of what reality could look like • They do not and can not take into account all potential future scenarios • We need to be transparent to all stakeholders on the assumptions and limitations.

• Common sense is still the most important risk management tool!

• Credit spreads can become extremely large • Illiquidity spreads should be considered for liabilities • Correlations can change quickly • Speed of model results is very important

The Modelers’ Hippocratic Oath* I will remember that I didn’t make the world, and it doesn’t satisfy my equations.

Though I will use models boldly to estimate value, I will not be overly impressed by mathematics.

I will never sacrifice reality for elegance without explaining why I have done so.

Nor will I give the people who use my model false comfort about its accuracy.

Instead I will make explicit its assumptions and oversights.

I understand that my work may have enormous effects on society and the economy, many of them behind my comprehension. * Emanuel Derman and Paul Wilmott (January 2009)

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