Sesión 7 Evaluación de Riesgo y Administración XXI Asamblea Anual de ASSAL XI Conferencia sobre Regulación y Supervisión de Seguros en América Latina y Seminario de Capacitación IAIS-ASSAL Santiago Chile, 21 de Abril de 2010 Takao Miyamoto, Secretaría de la IAIS English

1 Agenda 1.Control Activities 2.Objective Setting 3.Risk Identification –Major Risks 4.Risk Assessment 5.Planning and Execution –Strategies –Some Examples

Risk Management Process 2 Set objective Identify risks Monitor risks Assess risks Plan & Execute Change of business environment Control activities (corporate governance)

Risks Control Activities 3 Ideal control environment Real control environment with many holes (Source) J.Reason “Swiss Cheese Metaphor” Risks Huge loss –Some holes from active failures –Some holes due to latent conditions –Overconfidence in defense walls Defense by –Defense wall? –Simple luck? Chain reaction of failures

Objective Setting 4 Starting point of risk management and business strategy –Initiatives of board and/or senior management –Also input from business units Two key features –Risk appetite: risks insurers are (are not) willing to accept in pursuit of value/profit –Risk tolerance: acceptable level of variation around value/profit targets Both quantitative and qualitative terms are used.

5 Agenda 1.Control Activities 2.Objective Setting 3.Risk Identification –Major Risks 4.Risk Assessment 5.Planning and Execution –Strategies –Some Examples

Risk Identification 6 Underwriting (Insurance) Typical category –Risks assumed through insurance contracts insurers underwrite –Line of business: fire, marine, automobile, earthquake, death, injury etc. –Types: pricing, product design, claims, economic environment, policyholder behavior etc. Features Credit –Inability or unwillingness of counterparty to fully meet on/off-balance sheet contractual financial obligations –Source: default, downgrade, migration, spread, settlement, sovereign etc. –Relatively smaller for insurers compared to banks

Risk Identification 7 Market Typical category –Volatility and uncertainty of market value of assets/liabilities –Variables: stock price, interest rate, foreign exchange rate, commodity price etc. Features Liquidity –Obliged to procure funds (e.g. by liquidating assets) under unfavorable terms as financial obligations fall due –In worst case, unable to settle financial obligations Operational –Risk of loss resulting from inadequate or failed internal process, people, system, external events etc.

Example 8 (Source) The Geneva Association “Systemic Risk in Insurance”

9 Agenda 1.Control Activities 2.Objective Setting 3.Risk Identification –Major Risks 4.Risk Assessment 5.Planning and Execution –Strategies –Some Examples

Risk Assessment 10 High Low Severity Frequency Earthquake IT system trouble Daily share price change Two factors in assessing impact of risk –Frequency (likelihood/probability of occurrence) –Severity (loss size in case accident occurs) Risk map – more intuitive/simple method –Useful for classification –Most risk may not be so simple as to be classified this way Example

Risk Assessment 11 More quantitative/statistical method –Mean (1 st order), Variance/Standard Deviation (2 nd order), Skewness (3 rd order) etc. –Value at Risk (VaR): possible maximum loss over a specific time horizon (e.g. 1 year) at specific confidence level (e.g. 99%) –Tail Value at Risk (TVaR): average VaR beyond a specific confidence level Probability Loss Mean VaR (e.g. 99%) TVaR (e.g. 99%)

12 Agenda 1.Control Activities 2.Objective Setting 3.Risk Identification –Major Risks 4.Risk Assessment 5.Planning and Execution –Strategies –Some Examples

Planning and Execution 13 Two concepts Risk (loss) control –Intended to change characteristics (e.g. frequency and severity) of risks themselves –e.g. insurers conduct promotional activities against car theft (=> reduce frequency of car theft) –e.g. insures ask installation of sprinklers (=> mitigate severity of fire) Risk (loss) finance –Financial preparing for loss resulting from existence of risk –Necessary regardless of risk/loss control activity (no risk is impossible)

Tools of Risk Management - Overview 14 Risk (Loss) Control X PreventMitigate Risk Management Avoid Exploit (Expand or Diversify) Retain Transfer Risk (Loss) Finance FrequencySeverity Reduce

Risk Control 15 Avoid Strategy –Avoid underwriting certain product line or market segment –Because it is (unlikely to be) unprofitable, too risky, lower priority area –But does not mean no cost – opportunity cost exists Features Reduce –Take lesser amount of particular risk –Because risk amount is approaching insurer’s appetite and capacity Exploit (Expand or Diversify) –Particular risk may work as hedge to overall risk exposures –Possibly intentionally take particular risk for diversification effect

Risk Finance 16 StrategyFeatures Transfer –e.g. reinsurance (traditional) –e.g. derivatives, securitisations (ART: alternative risk transfer) –But create another risk (counterparty credit risk) Retain –Simply retain particular risk –Because insurer is confident to manage risk and has capacity –May need outside finance: borrowing, commitment line, new capital etc.

Example - Reinsurance 17 Advantages –Reduce and control risk profile –Manage/stabilise financial result –Create new capacity –Gain product expertise –Gain underwriting advice Types (in terms of procedure) –Treaty/Automatic: automatically reinsured based on pre- determined agreements and conditions –Facultative: whether to reinsure is decided for each case Types (in terms of risk sharing structure) –Proportional: quota share, surplus etc. –Non-proportional: excess of loss, aggregate, stop loss etc.

Example - Reinsurance 18 Insurer (retained) Reinsurer (ceded) Insurer (retained) Reinsurer (ceded) Shared in fixed proportion (amount changes) Amount over specified level is ceded (proportion changes) Insurer (retained) Reinsurer (ceded) Insurer or another reinsurer With upper limit Structure of risk sharing –Unit: per event, per risk, aggregate in certain time etc. –Based on: amount insured, loss etc. –Combination of reinsurances is applied to reach desirable risk profile.

Example - Securitisation 19 Example: Cat (catastrophe) bond –Use capacity of capital market (capacity may not be enough in insurance market) –Diversification due to low correlation with other asset classes (from investors’ perspective) (Source) Munich Re “Insurance-linked securities (ILS) market update”

Questions and Answers 20 Thank you very much!