Session 1 Risk Assessment and Management Regional Training Seminar IAIS-ASSAL San Salvador, El Salvador, November 2010 Takao Miyamoto, IAIS Secretariat

Agenda 1 1.Enterprise Risk Management (ERM) –General Framework 2.Risk Management Process –Risk Identification –Risk Assessment & Measurement –Planning & Execution 3.Final Remarks

Enterprise Risk Management (ERM) 2 Feedback Loop Governance and an Enterprise Risk Management Framework Feature 1 Role of supervision Feature 8 Feedback Loop Risk Management Policy Own Risk and Solvency Assessment (ORSA) Risk Tolerance Statement Economic and Regulatory Capital Continuity Analysis Enterprise Risk Management Framework Role of supervision

Process 3 Risk management policy –How all relevant & material risks are managed –Relationship between risk tolerance limits, regulatory capital, economic capital & processes/method for monitoring risks –Investment policies –Asset-liability management (ALM) –Relationship between pricing & product development Risk tolerance statement –Both quantitative & qualitative –Level of risk to which insurer is willing & able to be exposed

Process 4 Own Risk and Solvency Assessment (ORSA) –Self-assess all reasonably foreseeable & relevant material risks –Translate risk identification into capital needs –Include long-term continuity assessment Role of Supervision –Assess adequacy & soundness of insurer’s framework & processes –Take appropriate actions when necessary –Should not take “one-size-fits-all” approach – nature, scale & complexity of business & risks

Agenda 5 1.Enterprise Risk Management (ERM) –General Framework 2.Risk Management Process –Risk Identification –Risk Assessment & Measurement –Planning & Execution 3.Final Remarks

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 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 & 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”

Risk Assessment & Measurement 9 High Low Severity Frequency Earthquake IT system trouble Daily share price change Example 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 risks may not be so simple as to be classified this way

Risk Assessment & Measurement 10 Probability Loss Mean VaR (e.g. 99%) TVaR (e.g. 99%) Quantitative/Statistical method –Mean (1st order), Variance/Standard Deviation (2nd order), Skewness (3rd 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

Risk Assessment & Measurement 11 Mismatch between models & real world –Model risk –Parameter risk Need to –Validate & understand limitations of models –Complement use of models Stress testing –Measure financial impact of stressing risk factors –Also, reverse stress testing Scenario analysis –Consider financial impact of combination of circumstances based on scenarios

Planning & Execution 12 Two concepts Risk (Loss) control –Intended to change characteristics 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 preparation for loss resulting from existence of risk –Necessary regardless of risk control activity

Tools of Risk Management - Overview 13 Risk (Loss) Control X PreventMitigate Risk Management Avoid Exploit (Expand or Diversify) Retain Transfer Risk (Loss) Finance FrequencySeverity Reduce

Risk Control 14 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 & 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 15 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 16 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 Advantages –Reduce and control risk profile –Manage/Stabilise financial result –Create new capacity –Gain product expertise –Gain underwriting advice

Example - Securitisation 17 (Source) Munich Re “Insurance-linked securities (ILS) market update” Cat (catastrophe) bond –Use capacity of capital market (from insurer’s perspective) –Diversification due to low correlation with other asset classes (from investor’s perspective)

Agenda 1.Enterprise Risk Management (ERM) –General Framework 2.Risk Management Process –Risk Identification –Risk Assessment & Measurement –Planning & Execution 3.Final Remarks

Final Remarks 19 Risk management does not exist in isolation Link risk management with –Corporate objectives –Business strategy –Day-to-day operations –Capital management –Current circumstances Serve for enhancing strategic decision-making

20 ¡Muchas gracias!