Southeastern Actuaries Conference - Actuary.com€¦ · · 2008-05-30Southeastern Actuaries...
Transcript of Southeastern Actuaries Conference - Actuary.com€¦ · · 2008-05-30Southeastern Actuaries...
ING. Your future. Made easier.
Southeastern Actuaries Conference
Enterprise Risk Management (ERM)November 16, 2007
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Agenda
• ERM – Are you doing it?
• Definition of ERM – What is it?
• Industry Overview – What is going on?
• Primary Components of ERM – What are they?
• Rating Agency Perspective – What do they think?
• Economic Capital (EC) – What is it and what are we (ING) doing?
• Questions & Open Discussion – What can we learn from each other?
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Are You Doing ERM?
• How much risk is your company taking (provide a value)?• Is your company taking more risk or less risk than a year ago?
How do you know?• Has your investment risk increased or decreased during the
past three months? How do you know?• How much investment risk is your company taking relative to
your underwriting risk? How do you know?• Do you have the right amount of capital to support the risk your
company is taking? How do you know?
If you do not have answers to the above questions, then more than likely you are not doing ERM!
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Definition of ERM
• In its “Overview of Enterprise Risk Management,” the Casualty Actuarial Society describes Enterprise Risk Management as:
“…the discipline by which an organization in any industry assesses, controls, exploits, finances and monitors risk from all sources for the purposes of increasing the organization’s short- and long-term value to its stakeholders.”
Similarly, COSO defines ERM as:“…a process, affected by an entity’s board of directors, management and
other personnel, applied in a strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity goals.”
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Definition of ERM
• Differences between ERM and Traditional Risk Management (TRM)• Scope and Comprehensiveness – ERM covers ALL risks and is applied
across the entire organization• TRM was more focused on risk mitigation, while ERM also includes
strategic opportunities (e.g. optimizing results on a risk-adjusted basis)• TRM looked at risks individually, typically by experts in those areas (i.e.
silos)• ERM takes advantage of diversification benefits of looking at interactivity
of risks – Leads to the possibility of holding less capital• There is now a lot more focus on operational and reputation risk and their
potential impact
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Industry Overview
• The activity around ERM has increased significantly over the past year or two and can be attributed to several drivers:
• Regulation• Sarbanes-Oxley• Solvency II• SEC and NYSE requirements• Rating Agencies
• Public• Business scandals• Post 9/11
• Opportunities for Management• Achieve business goals rather than just minimize downside potential
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Industry Overview
• Education / Resources• SOA - Society of Actuaries
• Sponsors the ERM Symposium• CERA – Certified Enterprise Risk Analyst
• RIMS – Risk and Insurance Management Society• Risk Maturity Model
• An online resource that provides guidelines and best practices for developing and maintaining effective risk programs
• Allows companies to evaluate risk culture competency, identify gaps, and determine areas for improvement
• PRMIA – Professional Risk Managers International Association• PRM – Professional Risk Manager
• GARP – Global Association of Risk Professionals• FRM – Financial Risk Manager
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Primary Components of ERM
• Establishing an ERM framework and risk governance
• Risk identification
• Risk assessment
• Risk response
• Incorporation into performance measurement / management
• External risk reporting
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Rating Agency Perspective
• Rating agency’s evaluate the risks of a company and their ability to manage those risks
• Standard & Poor’s – Enterprise Risk Management (ERM) evaluation criteria
• Part of the rating process since October 2005• Evaluate ERM quality in five areas
• Risk management culture• Risk controls• Extreme risk management• Risk and economic capital models• Strategic risk management
• Classifications – Excellent, Strong, Adequate, Weak
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Economic Capital (EC)
I. What is Economic Capital? Why use it?
II. EC measurement and risk management in ING
III. Conclusions
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EC as part of the total balance sheet
Market Value Surplus= Available CapitalEconomic
Capital
Guaranteed liabilities
Excess Capital
Market Value of Assets
Market Value of
Liabilities
Risk margin
Economic Capital is the amount of assets that is needed in addition to the market value of liabilities to “guarantee” payment of all liability cash flows at a x% confidence level in a determined period of time.
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Economic Capital
Best Estimate Market Value
Surplus
99.95%
Economic Capital
Market Value Surplus in 1 year
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Why Stakeholders are Converging to EC
− Regulators demand that risks are well managed (to avoid taxpayer bail-outs)
− Depositors/policyholders expect safety of their savings and investments
− Rating agencies will only give high ratings to institutions able to measure and manage risk
Shareholders have entrusted the board with their capital
– They don’t want to lose it– They expect a decent return on it– They don’t want any surprises– They penalise volatility
ShareholdersAnalysts
RegulatorsRating AgenciesCreditors
SeniorManagement
Risk versusCapital
Risk versusReturn
Capital Adequacy Capital Efficiency
A common system is required for all users
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Discussion Points
I. What is Economic Capital? Why use it?
II. EC measurement and risk management in ING
III. Conclusions
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Capital models in ING
• Until 2002 - 150% EU Requirement• 2003-2005 - ING Capital Model (ICM) – still factor based• 2006 and onwards - Economic Capital
EconomicCapital
Market Valueof Liabilities
StatutoryReserves
150% EU Capital
Requirement
StatutoryReserves
ING CapitalModel
Requirement
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A Continual Improvement Process
Measurement
Control
Management
1999/2000 Start EC Pilots
2004: EC results used to calibrate ICM
2005:• Board & ALCO approval to further
implement EC• Input in MTP: MVaR limits• EV profit in strategic planning
process
2006:• MC Pricing targets• Full migration of EC, MVaR,• Focus on auditable, efficient risk
and value reporting processes• Risk governance• EV profit in incentive plans
Pre 1999: strong foundation in current and future assumption setting and cash flow projection experience
around Embedded Value calculations.
2007 Objectives• Auditable, efficient risk
and value reporting processes (ECAPS)
• Confirm usage of MCEV for internal management; consideration for valuation tool for external purposes: to be decided, considering model stability and (credit) spread recognition.
• Leverage ECAPS to change the way that actuaries view our business (risk management)
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How is Economic Capital Calculated?
• Assets, Liabilities, and Surplus at Market Value• EC = Change in Market Value Surplus under 1 in 2000 worst case
occurrences during next year • 1 in 2000 correlates to risk profile of AA rated company
• Required Capital = Sum of Individual Required Capitals based on Risk Type
• Credit and Transfer Risk • Market Risk• Business Risk • Operational Risk• Insurance (Life and Non-life) Risk
• less Diversification Effects• Total combined risk capital < sum of individual risk capitals• Diversification exists across risk types and business units
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Risk types correspond to a possible economic loss
RISK
Earnings Deviation
RISK
Earnings Deviation
Non-Life Risk
Claims Deviation
Non-Life Risk
Claims Deviation
LIFE Risk
Mortality Deviation
LIFE Risk
Mortality Deviation
OPERATIONAL RISK
Event Loss Deviation
OPERATIONAL RISK
Event Loss Deviation
BUSINESS RISK
Residual Earnings Deviation
BUSINESS RISK
Residual Earnings Deviation
MARKET RISK
Value at Risk
MARKET RISK
Value at Risk
TRANSFER RISK
Unexpected Transfer Loss
TRANSFER RISK
Unexpected Transfer Loss
CREDIT RISK
Unexpected Loss
CREDIT RISK
Unexpected Loss
Total Economic
Risk
Earnings Deviation due to variations in Credit Losses
Earnings Deviation due to inability to repatriate funds - immaterial for insuranceEarnings Deviation due to changes in the Market Price or Liquidity
Earnings Deviation due to changes in Operating Economics (e.g. Volume, Margins or Costs
Earnings Deviation due to One-off Losses unrelated to Volume, Margins and Costs
Earnings Deviation due to unexpected changes in mortality rates
Earnings Deviation due to changes in morbidity and P&C claims
Inte
r-ris
k di
vers
ifica
tion
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EC Competitive Advantages
Solvency II • Improved risk management improves view
Analyst’s View
ING’s Rating• Best Practice Risk Management will be essential part of rating
review process• Rating will influence share price and provide us with cheaper
capital
• Lobbying opportunities globally
• Capital consequences
• Analysts will recognise our pro-activeness
Pricing• Pricing on EC will better reflect risks in our products
• EC will identify unprofitable products or markets
• Exploit opportunities with EC pricing Vs. statutory
Managing our business on EC will benefit all our stakeholders
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Capital use - Managing market risks
• Measure• Objectively quantifying the market risks taken by ING Group • Measure equity, interest rate, foreign exchange, real estate, and credit spread risks
as well as credit risk- all adjusted for risk diversification
• Manage• Provide framework for optimal management of market risks in insurance (MVaR
covers 60% of total Economic Capital for ING Insurance)• Optimal allocation of scarce resources through allocation of limit space• Optimal determination of investment mix: business units to decide within limits• Making risks (i.c. risk-return) comparable throughout ING Group by creating a
‘level playing field’
GOAL: Objectively measure and actively manage market risks
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How to get it right? EC Application Software
Auditability • Clear control procedures and documentation leading to auditable EC reporting
• Large increase in automated processes • Supports auditable Risk Dashboard reporting
Timeliness • Timely quarterly reporting in line with financial calendar
Consistency • Standardised methodology and reporting format• Comparable assumptions and results across entities
Functional Improvements
• Improved methodologies, particularly on market risk calculations, diversification and aggregation of risks
• Expandable to support MCEV performance analysis and reconciliation
• Replicating portfolio for ALM interface
Market Risk Analysis • Faster Group wide impact of analysis of specific risks• Increased analysis & communication – move from getting the
numbers to using the numbers
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ECAPSTool
Reporting
ECAPS Overview
Replicating Portfolio
Economic Capital (EC) Calculation
Scenario Generator
Via Intranet
Business Unit (BU)
• Focus on providing asset/ liability data and non-market risk EC
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ECAPS - improvements
• Current methodology tries to measure individual liabilities veryaccurately, but makes big approximations for
• Market shocks (e.g. single factor for term structure, etc.)• Diversification / aggregation (e.g. simplified covariance matrix, Gaussian Copula)
• New methodology uses replicating portfolios to capture asset andliability risk profiles
• Much more accurate EC market shocks & diversification possible due to Monte-Carlo method
Old Method
New Method
Best PossibleCash Flow
Models
SimplifiedMarketShocks
Very SimplifiedAggregationTechniques
Best PossibleCash Flow
Models
SimplifiedPortfolio
Representation
AdvancedEC &
Aggregation
Overall Approximation
Error
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Discussion Points
I. What is Economic Capital? Why use it?
II. EC measurement and risk management in ING
III. Conclusions
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• Alignment of external, regulatory and internal move to enhanced risk measurement through EC will facilitate:
• Improved understanding of risks and therefore avoiding costly mistakes that may hurt the solvency of the insurer
• Better risk management in insurance companies• Provide more transparency for the external world• Senior executives will be able to make better informed
decisions about risk and capital, and ultimately improve the risk-adjusted business performance of the company
Summary
INCREASE TOTAL SHAREHOLDER RETURN