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2009 Seminar for the Appointed Actuary

Colloque pour l’actuaire désigné 2009

Session PD-4: The New World of Risk Management for Variable Annuities and Segregated Funds

Frank Zhang, CFA, FRM, FSA, MAAA, PRMExecutive Director

VA Financial Risk Management and Hedging Advisory Practice Leader

Ernst & Young LLP, New York

Séance TR-4 : Le nouveau domaine de la gestion du risque pour les rentes variables et les fonds distincts

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Agenda

• Events since 2008– Capital market disruptions– Segregated fund/variable annuity losses

• New areas of focus– Robust hedging program– Advanced financial modeling– Integrated financial risk management and pricing– Hedging strategy best practices

2009

Sem

inar

for

the

App

oint

ed A

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2009

Sem

inar

for

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App

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pour

l’ac

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Capital market disruptions

• What has happened since 2008:– Normality — what’s normal?– Liquidity — what liquidity?– Volatility — what volatility?

• Could this happen again?– Market fall another 50%?

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

2009

Sem

inar

for

the

App

oint

ed A

ctua

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que

pour

l’ac

tuai

re d

ésig

né 2

009

2

4

Segregated fund and VA losses

• Segregated fund and VA losses:– Capital squeeze from general account investment losses– Tracking errors — what errors?– Marked-to-market losses — short-term or real?– Trading losses — buy high and sell low?

• Effectiveness of risk management:– Hedged and unhedged– Market and actuarial– Is it clear who is responsible for everything?

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

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que

pour

l’ac

tuai

re d

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né 2

009

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

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né 2

009

3

5

• Events since 2008– Capital market disruptions– Segregated fund/VA losses

• New areas of focus– Robust hedging program– Advanced financial modeling– Integrated financial risk management and pricing– Hedging strategy best practices

Agenda20

09 S

emin

ar f

or t

he A

ppoi

nted

Act

uary

Col

loqu

e po

ur l’

actu

aire

dés

igné

200

920

09 S

emin

ar f

or t

he A

ppoi

nted

Act

uary

Col

loqu

e po

ur l’

actu

aire

dés

igné

200

9

4

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New areas of focus

• Robust hedging program• Advanced financial modeling• Integrated financial risk management and

pricing• Hedging strategy best practices

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

5

7

Robust hedging program

• Gold standard operation/process controls and risk management framework:

– Banks versus insurers

• Hedging performance is now a critical component of a company’s financials:

– New Board-level concerns– Is your program (or product) too complex for the CEO

to understand?

• Robust hedging P/L performance attribution:– Know why, so problem areas can be fixed

• Reporting and transparency2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

6

8

Advanced financial modeling

• Gold standard modeling tools• Continued improvements in research• Principles-based valuations/reporting• Nested stochastic simulations• Watch out for garbage in/garbage out

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

7

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Integrated risk management and pricing

• Gold standard pricing methodology• Start with the fundamental — pricing• Focus on underlying funds first• Integrate capital market inputs in pricing• Apply robust risk management techniques

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

2009

Sem

inar

for

the

App

oint

ed A

ctua

ryC

ollo

que

pour

l’ac

tuai

re d

ésig

né 2

009

8

10

Hedging strategy best practices

• Gold standard of risk management strategies– Greeks based versus the new mix of new metrics

• Determine trade-offs between: – Earnings volatility and capital optimization– Marked-to-market P/L (forward-looking implied or expected

volatility) and trading P/L (realized volatility)

• Identify implied risky bets• Link pricing with hedging• Know your options:

– Before you need them– When things are normal20

09 S

emin

ar f

or t

he A

ppoi

nted

Act

uary

Col

loqu

e po

ur l’

actu

aire

dés

igné

200

920

09 S

emin

ar f

or t

he A

ppoi

nted

Act

uary

Col

loqu

e po

ur l’

actu

aire

dés

igné

200

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