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© 2010 The Actuarial Profession www.actuaries.org.uk
GIRO conference and exhibition 2010Joseph Lo, Aspen Insurance UK Limited
Reverse Stress Testing
12-15 October 2010
Workshop Objectives
By the end of the workshop, …
… we shall be able to discuss current issues …
… surrounding reverse stress testing …
… in the context of a general insurance company.
2© 2010 The Actuarial Profession www.actuaries.org.uk
Contents
Case Study
• Context
• Regulator’s views
• RST v1.0
• RST v2.0
• Capital Model
Open Discussion
3© 2010 The Actuarial Profession www.actuaries.org.uk
Context: Aspen
Bermuda domiciled Specialty Insurer and Reinsurer
• London Market (a UK company and Syndicate 4711)
• Bermudan company and US companies
• Branches
Listed on the NYSE
• Common equity, hybrids and debt
Insurance classes of business include:
• Property, Casualty, Marine and Aviation, Financial and Professional Lines
4© 2010 The Actuarial Profession www.actuaries.org.uk
Regulator’s views
FSA’s Policy Statement PS09/20
• Complements stress and scenario testing (SST)
• Risk management tool
• Assess vulnerability of business model– Market losing confidence in the firm– Scenarios most likely to cause failure of business model
• Decisions regarding risk mitigations / triggers for future actions
• Qualitative & quantitative
5© 2010 The Actuarial Profession www.actuaries.org.uk
RST v1.0Background
Early 2009
• Subprime Crisis / Credit Crunch / Financial Meltdown
• FSA’s CP 08/24
• Internal stochastic model
6© 2010 The Actuarial Profession www.actuaries.org.uk
-1,000,000 -800,000 -600,000 -400,000 -200,000 0 200,000 400,000 600,000 800,000 1,000,000
RST v1.0Analysis
Steps
• Ruled out events that are less likely than the “most likely” ones
• Considered causes of actual illiquidity in a reverse manner
• Considered feared illiquidity such as inability to renew banking facilities
• Capital considerations – from BCAR’s perspective
• Assuming loss of confidence from a P&L event and unable to raise capital
• Used internal model to consider drivers of these P&L events
7© 2010 The Actuarial Profession www.actuaries.org.uk
RST v1.0Outcomes
Example outcomes
• Some drivers were deemed important to control:– Catastrophe risk with retrocession placement– Clash risk with a company-wide assessment of clash
potential between classes
• Some were seen as unlikely, and no further action was recommended:– Actual illiquidity without a P&L event
8© 2010 The Actuarial Profession www.actuaries.org.uk
RST v1.0Some lessons
Granularity of internal model
Framework for testing how risk sources interact
• Although the framework is biased towards the downward paths
Framework for communicating risk sources
• Giving a sense of cause and effect
Group level exercise
9© 2010 The Actuarial Profession www.actuaries.org.uk
RST v2.0Background
2010
• Enhanced Stress and Scenario Testing
• FSA PS 09/20
• More intensive Solvency 2 work
• Internal working party – chaired by UK CRO, together with underwriters, actuaries, cat modellers, risk managers, a financial modeller; entity CROs
• Analysis performed in v1.0
10© 2010 The Actuarial Profession www.actuaries.org.uk
RST v2.0Stress and Scenario Testing
SST is a main tool
• 40+ scenarios
– Insurance risk (clash, reserve deteriorations, catastrophes)
– Market risk (adverse economic scenarios)
– Operational risk
– Credit risk (failure of reinsurers or brokers)
– Group risk (failure of individual companies within Aspen)
• Support role of the internal model
• Various severities and probabilities
• Documentation of narratives, discussions and assumptions
11© 2010 The Actuarial Profession www.actuaries.org.uk
RST v2.0Broadening the Definition of Failure
Failure is broader than Regulatory Insolvency
• Loss of confidence– Investors, rating agencies, policyholders
• Actual lack of liquidity
• Large share price falls
A failure can happen much earlier than “destruction”
12© 2010 The Actuarial Profession www.actuaries.org.uk
VaR 99.5
Failure can happen here
RST v2.0Chain of Events
Adverse Consequences
“Unfortunate” Coincidences
Most likely
13© 2010 The Actuarial Profession www.actuaries.org.uk
RST v2.0Example following major catastrophe event
14© 2010 The Actuarial Profession www.actuaries.org.uk
Three large Windstorms
Large market loss
Model underestimating results
1 in 250 AEP
Posting Collaterals
Trigger of net worth covenants re banking facility
Illiquidity
Forced asset sale
Major reinsurers default
Company specific issue(s)
Inability to raise capital
Inability to pay claims on time
…
Loss of credit rating …
Other possible unfortunate coincidences:
Adverse forex
General 1 in 20 non cat P&L
or or
Loss of investor confidence
RST v2.0Another Potential RST Candidate
Downgrade of Major Sovereign
• Fiscal consolidation credibility compromised
• Market loses confidence in sovereign
• Collapse of values of sovereign’s bonds held by company
• Feared illiquidity of the company
• Possible high levels of insurance losses from financial lines
As much about thought process and qualitative input as quantitative assumptions
15© 2010 The Actuarial Profession www.actuaries.org.uk
AppendixLinkages with Internal Capital Model
16© 2010 The Actuarial Profession www.actuaries.org.uk
SST / RST
Capital Model
Use opportunities:
Quantification: probabilities and severities – especially with modelled P&L events
E.g. catastrophe losses, reserve deteriorations, investment losses
Validation opportunities:
E.g. Do we see implied economic scenarios in the ESG?
E.g. Are unmodelled clash events adequately represented by the copulas?
Open Discussion
Possible Topics
• What other issues do you see?
• Concepts of business failures
• “Most likely” scenarios
• Quantification difficulties
• Implementation challenges
• Links with Solvency 2
• Non London Market companies
17© 2010 The Actuarial Profession www.actuaries.org.uk