Report on the IAA Activities in ERM

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Report on the IAA Activities in ERM

David Ingram, CERA

Chairman

Enterprise & Financial Risks Committee, IAA

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IAA Background

Worldwide association of professional actuarial associations (62 Full Member and 26 Associate Member associations)

MISSION:

To represent the actuarial profession and promote its role, reputation and recognition in the international domain;

To promote professionalism, develop education standards and encourage research, with the active involvement of its Member associations and Sections, in order to address changing needs.

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ERM is new Focus of IAA

Now One of Top Priorities

Global CERA Treaty

Role of the Actuary in ERM Report

Enterprise & Financial Risks Committee

AFIR ==> AFIR/ERM

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Global CERA Treaty

Not officially an IAA initiative

13 Actuarial Organizations are signatories

Legal entity in Switzwerland owns CERA

3 Associations are now certified to grant CERA– SOA – 700 awarded– IFA(UK) – 9 awarded– IAAust – 20 awarded

3 Associations in process to be certified– CAS, South Africans, Netherlands

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Role of the Actuary in ERM

Report to IAA Executive Committee – Summer 2010

Actuarial USPs– Familiarity with strong range of quantitative risk

management techniques– Rigor in approaching the assignment– Integrity in executing the assignment– Objectivity in communicating in business terms about the

assignment– All Reinforced by the most demanding professional

requirements.

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Action Plan

Promote the position of actuaries in ERM Field

Support the Globalization of CERA

Provide Platforms for CPD in ERM for actuaries around the world

Support and direct research in ERM

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Action Plan

To be executed by – Exec Committee – CERA committee– Enterprise & Financial Risks Committee– AFIR Section– Advice and Assistance Committee– Insurance Regulations Committee

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Existing Work– ERM Report– CERA Report– Other Financial Crisis Report

New Work– Actuarial Review of Risk Management Practices

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New Tasks from Role of the Actuary Report– Work with the IMF on projects relating to risk management

three projects subsequently initiated by Coleman & Ingram with Supranational Committee

– Conduct a Survey of ERM Practices to be started for Sydney

– Construct a library of Case Studies to be started by Sydney

– Develop a package of material to promote ERM to actuaries Work has started on document providing guidance on

guidance for actuaries on ORSA – adapting a document prepared by the Groupe Consultatif

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AFIR & ERM

AFIR is one of the longstanding sections of the IAA– AFIR objective - the promotion of actuarial research in

financial risks– AFIR organises colloquia and publishes papers on the

subject.

In 2011, is planning to adopt ERM as a key focus

AFIR will also take up new tasks from the Actuarial Roles in ERM report

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AFIR & ERM

New Tasks

Develop List of Top Outstanding ERM research questions

Develop a Web site for exchanging ERM Research References

Sponsor Local Meeting Panel Discussions on International approaches to ERM, Differences, Impact in Local Area

Find Speakers & Topics for Global ERM Colloquium in 2012

Sponsor Webinars on ERM topics

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ASB ERM Task Force

Two Discussion Draft Standard of Practice Risk Assessment Risk Treatment

Will be distributed for discussion in the spring

RISK MANAGEMENT THROUGH THE BUSINESS CYCLE

Alice Underwood, PhD, FCAS

Dave Ingram, FSA, CERA, FRM, PRM

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Agenda

The theory of plural rationalities

The four seasons of risk

The four risk management strategies

Rational adaptability – a radical ideal

Practical harmonization – the inelegant solution

Risk attitudes and the insurance market

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Plural RationalitiesFour views of risk

Managers

Pragmatists

Conservators

Maximizers

1616

Maximizers’ view

Risk is not very important – profits are important

It’s fine to accept large risks, as long as the price is right

Risk is mean reverting:

– Gains will always follow losses

– The best companies will have larger gains and smaller losses over time

1717

Conservators’ view

Increasing profit is not as important as avoiding loss

Need to tightly limit risks

The world is in a delicate balance

– Any major change could send things into ruin

1818

Managers’ view

Risk is measurable and controllable

Risk and reward should be carefully balanced

Experts are best suited to

– Help find risks offering the best rewards

– Manage these risks to keep firm safe

1919

Pragmatists’ view

The future is totally unpredictable

You can’t control risk so there is no point in trying

It is usually best to

– Avoid major commitments

– Keep options open

– Seek freedom to react to changing conditions

2020

Would you say that your own risk attitude is:

Managers

PragmatistsConservators

Maximizers

Would you say that your own risk attitude is:

AttitudeRisk

ManagersSingle Insurer

Employees Actuaries

Maximizer 9% 9% 7%

Manager 72% 73% 66%

Conservator 7% 8% 13%

Pragmatist 11% 11% 13%

2222

Would you say that your firm’s predominant risk attitude is:

Managers

PragmatistsConservators

Maximizers

Would you say that your firm’s predominant risk attitude is:

AttitudeRisk

ManagersSingle Insurer

Employees Actuaries

Maximizer 23% 9% 17%

Manager 40% 52% 47%

Conservator 29% 30% 28%

Pragmatist 7% 8% 8%

2424

Dynamic beliefs

Risk attitudes change with

– Changes in environment

– Changes in risk capacity

– New experiences

This is true of

– Individuals

– Groups

– Firms

2525

Agenda






Risk attitudes and the insurance market

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Four seasons of risk

2727


Long term averages seem to hold up well

Hedging has the expected impact

MODERATE

2828


Risky decisions pay off handsomely

Unhedged positions beat out carefully hedged positions

BOOM

2929


Suddenly, things get really RISKY

Almost any course of action presents

potentially fatal threats

UNCERTAIN

3030


Many risks have turned into LOSSES

Risk management focuses on survival

BUST

In 2007 and 2008, the risk environment for my business was:

Moderate

Boom

Uncertain

Bust

In 2007 and 2008, the risk environment for my business was:

2007-08Environment

RiskManagers

Single Insurer Employees Actuaries

Moderate 29% 22% 27%

Boom 14% 19% 23%

Uncertain 46% 45% 35%

Bust 11% 14% 15%

3333

Risk environment impacts risk attitude

During the BOOM

Attitudes shift towards Maximizer

During the BUST

Attitudes shift towards Conservator

In UNCERTAIN times

Attitudes shift towardsPragmatist

In MODERATE times

Attitudes shift towardsManager

Agent Based ModelSurprise Game

Resources by Strategy

0%

20%

40%

60%

80%

100%

Pragmatists Conservators Maximizers Managers

How many times has your firm’s risk attitude changed between 2006 and now?

0

1

2

3 or more

How many times has your firm’s risk attitude changed between 2006 and now?

# Changes since 2006

RiskManagers


0 20% 9% 36%

1 31% 20% 33%

2 34% 50% 24%

3 or more 16% 21% 7%

3737

Agenda






Risk Attitudes and the Reinsurance Market

3838

Risk management strategies

Diversification

Loss controlling

Risk trading

Risk steering

3939

Diversification

Oldest type of risk management

– Spread exposures across different classes of risks

– Avoid large risk concentrations

Formal diversification programs set targets for the spread of risk

– Maximums and minimums for various classes of risk

ERM adds idea of interdependencies across classes

– Provides better quantification of the benefits of risk spreading

4040

Loss controlling

Most traditional form of risk management

– Identify and mitigate the most significant risks

Commonly practiced by non-financial firms

– Also applies to financial risk

Careful underwriting of loans / insurance policies

Claims management & credit workout

ERM has added inclusion of an aggregate, firm-wide view of risk

4141

Risk trading

Newer form of risk management

– Arose from trading desks and the insurance industry

Focus on getting the price of risk correct

– Requires complicated models of risk, reward, and economic capital

Can be applied on a transaction-by-transaction or other “siloed” basis

– Establishment of a consistent risk valuation on a firm-wide level is risk trading ERM

4242

Risk steering

Applies the ideas of risk trading at a macro level to the major strategic decisions of the firm

– Seeks the optimal risk / reward balance

– Tries to steer the firm in that ideal direction

Fundamentally an enterprise-wide approach

Some seem to think that only risk steering is “real” ERM

4343

Favorite risk management strategies

Conservators favor loss controlling

Maximizers favor risk trading

Managers favor risk steering

Pragmatists favor diversification

The predominant risk management strategy of my firm is:

Diversification

Loss Controlling

Risk Trading

Risk Steering

The predominant risk management strategy of my firm is:

FirmStrategy

RiskManagers


Diversification 27% 31% 18%

Loss Controlling 41% 6% 29%

Risk Trading 8% 12% 27%

Risk Steering 25% 51% 25%

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Pro-cyclical factors

During each stage

– Group in control picks up followers

– The other groups shed followers

– Timing across firms not synchronized, but close enough to magnify the ups and downs of the market as a whole

A retelling of the obvious?

– But the 4 risk strategies were identified over 25 years ago by anthropologists seeking to explain completely different situations

– Since then, these 4 groupings have been found over and over in many different contexts

Can the insurance industry learn something useful from this framework?

4747

Agenda






Risk Attitudes and the Reinsurance Market

4848

Rational adaptability

Discipline means sticking to your strategy no matter what

Adaptability means aligning

– Risk attitude

– Risk environment

– Risk strategy

4949

Rational adaptability

Risk Environment BOOM BUST UNCERTAIN MODERATE

Risk Attitude Maximizer Conservator Pragmatist Manager

Risk Management Strategy

Risk Trading

Loss Controlling Diversification Risk

Steering

Agent Based ModelPreliminary Findings

Stay the CourseStay the Course Average Return Std Dev Return Failure Rate

Pragmatists 0 15.3 10.61%

Conservators 0 5.39 0.01%

Maximizers 4.28 32.08 26.96%

Managers 2.88 17.96 12.90%

AdaptationAdaptation Average Return Std Dev Return Failure Rate

0% -1.69 19.35 19.97%

25% 1.94 20.12 16.09%

50% 5.56 20.21 12.19%

75% 9.19 19.64 8.32%

100% 12.81 18.46 4.76%

The chance that my firm could “get it right” and identify the changing risk environment and adapting our risk management strategy is:

0%

25%

50%

75%

100%

The chance that my firm could “get it right” and identify the changing risk environment and adapting our risk management strategy is:

Chance of “getting it right”

RiskManagers


0% 7% 5% 5%

25% 30% 19% 19%

50% 38% 44% 44%

75% 25% 27% 27%

100% 0% 5% 4%

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Agenda






Risk Attitudes and the Insurance Market

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Be realistic

Rational adaptability is an ideal strategy

Almost impossible to simultaneously

– Know when the risk environment shifts

– Do what it takes to

Shift the firm's risk attitude

Execute the new risk strategy competently

5555

Harmonization

A practical alternative

An inelegant solution

Keep all four risk attitudes in the discussion

Create compromise strategies

5656

Conclusions

As with any other strategy, harmonization must be more than superficial

– Important to truly value all views of risk

– Really believe that there is no totally wrong view

Keep your eye on the rational adaptability ideal

– Your course should be somewhere between “stay the course” and rational adaptability

– Over time getting closer and closer to the ideal

5757

Agenda






Risk Attitudes and the Insurance Market

Risk Attitudes and the Insurance Business

Insurance Market is interplay of

Risk Attitudes of Customers

Risk Attitudes of Insurers

Risk Environment – current and recent history

What are the current dynamics?

DISCUSSION

5959

Contact information

David Ingram

[email protected]

+1 212 915 8039

Alice Underwood

[email protected]

+1 212 915 8439

ERM THROUGH THE BUSINESS CYCLE

Alice Underwood, PhD, FCAS

Dave Ingram, FSA, CERA, FRM, PRM

Documents

Report on the IAA Activities in ERM