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Linkage of Risk, Capital and Financial Management

Linkage of Risk, Capital and Financial Management. John J. Kollar, FCAS, MAAA, CPCU, RWW November 12, 2007. Outline . ERM wave ERM – quantification Some linkage indicators. Enterprise Risk Management (ERM). Enterprise-wide perspective Holistic Consistency

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Linkage of Risk, Capital and Financial Management

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  1. Linkage of Risk, Capital and Financial Management John J. Kollar, FCAS, MAAA, CPCU, RWW November 12, 2007

  2. Outline • ERM wave • ERM – quantification • Some linkage indicators

  3. Enterprise Risk Management (ERM) • Enterprise-wide perspective • Holistic • Consistency • Risk of loss/Opportunity for gain • Quantification of uncertainty • Consistent metrics • Board & Executive management • Clear objectives & expectations • Appropriate resources (team) • Regular reports to the Board

  4. ERM “Drivers” • Financial services convergence • Gramm-Leach Bliley Act • Improved corporate governance • Sarbanes Oxley Act (SOX) • Consolidation • Acquisitions (opportunities) • Rating agencies • S&P, etc. • Risk management evolution – not revolution

  5. ERM “Drivers” • Globalization • Basel II (banks) • International Assoc. of Insurance Supervisors (IAIS) • Guidance Papers – ERM, internal models • ERM Practice Paper (IAA) • NAIC monitoring • Principles Based Reserving (life, pension, etc.) • Risk Focused Surveillance (examinations) • Convergence of FASB to IASB • Fair Value Accounting – discounting, risk margins • SEC proposed rule – use of International Financial Reporting Standards for foreign firms

  6. Solvency II – Aims • Establish solvency standard to match risks • Encourage risk control in line with IAIS principles • Harmonize across European Union • Assets and liabilities on fair value basis consistent with IASB if possible • Set higher solvency standard than currently to permit timely intervention • Approach broadly consistent with Basel II

  7. Professional Societies/Associations ERM Developments

  8. Build on Existing Programs • Mission statement • Vision • Strategic plan – opportunities • Disaster recovery plan • SWOT analysis • Budget analysis • Corporate objectives • Incentive compensation • Asset liability management • Reinsurance program

  9. Quantify Risks & Opportunities • Establish a database to be used in measuring and monitoring risks • Data quality • Acquire information to • Supplement insurer’s own data • Benchmark to industry data • Evaluate opportunities

  10. Aggregate Risks & Opportunities • Reflect correlation/diversification among risks and opportunities • Use catastrophe model to reflect geographic concentration • Identify metrics that can be used to analyze aggregates • Risk appetite metric (Board) • Return on risk adjusted capital (RORAC) • Economic capital

  11. Aggregate Loss Distribution& Implied Economic Capital Value at Risk TVaR

  12. Risk Measurement & (Cost of) Capital Allocation by Line, etc.

  13. Optimize Mix of Capital and Reinsurance Relative Costs Net Cost of Reinsurance Cost of Capital Income Tax Deduction Investment Income

  14. Confidence Interval Around the Target Combined Ratio

  15. Marketing/Underwriting StrategyReflect Risk in Planning Change

  16. Reflect Pricing Risk • Develop a distribution of pricing scenarios reflecting marketplace conditions (cycle): • Pricing • Coverage changes • Policyholder selection • Determine a distribution of financial results: • Adjust premiums • Calculate (projected) combined ratio • Calculate (projected) return on capital

  17. Some Linkage Indicators • Uncertainty reflected in capital and financials as well as in risk management • Market valuations of assets & liabilities • Risk/capital allocated by business unit • Consistent objectives • Corporate financials • Incentive compensation • Consistent strategic decision making • One set of books • Corporate culture

  18. Presenter’s contact details John J. Kollar, FCAS, MAA, CPCU, RWW ISO 201-469-2340 jkollar@iso.com

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