Getting you there. What is Risk Management of an Insurance Company, a view of a Head of Insurance Risk? Olav Jones, Head of Insurance Risk Olav Jones 29-11-2006 1
Agenda I. Risk Management in Insurance II. Core Risk Management Principles III. Some typical risks for life insurance companies and how to manage them Olav Jones 29-11-2006 2
Risk Management is about taking profitable risks (1) Taking risk is good allows us to provide services to our customers and to make money for our shareholders Risk Management is not about stopping people from taking risks Risk Management is not (only) complicated modelling Olav Jones 29-11-2006 3
Risk Management is about taking profitable risks (2) Identifying and really understanding the risks you take Taking more of the profitable risks Avoiding unprofitable risks and risks you cannot afford to take Maximising risk adjusted returns Olav Jones 29-11-2006 4
Risk Management should be a core skill for insurance companies Risk taking and risk management (1) are inherent parts of running any business,however for an insurance business, it is even more important for three key reasons: 1. Risk management is the actual product we take risk away from customers and then manage this through one or more of the following: Diversifying across many customers Hedging through the capital markets or re-insurers Taking risks ourselves supported by sufficient solvency capital Olav Jones 29-11-2006 5
Risk Management should be a core skill for insurance companies (2) 2. Risk impacts the cost of services that we sell Insurance is one of the few businesses where the cost of the goods we are selling is not known and may not be known for many years understanding this uncertainty is core to long term profits Olav Jones 29-11-2006 6
Risk Management should be a core skill for insurance companies (3) 3. Risk of insolvency impact ability to sell insurance Unlike, for example a clothes seller, risk of insolvency has a huge impact on our ability to sell our products: People will only buy insurance from a company they believe will be around to pay the guarantees Olav Jones 29-11-2006 7
Agenda I. Risk Management in Insurance II. III. Core Risk Management Principles Some typical risks for life insurance companies along with some tools and techniques for managing them Olav Jones 29-11-2006 8
Core Risk Principles One Company approach Strong Risk Governance Disciplined approach to risk management Focus on the economics Olav Jones 29-11-2006 9
Core Risk Principles: One Company Approach - To maximise benefits of being a large group achieved through consistency and collaboration In practice this means Treating Risk Management as a core skill and a potential competitive advantage Maximising group advantages of scale and diversification Scale - to negotiate better deals with suppliers Diversification - so that we hedge net group positions and coordinate reinsurance buying at group level Maximise knowledge sharing to avoid re-inventing the wheel across the group Consistency in measurement and management of risks to improve efficiency, transparency and improve risk management Olav Jones 29-11-2006 10
Core Risk Principles: Strong Risk Governance - To ensure risk management functions properly and is core to managing the business In practice this means Clear responsibilities and cascading risk structure Chief Risk Officer who, supported by central team of risk specialists develops, in collaboration with the businesses, recommendations on methodologies, policies and limits Risk Committees who monitor risks, approve methodologies, policies and limits and make key risk decisions Transparency on risk taking and reporting of risks Olav Jones 29-11-2006 11
Core Risk Principles: Disciplined Approach to Risk Management - To ensure risks are identified, measured and managed and only profitable affordable risks are taken In practice this means Risk Taxonomy covering full range of potential risks Disciplined approach to Identification, Measurement and Management Only taking risks we have enough solvency capital to afford to take Only take risks which are profitable - it is not acceptable to blame market conditions for not pricing to cover risks, capital and other costs this should only be very short term or part of an explicit, quantified and monitored strategy to create long term value Optimising risk vs return Olav Jones 29-11-2006 12
Core Risk Principles: Focus on Economics - To ensure risks are measured properly and the interaction between risk taking and value creation is really understood In practice this means Recognising that risk is not just about the risk of making a P&L loss, it is about understanding the expected outcome and the volatility around it Focus on Value rather than just one year profits figure or sales volumes because insurance products are often very long term Market Consistent Valuation of Assets and Liabilities valuing all assets and liabilities using market consistent valuation approaches used for risk management purposes Market Consistent Embedded Value our new reporting will align EV with Fair Value methods - used for more general management and external reporting purposes Using Economic Capital as the core risk measure because it is the only risk measure which is comparable across all risk types, businesses and geographies This is in line with developments in Solvency II Olav Jones 29-11-2006 13
Agenda I. Risk Management in Insurance II. III. Core Risk Management Principles Some typical risks for life insurance companies along with some tools and techniques for managing them Olav Jones 29-11-2006 14
Insurance companies can face a very wide range of risks Debtholders Rating Agencies Regulators Risk vs. Capital RISK = Volatility Risk vs. Return Shareholders Stock Analysts Operational Risk Investment Risk Insurance Risk Business Risk Event Risk Credit Risk Market Risk Property & Casualty Risks Life Risks Changes in business volumes Changes in margins and costs Fraud Unintention al errors Legal risk Man-made shocks Compliance - Loans Derivative counterparties Reinsurance counterparties Settlement Equities Bonds Foreign Exchange Real Estate ALM risk Liquidity risk Attritional losses Large losses Catastrophe Losses Mortality/ Longevity Morbidity Olav Jones 29-11-2006 15 Risk Taxonomy
Some typical key risks for a life company Investment risks Risk that assets (investment income) and liabilities (policyholder claims) react differently to changes in interest rates, stock markets, credit defaults, exchange rates etc. Lapse risk Risk that customers lapse earlier or (if guarantees are higher than current investment returns) later than expected can be strongly related to investment risk Misselling (compliance) risk Risk that costs (eg compensation payments) arise due either to company compliance rules not being followed or the company not having designed the correct compliance procedures to ensure customers are sold appropriate products in the appropriate way Olav Jones 29-11-2006 16
Key questions relating to these (or any risks) What was the assumed base case for these risks when designing and pricing the product? How much variation can there be from the base case and what would be the impact on profits and value? How do actual outcomes compare to the original assumptions Are the risks within the limits set by the Risk Committee? Do we have enough solvency capital to withstand adverse events caused by the risk? Do we have enough profit margin to reward us for taking the risk? Can we improve risk/return in some way? Olav Jones 29-11-2006 17
Investment Risk tools and techniques Risk Measurements Consistent measurement of investment mix and liabilities using Fair Value and then risk is measured using Economic Capital (Fair Value at Risk to 99.97% confidence) Important to be able to aggregate to get total view Stress testing provides additional useful and easy to understand information Duration of Equity important additional measure for interest rate risk Monitor closely actual vs assumed investment returns Monitor closely actual vs assumed claims and bonus payouts Limit setting Limits set in terms of Value-at-Risk, Earnings-at-Risk and Solvency Optimising risk/return Modelling to identify optimum investment mix and durations Hedging techniques, investment rules eg CPPI etc Olav Jones 29-11-2006 18
Lapse Risk tools and techniques Risk Measurements Lapses studies are key to develop good base case estimates For new products where there is no data use market data, similar products together with common sense assumptions In particular seek to understand policyholder behaviour How much are they influenced by new offers, current investment rates etc? How much are they constrained by tax benefits or surrender penalties? Track actual vs assumed lapses and look out for changes in behaviour Stress testing provides easy to understand information take care to stress tests products separately as customer behaviour will vary depending on benefits to them Optimising risk/return Lapse penalties, loyalty bonuses etc Commission claw-back from distributors Identify good customers and incentives distributors to sell to them Olav Jones 29-11-2006 19
Compliance Risk tools and techniques Risk Measurements Be clear internally about who your products are for and the what the policyholder can expect to get Develop internal rules on selling practices and ensure staff know them Monitor if these rules are followed Customer surveys, Phantom Shopper, Buy your own products Ensure you understand and manage your sales force s incentives Ensure customers understand what they are buying and risks they take Monitor customer complaints and monitor legal cases Monitor political views on insurance companies Optimising risk/return Use information gained to improve marketing and compliance processes Whatever is the norm in your market aim to have (at least slightly) better sales practices than your competitors never be worse Take early action once you are aware of a problem Seek marketing and brand value from good sales practice to help compensate for costs Olav Jones 29-11-2006 20