Practical Risk Management Issues for Life Insurers

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Practical Risk Management Issues for Life Insurers

• George Tang

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Agenda

• Why Risk Management (RM)
• RM Functions their Implications
• Cultural Issues For Asian Companies
• Useful Tools Metrics
• Interdependency of Major Risk Factors
• Pertinent Reports

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Why Risk Management

• Discipline to Identify, Measure, Understand
  Risks so Company can
• Minimize possibility of insolvency
• Anticipate and smooth out earnings surprises
• Take better risks improve performance
• Avoid being overly conservative
• Optimize resources and capital
• International Accounting Standard
• Phenomenal Failures Due to Lack of RM

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Companies are Always in the Grips of their
Dumbest Competitor
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RM Functions and Their Implications

• Relationship between ALM and RM
• ALM C1 C3 Risks
• Risk Management may include
• Operations
• Products
• Financials
• Investments (ALM, FX)
• Legal (MA)
• Market Conduct

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RM Functions and Their Implications

• Coordination vs. Decision Making
• Identify Issues
• Quantify Risks
• Facilitate Optimal Solutions
• Consensus Among Pertinent Disciplines
• Approval from Senior Management

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Product Management
Sr. Mgmt
M A
Human Resource
Fin.Rpt
Risk Mgmt
Investment
Internal Audit
Financial/ Accounting
Legal
Admin/ Systems
Sales/Mktg
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RM Functions and Their Implications

• Key Ingredients for A Successful RM Role
• Working Knowledge of Major Disciplines
• Understanding of Output Correlation Between
  Different Departments
• Good Communication/Coordination Skills
• Willingness to Raise Difficult Issues Rally
  Others Towards Full Final Resolutions

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Organizational Issues

• Management Objectives
• New Personnel or Reorganization
• Budget Expense Issues
• Composition of RM Committee

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Cultural Issues in Asia

• Subservience Is Often Perceived as Virtuous
• Open Free Expression of Ones Idea Could be
  Perceived as Either Ignorance or Arrogance
• Reticence on Controversial Topics
• Reluctance to Convey a Direct No

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Cultural Issues in Asia

• Numbers Can Set you Free
• Present Issues Along with Possible Solutions
• Seek Individual Opinions Privately
• Use Group Forums to Confirm Key Decisions
• Positive Attitude

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Useful Tools Metrics 1

• Durations Convexities
• Arbitrage-Free Scenarios
• Product Design Government Regulations Could
  Result in High or Negative Durations
• Dollar Duration
• Dynamic Lapse Model
• Competitive Rate History

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Useful Tools Metrics 2

• Earnings at Risk (EaR)
• Project earnings over various scenarios, may
  include new business
• Rank results
• Calculate the average
• The difference between the average the 10th
  worst result out of 1,000 scenarios is the EaR _at_
  the 99th confidence level

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Useful Tools Metrics 3

• Embedded Value at Risk
• Generate interest or yield scenarios
• Project Distributable Earnings (DE) based on
  inforce business on valuation date, plus free
  surplus
• Discount DE along each scenario with 1-yr rates
  based on Cost of Capital plus risk margin

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Useful Tools Metrics 3

• Rank the Results
• Calculate the Average
• The difference between the average the 10th
  worst result out of 1,000 scenarios is the
  Embedded Value at risk at the 99 confidence
  Level

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Interdependency of Major Risk Factors An
Example

• Surplus Before After Acquisition
• Company A Company B AAfter
  Buying B Asset Liab Asset Liab
  Asset Liab
• Bonds 100 60
  150
• Stocks 10
• Reserves 80 50
  130
• Surplus 20 10 20
• RBC Charge 10 4 X

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Interdependency of Major Risk Factors An Example

• Risk profile after Acquisition
• If company B is an insurance company
• Replace RBC charge for the purchase price w/
  company Bs RBC charge
• Avoid Double Gearing if company B is a
  non-insurance entity with solvency requirement
• Determine unique risk factors if company B is in
  the other category

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Pertinent Results Reports

• Executive Summary
• Major Findings
• New, old, possible future risk exposures
• Current risk profile its impact on company
• Discussions on decisions, actions, results
• Overall Risk Assessment
• Description quantification of risk exposures
• Results of risk measurements
• Sensitivity under various scenarios

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Pertinent Results Reports

• Executive Summary (continued)
• Summary of Risk Measures
• - Tables graphs showing key numbers
• Action Plan
• - Documentation of next step(s)
• - Target dates, timeline, resources

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Pertinent Results Reports

• Overview Analysis
• Key Factors
• Risk and Profitability Drivers
• Core Risks for Entity
• Other Key Risks Facing Entity
• Overview of Issues in U.S. Market
• Overview of Regulatory Environment

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Pertinent Results Reports

• Overview Analysis (Continued)
• 2) Methodology and Assumptions
• - Use appendices for details
• 3) Description and Analysis of Strategies
• - Current and alternative strategies
• 4) Description of Models
• 5) Historical and Empirical Support Data

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Pertinent Results Reports

• Results
• Detailed Tabular Summary of Results
• Individual Sections with Sensitivity, Volatility,
  Distribution of Earnings under Various
  Confidence Levels
• Additional Analysis