Agenda

Topic

ORSA & ERM

Issue

Context Linking business strategy and risk strategy Performance measurement How practically can I use them interactively?

Lots of performance metrics, so how do I make decisions?

Risk appetite How do I generate risk appetite statements?

Operationalising risk appetite How do I set risk limits / budgets?

Strategic Approach Business strategy

What are our competitive advantages? Are we generating value for our members?

Strategic risk management

Which risks do we want to take and why?

How much risk do we want to take?

Enterprise risk and capital management framework Risk & capital models

What risks do we face?

What is the range of potential impacts?

How do our risks interact?

Emerging risk mgt

What are the threats & opportunities to our business? Are events likely to invalidate our model? What is the plan to manage threats? What are the triggers?

Solvency & capital management

How much capital do we need to hold in each entity? How do we manage risk-taking?

Culture

How do we behave in managing our business?

Embedded through business processes

Strategic planning Products & pricing Governance & controls Performance mgt Capital mgt Reporting

Articulate the business model

 

The business model Outlines what the business does, and



How it makes money doing it

 

Helps stakeholders to Understand where the return is expected to come from, and



The sort of risks the business is expected to take.

LONG TERM PROFITABILITY OF FIRM = PROFIT POTENTIAL OF INDUSTRY or MARKET SEGMENT + / COMPETITIVE ADVANTAGE OF FIRM IN THAT SECTOR

Qualitative risk strategy/risk appetite statements

• • • •

Overarching principles:

We do not wish to take unrewarded risks We do not want to take risks that are not consistent with the delivery of our strategy as an insurer.

We will take on risks dependent on the expected return exceeding the cost of capital We will charge a price for accepting risk that seeks to optimise our risk/reward profile and that fully reflects the cost of taking that risk

By risk category - market risk:

 The Group has no appetite for market risk exposures except where exposures arise as a consequence of core strategic activity (principally as a consequence of exposure of revenue streams to market risks).   Business units are expected to limit market risk exposures by matching the features of liabilities to features of assets. Exposures may be incurred where there is an overriding business need and specific appetites will be established as necessary.

Business strategy

……

Example evidencing challenge

Implications for Risk and Return

We have appetite for taking [xxxx] risk as we believe that we can achieve [return] on this risk

Validating strategic alignment

Questions as to how strategies align or may appear mis-aligned We do not want to take [xxxxx] risk as we believe the upside to be limited.

Target return

Context of risk and return

Target risk appetite Impact of balancing multiple appetite statements. Zone bounded by target tolerances controlled by limits Risk

Risk-adjusted ‘primary’ performance measures

Franchise value

= Net assets + Present value of potential transfers to members from in-force business + Goodwill for new business member value add capability

Economic Value Creation (EVC)

• • • • EVC is a measure of value created less the explicit cost of holding the required economic capital Cost of capital used is not the same for all products / projects Capital allocated reflects diversification benefits If EVC is greater than zero, value has been generated for members • • • •

Risk-Adjusted Return on Lifetime Economic Capital (RARLEC)

RARLEC is a measure of how much value is generated for members relative to the risks being taken on Simple way of ranking products when making capital allocation decisions EVNB/PV(ECap) Economic value of new business (EVNB) is the EVC at point of sale of a policy

Other metrics (constraints)

 New business strain  IFRS profit  Payback period  Distributable cash  Solvency II profit  …….

Dimensions 1 Capital 2 Earnings

Common risk appetite dimensions

Definitions

 Buffer above regulatory diversified Solvency Capital Requirement (SCR) in a 1-in-10 event  Pre-defined 1-in-10 event results in, at worst, zero Group operating profit

3 Liquidity 4 Franchise value BAU cash flows Brand & reputation

 Ability to meet BAU cash outflows on a day-to-day basis

In a stressed scenario

 Coverage of liquid assets over net cash flows in a 1-in-10 shock event  Reflection of how our brand is perceived by our major stakeholders, e.g. customers, employees & regulator

Operational & capability

 Tracking events that could occur and result in operationally being unable to deliver the strategic plan

Setting risk limits using risk appetite

• • The target capital level has been established at 140% of the SCR Amber trigger level established at the capital position of being able to cover 170% SCR.

Risk category Total Financial Equity Interest rate Business Operational Regulatory capital requirement

1000 500 300 200 100 400

Economic Capital target (140% coverage)

1400 (=1000 * 1.4) 700 140 560 420 280

Amber trigger level (170% coverage)

824 (=1400 / 1.7) 412 246 165 83 329 Limits move over year in line with plan numbers SCR multiples are implied solvency levels and therefore risk capital limits are inverted Then refine to assess how RAG statuses should change to reflect earnings risk appetite and risk strategy output RAG for each risk proportionately allocated from central target

Setting risk limits using risk appetite

• • The target capital level has been established at 140% of the SCR Amber trigger level established at the capital position of being able to cover 170% SCR.

Risk category Total Financial Equity Interest rate Business Operational Regulatory capital requirement

1000 500 300 200 100 400

Economic Capital target (140% coverage)

1400 (=1000 * 1.4) 700 140 560 420 280

Amber trigger level (170% coverage)

824 (=1400 / 1.7) 412 246 165 83 329

Risk category

-

Total Financial

-

Equity Interest rate Business Operational Marginal contribution (base)

45% 75% 60% 45% 25% 60%

Marginal contribution (scenario)

48% 80% 62% 50% 24% 63% Scenario: business operating at the upper red limit for particular risk type Scenario tests whether limits reasonably protect diversification benefit

Summary : linking risk and reward under Solvency 2

  

Performance metrics have explicit allowance for risk that is appropriately costed

 This means creating value greater than zero is creating value for shareholders  Define primary metrics and identify other metrics that act as constraints

Risk appetite is multi-dimensional

 It focuses on what the Board is concerned about in running the business   Derived from stakeholder expectations Capital risk appetite and risk limits link together  Limits set to preserve benefit of diversification

Economic (risk) capital is allocated appropriately to those products that create the risk exposure

   Ensures products are charged appropriately for capital usage Projections of the risk profile are appropriate as business mix and volume change Ensures the assessment of return from taking risk is appropriately allocated to products to ensure we grow the right parts of the business

Questions and comments?

Christopher Chappell E-mail: [email protected]