Transcript Risk Management - University of Connecticut

Enterprise Risk
Management in Life
Insurance Company
Yi Zheng
Portfolio Modeling Analyst,
Manulife Investment Division
University of Connecticut
12/3/2014
Manulife Financial Corporation operates as John Hancock in the United States, and Manulife in other parts of the world.
Agenda
 What is Risk Management?
 The Definition of Enterprise Risk Management (ERM)
 Risk Identification (Risk Types)
 Risk Measurement (Risk Quantification)
 Risk Appetite (Risk Decision Making)
 Risk Culture/Philosophy
 Benefit of Enterprise Risk Management (ERM)
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What is Risk Management?
 Definition of Risk
 Risk is uncertainty
 Risk includes upside volatility
 Risk is deviation from expected
 Risk Management
 Balancing risk and reward
 Balancing art and science
 Balancing process and people
 Risk Management is ultimately about people
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Definition of Enterprise Risk Management
 James Lam, Enterprise Risk Management-From Incentives
to Controls (2nd edition):
 “ERM is a comprehensive and integrated framework for managing
key risks in order to achieve business objectives, minimize
unexpected earning volatility, and maximize firm value.”
 Sim Segal, Corporate Value of Enterprise Risk
Management-The Next Step in Business Management:
 “The process by which companies identify, measure, manage, and
disclose all key risks to increase value to stakeholders.”
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Risk Identification
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Risk Measurement
 Three popular risk measures
 Value at Risk (VaR): The amount of losses that an entity is not
expected to exceed, at a specified confidence level and period of
time (i.e. 95% 1-day VaR is a level of loss that is expected to be
exceeded only 5% of days)
 Volatility: A measure that provides information about uncertainty of
returns over a defined time period (i.e. may be expressed as a
standard deviation of returns over the specified time period or the
standard deviation of “tracking error” vs. a specified index)
 Expected Shortfall: The expected size of loss that for all losses
exceeding a defined threshold
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Risk Measurement in Life Insurance Company
 Three key risk measurements applied in Life Insurance
Company.
 Earnings at Risk (EaR), which focuses on earnings volatility: the
amount by which quarterly earnings can be expected to vary from
plan earnings no more than a pre-defined level
 Economic Capital (EC), which focuses on capital adequacy: Amount
of capital needed, together with policyholder liabilities held, to
ensure the company can fulfill all policyholder obligations under
extreme stress
 Risk Based Capital (RBC) or Minimum Continuing Capital and
Surplus Requirements (MCCSR)
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Risk Measurement Example
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Why Risk Appetite?
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Risk Portfolio in Life Insurance Company
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The Problem of Operationalizing Risk Taking
 Investors and managers are faced with decisions about how
much and what types of risk to take
 It is a simple concept with major execution challenges
 What is the relevant universe of risk?
 How can risk be measured?
 Which risks do we want and how much of each?
 How can the desired risk profile be achieved?
 The goal of the Risk Appetite framework is to make that
operationalization possible
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Risk Appetite Framework
 Establishes and defines the risk types that are relevant
(e.g., “Public Equity Risk”=risk from the changes in the level
the equity markets)
 Define how risk will be measured (e.g., “how much money
do we lose if the S&P 500 drops by 5% tomorrow”)
 Defines a risk appetite through quantitative limits and
qualitative statements
 “We want to lose no more than $100 million if the S&P 500 drops by
5% tomorrow.”
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Risk Appetite by Risk Category
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Risk Categories
Key Considerations
Strategic
The business on the global market? Should we enter a new produce market (VA, LTC, etc.)?
General Interest Rates
and Interest Spreads
This risk is difficult to inherent in the products and investments. The hedging Strategy?
Public Equity
Investors have more efficient ways of taking this risk than investing in a financial institution.
Real Estate, ALDA, Credit
Benefit from this risk by subjecting to diversification, liquidity, capital impacts, liability
matching, etc.
Currency
It is difficult to get paid or hedge this risk over a long term for a global company.
Mortality and Morbidity,
P&C Claims
Obligation of Insurance Company to take this risk. Wide financial swings if key assumptions
are incorrect.
Policyholder Behavior
Experience can change quickly and hard to measure.
Operational
Unintended consequences and natural byproduct of the employee’s activities.
Liquidity
The ability to sell assets. Change in liquidity demand.
Risk Appetite Framework Summary
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Drivers of Risk Management
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Risk Culture/Philosophy
 Traditionally, companies managed risk in organizational
silos. Market, credit, and operational risks were treated
separately and often dealt with by different individuals or
functions within an institution.
 The problem is that individual risk functions measure and
report their specific risks using different methodologies and
formats.
 Risk management should act like a fund manager and set
portfolio targets and risk limits to ensure appropriate
diversification and optimal portfolio returns.
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Risk Culture/Philosophy
 A key barrier for many life insurance companies in
implementing ERM is that each of the financial risks within
the overall business portfolio is managed independently.
 The actuarial function is responsible for estimating liability risks
arising for the company’s insurance policies.
 The investment group invests company’s cash flows in fixed-income
and equity investments.
 The interest rate risk function hedges mismatches between assets
and liabilities.
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Benefit of Enterprise Risk Management
 Enterprise Risk Management (ERM) provides integrated
analyses, integrated strategies, and integrated reporting
with respect to an organization's key risks, which address
their interdependencies and aggregate exposures. In
addition, an integrated ERM framework supports the
alignment of oversight functions such as risk, audit, and
compliance. Such an alignment would rationalize risk
assessment, risk mitigation and reporting activities.
 Enterprise Risk Management has three major benefits:
 Increase organizational effectiveness
 Better risk reporting
 Improved business performance
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Benefit of Enterprise Risk Management
 A life insurance company which has implemented ERM
would manage all of its liability, investment, interest rate,
and other risks as an integrated whole in order to optimize
overall risk/return. The integration of financial risks is one
step in the ERM process, while strategic, business, and
operational risks must also be considered in the overall
ERM framework.
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Thank You
Questions are Welcome
Manulife Financial Corporation operates as John Hancock in the United States, and Manulife in other parts of the world.