Financial Risks David Wong Friday 21 May 2004

Financial Risks David Wong Friday 21 May 2004, Staple Inn Hall p w c

Financial Risks § Concept of Financial Risks in General Insurance § Types of Risks § Managing Risks § Where are we today? p w c

What are Financial Risks? Financial Risks p w c

Financial Risk and Capital § Different insurers have different levels of risk Risk Capital § Insurer’s risk profiles change over time § The insurer’s capital requirement will depend on it’s risk tolerance/appetite p w c

Risk and Capital: Financial Risk Quantifiable Risks Model Capital Controls Qualitative Risks (capital value) Universe of Risks Qualitative Risks (no capital value) p w c Add-Ons

Drivers: Increased Focus on Risk § Regulatory § CP 190 for Insurers, CP 04/7 for Lloyd’s § Capital Management Improvements § Competitive Advantage § Turning Risk into Value p w c

Types of Risks p w c Insurance risk Operational risk Market risk Liquidity risk Credit risk Group risk

Reasons for Insurer Failures p w c Source: FSA Occasional Paper 20 “Managing Risk: Practical lessons from recent “failures” of EU insurers”

Managing Risks: Risk Management Framework Strategy § § Direction and objectives Culture and language Risk policy and definition Capital allocation Organisation Structure Infrastructure § § § Methodologies § Technology / systems § Management information Processes § § § p w c Risk identification Risk assessment Risk response Risk monitoring / reporting Capital modelling / allocation Departments / Committees Reporting lines Roles and responsibilities Skills and resources

Risk Management – Who is involved? Board & Senior Management Risk Management Core Involvement Treasury p w Reinsurance Tax Partial Involvement External Parties Underwriters/ Account Managers IT Finance Claims Actuaries Accounting Sales & Marketing Consultants c FSA Rating Agencies Reinsurers

Managing Risks: Key Steps Enterprise Risk Management Risk Appetite Management Buy-in Risk Register Risk Profile Risk Assessment Risk Based Capital Management Information Risk Monitoring p w c

Managing Risks: Key Steps Enterprise Risk Management Risk Appetite Management Buy-in Risk Register Risk Profile Risk Assessment Risk Based Capital Management Information Risk Monitoring p w c

Articulating risk appetite Quantitative measures Probability of Ruin Credit rating Target return on capital Qualitative measures Core competencies Activities to be excluded or avoided Level of new business activities Zero tolerance Regulatory mis-compliance p w c 8

Risk Registers § Identification of risks § Initial view of relative significance to the company § Input to stress & scenario testing/DFA/ICA Risk Type Description Probability/ Severity Market Risk Fall in Equity Market Med Probability High Severity p w c Controls & Mitigants Action Med Controls: Model using S&S Investment Policy

Risk Registers - Issues § § § p Capturing risks not issues Operational not operations risks Categorisation Consistency Assessment of controls w c

Risk Based Capital: ICA Insurance Risk Market Risk Credit Risk Planning & Insurance Model Capital requirement for Insurance, Market and Credit risks Operational Risk Liquidity Risk Group Risk Consider Definition Marketability of assets Capital structure Maximum cash outflow Contagion risk Loss history Systems & controls Contingency plans Estimate correlations between risk areas and determine aggregate capital requirement Internal Capital Assessment p w c

Management Information § Key Performance Indicators § Solvency Margin § Key Risk Indicators § Risk and Solvency Scorecard § Trigger Events Report p w c

Where are we today? § Pw. C Enterprise-wide Risk Management for he Insurance Industry § UK Insurers p w c

Financial Risks – Key Messages § Key area of focus § Framework to embed risk and capital management in the organisation § Opportunity rather than threat p w c