Transcript
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 1/39
4-1
Chapter 4
AdvancedTopics in Risk
Management
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 2/39
4-2
Agenda
• The Changing Scope of Risk Management
• Enterprise Risk Management
• Insurance Market Dynamics
• Loss Forecasting
• Financial nalysis in Risk ManagementDecision Making
• !ther Risk Management Tools
• I" case# $aring case%
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 3/39
4-3
Outcome
• &le to apply 'ifferent risk managementtechni(ues to manage risk e)posure
• *n'erstan' the causes of &ig losses in I"case an' $aring case%
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 4/39
4-4
The Changing Scope of Risk Management
• To'ay# the risk manager+s ,o&-
. In/ol/es more than simply purchasinginsurance
. Is not limite' in scope to pure risks• The risk manager may &e using-
. Financial risk management
. Enterprise risk management
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 5/39
4-5
The Changing Scope of Risk Management
• Financial Risk Management refers to the i'entification#analysis# an' treatment of speculati/e financial risks-
. Commo'ity price risk is the risk of losing money if theprice of a commo'ity changes# e%g% oil# gol'# cotton# etc%
. Interest rate risk is the risk of loss cause' &y a'/erseinterest rate mo/ements# e%g% &on' price changes 0ithinterest rate
. Currency e)change rate risk is the risk of loss of /aluecause' &y changes in the rate at 0hich one nation1s
currency may &e con/erte' to another nation+s currency#e%g% o/ersea su&si'iaries
• Financial risks can &e manage' 0ith capital marketinstruments
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 6/39
4-6
Exhibit 4.1 Managing Financial Risk2T0oE)amples
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 7/39
4-7
Exhibit 1 Managing Financial Risk2T0oE)amples
Should we use futures or option?
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 8/39
4-8
The Changing Scope of Risk Management
• n integrate' risk management program is a
risk treatment techni(ue that com&inesco/erage for pure an' speculati/e risks in thesame contract
• Some organi3ations ha/e create' a ChiefRisk !fficer CR!5 position
. The chief risk officer is responsi&le for thetreatment of pure an' speculati/e risks face' &ythe organi3ation
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 9/39
4-9
Entepise Risk Management
• Enterprise Risk Management ERM5 is a comprehensi/e risk
management program that a''resses the organi3ation+s pure#speculati/e# strategic# an' operational risks
. Strategic risk refers to uncertainty regar'ing an organi3ation+sgoals an' o&,ecti/es#
. !perational risks are risks that 'e/elop out of &usinessoperations# such as pro'uct manufacturing
. s long as risks are 66666positi/ely correlate'# the com&inationof these risks in a single program re'uces o/erall risk
. 7early half of all *S firms ha/e a'opte' some type of ERM
program. $arriers to the implementation of ERM inclu'e organi3ational#
culture an' turf &attles
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 10/39
4-10
The !inancia" Cisis andEntepise Risk Management
• The *S stock market 'roppe' &y morethan fifty percent &et0een !cto&er 899:an' March 899; ne)t sli'e5
. The melt'o0n raises (uestions a&out the use ofERM
. !nly <= percent of e)ecuti/es sur/eye' sai'they ha' a 0ell>formulate' an' fully>
implemente' ERM program
“Interesting” to learn that insurance company took the bet,
e.g. AIG
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 11/39
4-11
Exhibit #Timeline of
E/ents Relate'to the FinancialCrisis
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 12/39
4-12
$id ERM fai"% o did companies simp"& fai"to use it pope"& egu"ated'
• The falls of Lehman $rothers# Merrill Lynch an' merican
International "roup• ?illiam @% Aanning# e)ecuti/e /ice presi'ent at ?illis Re Inc%
. BIn the firms that really took a nose'i/e# the CE!s an'the 'irectors seeme' to care only a&out earnings# an'not a&out ho0 much risk 0as &eing taken% There 0as nopenalty for &etting the firm% They 'i'n1t take ERM /eryseriously%
. $laming ERM for a company1s failure is like ri'ing in a car0ithout a seat &elt# then &laming the seat &elt for yourin,uries
. I" asi'e# the insurance in'ustry has mostly a/oi'e' &iglosses so far &ecause propertycasualty firms ha/e al0aysemphasi3e' un'er0riting risk
Rea' Risking the Enterprise &y $onnie $re0er Ca/anaughat http://www.amper.com/publications/risk-enterprise-management.asp
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 13/39
4-13
ERM
• Integrating enterprise risk management 0ithorgani3ational strategy- an ERM program mustalign 0ith corporate strategy to gi/e theorgani3ation a complete an' comprehensi/eapproach to managing risk#
. The RM ournal# May <# 899; &y Gillackey# @enry
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 14/39
4-14
(nsuance Maket $&namics
• Decisions a&out 0hether to retain or transfer risks areinfluence' &y con'itions in the insurance marketplace
• The *n'er0riting Cycle refers to the cyclical pattern ofun'er0riting stringency# premium le/els# an' profita&ility. @ar' market- tight stan'ar's# high premiums#
unfa/ora&le insurance terms# more retention. Soft market- loose stan'ar's# lo0 premiums# fa/ora&leinsurance terms# less retention
. !ne in'icator of the status of the cycle is the com&ine'ratio-
Premiums
Expensesng Underwriti Expenses Adjustment Loss Lossess Paid RatioCombined
++=
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 15/39
4-15
Exhibit ) Com&ine' Ratio for ll Lines ofAroperty an' Lia&ility Insurance# <;H.899=J
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 16/39
4-16
(nsuance Maket $&namics
• Many factors affect property an' lia&ility insurancepricing an' un'er0riting 'ecisions-. Insurance in'ustry capacity refers to the
relati/e le/el of surplus
• Surplus is the 'ifference &et0een aninsurer+s assets an' its lia&ilities
• Capacity can &e affecte' &y a clash loss#0hich occurs 0hen se/eral lines of insurancesimultaneously e)perience large losses
. In/estment returns may &e use' to offsetun'er0riting losses# allo0ing insurers to setlo0er premium rates
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 17/39
4-17
(nsuance Maket $&namics
• The tren' to0ar' consoli'ation in the financial ser/ices in'ustry iscontinuing
. Consoli'ation refers to the com&ining of &usinesses throughac(uisitions or mergers
• !0ing to mergers# the market is populate' &y fe0er# &ut
larger in'epen'ent insurance organi3ations• There are also fe0er large national insurance &rokerages
. n insurance &roker is an interme'iary 0ho representsinsurance purchasers
. Cross>In'ustry Consoli'ation- the &oun'aries &et0een insurance
companies an' other financial institutions ha/e &een struck 'o0n• Financial Ser/ices Mo'erni3ation ct of <;;;
• Some financial ser/ices companies are 'i/ersifying theiroperations &y e)pan'ing into ne0 sectors
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 18/39
4-18
Capita" Maket Risk !inancingA"tenatives
• Insurers are making increasing use of capital markets toassist in financing risk. Securiti3ation of risk means that insura&le risk is
transferre' to the capital markets through creation ofa financial instrument-
• catastrophe &on'J permits the issuer to skip or'efer sche'ule' payments if a catastrophic lossoccurs
. n insurance option is an option that 'eri/es /aluefrom specific insurance losses or from an in'e) of/alues%• 0eather option pro/i'es a payment if a specifie'
0eather contingency e%g%# high temperature5occurs
• 'ou&le>trigger option is a pro/ision that pro/i'esfor payment only if t0o specifie' losses occur
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 19/39
4-19
Capita" Maket Risk !inancing A"tenatives
• 'ou&le>trigger option e)ample.often use' for insurance purposes#.pays off only if 8 e/ents occur%.&uy this option to limit losses that are /ery
unlikely# &ut /ery e)pensi/e if they &oth
occurre'%
. The impact of risk securiti3ation is an 6666666 in
capacity for insurers an' reinsurers• It pro/i'es access to the capital of many
in/estors
JCat6$on's6Demystifie' your reference5
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 20/39
4-20
Exhibit 4 Catastrophe $on's- nnual 7um&er ofTransactions an' Issue Si3e
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 21/39
4-21
*oss !oecasting &rief account5
• The risk manager can pre'ict losses usingse/eral 'ifferent techni(ues-. Aro&a&ility analysis
. Regression analysis. Forecasting &ase' on loss 'istri&ution
• !f course# there is no guarantee thatlosses 0ill follo0 past loss tren's
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 22/39
4-22
*oss !oecasting
• Aro&a&ility analysis- the risk manager can assignpro&a&ilities to in'i/i'ual an' ,oint e/ents. The pro&a&ility of an e/ent is e(ual to the num&er
of e/ents likely to occur K5 'i/i'e' &y the num&erof e)posure units 75
• May &e calculate' 0ith past loss 'ata. T0o e/ents are consi'ere' in'epen'ent e/ents if
the occurrence of one e/ent 'oes not affect theoccurrence of the other e/ent
. T0o e/ents are consi'ere' 'epen'ent e/ents if the
occurrence of one e/ent affects the occurrence ofthe other. E/ents are mutually e)clusi/e if the occurrence of
one e/ent preclu'es the occurrence of the secon'e/ent
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 23/39
4-23
*oss !oecasting
• Regression analysis characteri3es therelationship &et0een t0o or more /aria&lesan' then uses this characteri3ation to
pre'ict /alues of a /aria&le. For e)ample# the num&er of physical 'amage
claims for a fleet of /ehicles is a function of thesi3e of the fleet an' the num&er of miles 'ri/en
each year
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 24/39
4-24
Exhibit + Relationship $et0een Aayroll an' 7um&erof ?orkers Compensation Claims
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 25/39
4-25
*oss !oecasting
• loss 'istri&ution is a pro&a&ility 'istri&ution oflosses that coul' occur. *seful for forecasting if the history of losses ten's to
follo0 a specifie' 'istri&ution# an' the sample si3e is
large. The risk manager nee's to kno0 the parameters of
the loss 'istri&ution# such as the mean an' stan'ar''e/iation
. The normal 'istri&ution is 0i'ely use' for lossforecasting• 7ote- it can &e /ery incorrect
• If @SI 'oes not follo0 normal 'istri&ution# ho0 can you 'oforecasting
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 26/39
4-26
!inancia" Ana"&sis in Risk Management$ecision Making
• The time /alue of money must &e consi'ere' 0hen'ecisions in/ol/e cash flo0s o/er time
. Consi'ers the interest>earning capacity of money
. present /alue is con/erte' to a future /alue throughcompoun'ing
. future /alue is con/erte' to a present /alue through'iscounting
• Risk managers use the time /alue of money 0hen-
. naly3ing insurance &i's
. Making loss control in/estment 'ecisions
• The net present /alue is the sum of the present /alues of the futurecash flo0s minus the cost of the pro,ect
• The internal rate of return on a pro,ect is the a/erage annual rateof return pro/i'e' &y in/esting in the pro,ect
Still remember what they mean? Refer to your FM text.
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 27/39
4-27
(nsuance bids examp"e
T0o &i's
<% nnual Aremium-=9#999# per>claim'e'ucti&le H#999
8% nnual Aremium-N9#999# per>claim'e'ucti&le <9#999
RO4P
Expected
Number of
Losses
Expected Size
of Lossess
11 $5,000
6 $10,000
3 > $10,000
Which bid is better?
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 28/39
4-28
(nsuance bids examp"e
• $i' <- e)pecte' cash outflo0s in one year O
• AQ'e'ucti&le O
• Total outlflo0- AQ'e'ucti&le Alus premium
• $i' 8-
• !utflo0s-• A/'e'ucti&leO
• Total outlflo0-
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 29/39
4-29
Making "oss conto" investment decisions
• The installation of leakage control system ise)pecte' to generate an after>ta) net cashflo0 of <99#999 per year for H year#rOP# the installation cost is 499#999%Shoul' the system &e installe'
• 7AQ O AQ of the fi/e <99#999 . cost of the
installation O48<#8N >499#999 O8<#8N
• !R IRR O:%;NP
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 30/39
4-30
Othe Risk Management Too"s• risk management information system RMIS5 is a
computeri3e' 'ata&ase that permits the risk manager to store
an' analy3e risk management 'ata. The 'ata&ase may inclu'e listing of properties# insurance
policies# loss recor's# an' status of legal claims. Data can &e use' to pre'ict an' attempt to control future
loss le/els• Risk Management Intranets an' ?e& Sites
. n intranet is a 0e& site 0ith search capa&ilities 'esigne'for a limite'# internal au'ience
• risk map is a gri' 'etailing the potential fre(uency an'se/erity of risks face' &y the organi3ation. Each risk must &e analy3e' &efore placing it on the map
High
!rob"bi#i
t%edium
Lo&
Lo& %edium High
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 31/39
4-31
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 32/39
4-32
Othe Risk Management Too"s
• Qalue at risk QR5 analysis in/ol/es calculating the0orst pro&a&le loss likely to occur in a gi/en time perio'un'er regular market con'itions at some le/el ofconfi'ence. The QR is 'etermine' using historical 'ata or
running a computer simulation. !ften applie' to a portfolio of assets
. Can &e use' to e/aluate the sol/ency of insurers
. financial firm may 'etermine that it has a HP onemonth /alue at risk of <99 million% This means thatthere is a HP chance that the firm coul' lose more
than <99 million in any gi/en month% Therefore# a<99 million loss shoul' &e e)pecte' to occur oncee/ery 89 months%http-000%in/estope'ia%comterms//ar%asp
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 33/39
4-33
Othe Risk Management Too"s
• Catastrophe mo'eling is a computer>assiste'
metho' of estimating losses that coul' occur as aresult of a catastrophic e/ent. Mo'el inputs inclu'e seismic 'ata# historical
losses# an' /alues e)pose' to losses e%g%#&uil'ing characteristics5
. Mo'els are use' &y insurers# &rokers# an' largecompanies 0ith e)posure to catastrophic loss
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 34/39
4-34
Othe Risk Management App"ications
• n accurate forecast of the timing an' magnitu'e of
claims is especially important 0hen losses are retaine'• The a&ility to forecast ultimate claims for lia&ility lines is
an important skill for the risk manager. Loss 'e/elopment factors LDFs5 are multipliers that
can &e applie' to claims settle' to 'ate to estimate
the ultimate claims for a perio'. general up0ar' tren' in lia&ility an' 0orkerscompensation claim totals after the initial reporting perio'calle' %
. LDFs are use' to arri/e at the ultimate /alue that can &e
e)pecte' for a claim% For e)ample# an LDF of <%H9 meansthat for e/ery < of current claims# the ultimate payout0ill &e <%H9% total of H9#999 in current claims 0oul'result in an ultimate payout of :H#999%http-000%irmi%comonline
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 35/39
4-35
The !inancia" Cisis and EntepiseRisk Management% the A(, case• I" mentions an acti/e ERM program in its 899: <9>G
Report
. Riskiness of the Financial Aro'ucts Di/ision 0as notfully appreciate'
• The 'i/ision 0as issuing cre'it 'efault s0aps
• cre'it 'efault s0ap CDS5 is an agreement in0hich the risk of 'efault of a financial instrument istransferre' from the o0ner of the financialinstrument to the issuer of the s0ap pooling5
• The 'efault rate on mortgages soare' an' thecompany 'i' not ha/e the capital to co/erguarantees
• The lessons learne' &y risk managers from the financialcrisis 0ill influence ERM in the future
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 36/39
4-36
The use of deivatives to obscue ba"ance sheetisks is a manifestation of that appoach
• Deri/ati/es# I" an' the Future of Enterprise RiskManagement &y Michael "% ?acek
. Deri/ati/es are attracti/e &ecause they can often &estructure' to replicate tra'itional asset transactions &ut
0ith a much lighter &alance sheet impact%. Remem&er- a corporate &on' can &e replace' &y a
'efault free &on' o&ligation e%g% treasuries5 an' a shortput option relate' to the firm /alue
• ?hat 0oul' happen if &on' 'efault occurs
. Let+s look athttp-000%soa%orgli&raryessaysrm>essay>899=>0acek
%p'f to in/estigate 0hat+s happening%
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 37/39
4-37
A(, and C$S
• t a congressional hearing last 0eek# Rep% "aryAeters D%# Mich%5 aske' I" Chief E)ecuti/eE'0ar' Li''y# ?here 0as the risk management ofyour company ?here 0as the failure of your o0n
internal risk>management proce'ures • Mr% Li''y respon'e'# ?e ha' risk>management
practices in place% They generally 0ere not allo0e' to go up into the financial>pro'ucts &usiness%
http://wheelhouseadvisors.wordpress.com MARCH 30, 2009
Reading: ISDA-AIGandCDS.pdf
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 38/39
4-38
C$S as insuance% ecent deve"opment
• ?all St looks to &oost market in *S muni CDS# FT- Fe&ruary 89<<. ?all Street is seeking to e)pan' the market for 'eri/ati/es. allo0 &anks an' in/estors to profit fromor he'ge against
&on' 'efaults &y struggling *S states an' localgo/ernments
• $anks Look to Arofit on Muni>$on' Fears. DECEM$ER 8<# 89<9# http-online%0s,%com
. For the first time in t0o years# S0it3erlan'1s *$S " has&egun making markets in 'eri/ati/es tie' to municipal&on's an' other securities%
. Separately# fi/e large 'eri/ati/es 'ealers2$ank of merica
Corp%1s $ank of merica Merrill Lynch# Citigroup Inc%#"ol'man Sachs "roup Inc%# %A% Morgan Chase Co%# an'Morgan Stanley2met last month in 7e0 ork to 'iscussstan'ar'i3ing the paper0ork for Bmuni CDSsB in an effortto attract more &uyers an' sellers%
7/17/2019 Chapter 4s
http://slidepdf.com/reader/full/chapter-4s 39/39
4 39
Sti"" a tin& maket
• The si3e of the municipal CDS market isa&out H9 &illion#
• The si3e of the o/erall municipal>&on'
market is a&out 8%= trillion%
top related