Company Enterprise Risk Management & Stress Testing Case Study.

Company EnterpriseCompany EnterpriseRisk Management & Stress TestingRisk Management & Stress Testing

Case StudyCase Study

moderated by

Joe Petrelli Sr.President, Demotech, Inc.

presented by

Anya KutsinaDirector, U.S. RE Analytics / Ultimate Risk Solutions

Implementing Implementing

ERM and DFAERM and DFA

UtilizingUtilizing

Risk ExplorerRisk Explorer

The Importance of ERM for an Insurance Company

Why this topic is relevant

Evolution from RM to ERM

Industry Challenges

What is DFA?

Analyzing DFA results

Solvency Testing

Structure of a DFA model

URS DFA Application Suite

AgendaAgenda

Case Study: Lake George P&C Company

Lines of Business

Assets

Reinsurance Structure

Viewing Simulation Results

Comparison of Reinsurance Programs

Analysis of the Company’s Equity position under different scenarios.Cost / Benefit Analysis

Conclusion - Q&A

Agenda Agenda (cont’d)(cont’d)

Why this topic is relevantWhy this topic is relevant

The source of origination for ERM, DFA concepts

Risk Management process is the foundation for Enterprise Risk Management

Static (deterministic) Financial Analysis is the foundation for Dynamic Financial Analysis

Evolution of both from original concepts

Dynamic Financial Analysis

The definition of RiskThe definition of Risk

Evolution of Risk Management

Any event that presents Any event that presents the possibility of loss or the possibility of loss or danger to organizations or danger to organizations or peoplepeople

Uncertainty – dealing with Uncertainty – dealing with the unknown and the unknown and uncertainty of outcomesuncertainty of outcomes

Risk Management: the original Risk Management: the original conceptconcept

Risk Management is a process for managing the uncertainty created from unexpected, unintended or accidental events

A process for making decisions that will minimize the impact of risk

The original focus was primarily on “Pure Risks”

Evolution of Risk Management

Evolution from RM to ERMEvolution from RM to ERM

Enron and other scandals prompted Congress to call for more financial controls

Calls for even greater corporate governance resulted in Sarbanes-Oxley Act of 2002

Government and regulatory authorities responded by creating the Committee of Sponsoring Organizations (COSO) of the Treadway Committee

Rating organizations such as AM Best include it in their analysis

Evolution of Risk Management

ERM – Holistic ManagementERM – Holistic Managementof Riskof Risk

Enterprise risk management is driven by the concept that one cannot effectively protect the whole organization without analyzing all factors that influence financial outcomes.

Risk is viewed across the entire enterprise

Evolution of Enterprise Risk Management

The Focus of ERMThe Focus of ERM

It considers the impact of “speculative, It considers the impact of “speculative, economic or business risks” on entity economic or business risks” on entity as well as “pure risks” as well as “pure risks”

ERM incorporates each of ERM incorporates each of management’s decisions with respect to management’s decisions with respect to riskrisk

Who is in charge of risk at your Who is in charge of risk at your company? How is it managed?company? How is it managed?

Who has the role of Chief Risk Officer?Who has the role of Chief Risk Officer?

ERM — General Concepts

Regulatory Inquiries

I.e. Stress Testing

Reinsurance Optimization

Strategic Asset Allocation

Capital Allocation

Performance Measurement

Business Mix

Pricing Decisions

Mergers and Acquisitions

Dynamic Financial Analysis

DFA applicationsDFA applications

Dynamic Financial AnalysisDynamic Financial Analysis

ERM Tools

Scenario testing – projects business results under Scenario testing – projects business results under selected deterministic scenarios into the future. selected deterministic scenarios into the future. Results based on such scenario are valid only for Results based on such scenario are valid only for this specific scenario.this specific scenario.

Stochastic simulation (DFA) – thousands of different Stochastic simulation (DFA) – thousands of different scenarios are generated stochastically allowing for scenarios are generated stochastically allowing for the full probability distribution of important output the full probability distribution of important output variables, like surplus, written premium, loss ratiosvariables, like surplus, written premium, loss ratios ..

Setting the Time HorizonSetting the Time Horizon The first step used to compare different strategies is to

apply a fixed time horizon

In the Insurance industry a projection period of five to ten years seems to be a reasonable choice simulate to determine the long term effects of a

chosen strategy

simulated values are less reliable over a longer projection period

ERM Tools - Dynamic Financial Analysis

Analyzing DFA ResultsAnalyzing DFA Results

Return measure (e.g. expected surplus)

Risk measure (e.g. expected policyholder deficit)

Efficient strategy –– if there is no one with lower risk at the same level of return, or higher return at the same level of risk

Dynamic Financial Analysis

Solvency TestingSolvency Testing

Financial position of company is evaluated from the perspective of regulators, agents and insureds

Quantify in probabilistic terms whether the company will be able to meet its commitments in the future

DFA provides a range of results regarding the anticipated Surplus of the company

Dynamic Financial Analysis

What isWhat is ??

Portfolio risk management

Risk modeling

Reinsurance/retro-cession analysis

Risk-based capital calculation

Cash flow testing and financial planning (Statutory and GAAP)

Dynamic Financial Analysis

FUNCTIONALITYFUNCTIONALITY

Dynamic Financial Analysis

Evaluating Ceded Reinsurance/ Evaluating Ceded Reinsurance/ Retrocession ProgramsRetrocession Programs

Handle any complexity

Easy to design alternative programs

Analyse the impact on: Capital requirement

Profit RAROC

Reinsurance cost allocation

Dynamic Financial Analysis

RBC and Capital AllocationRBC and Capital Allocation

Compare Capital alternatives:

Varying risk assumption Varying reinsurance or

investment strategies

Measure ROE for any portfolio segmentation

Dynamic Financial Analysis

Case StudyCase Study

Conclusion - Conclusion - Basic ERM ComponentsBasic ERM Components

Dynamic Financial AnalysisDynamic Financial Analysis