This Milliman Asia ERM Newsletter highlights the latest developments in enterprise risk management (ERM) across the Asia Pacific region. ERM activity in the insurance sector is accelerating at a rapid pace around the region, especially since a number of regulators have introduced Own Risk and Solvency Assessments (ORSA). Even in countries where ORSA has not been introduced yet, there is an increased interest among risk managers who realize the value that ERM can add to their business through enhanced business resilience.
The newsletter features regulatory and market developments related to ERM from India, Singapore, and Thailand. An article by Neil Cantle on the complexity of risk within businesses is also included.
In this interview with InsuranceERM (subscription required), Milliman’s Neil Cantle and Elliot Varnell reflect on key issues impacting Europe’s insurance industry in 2013. They also discuss some challenges the industry may face in 2014.
Here’s an excerpt from the interview:
What will 2013 be remembered for?
Varnell: I would suggest that it was the year that Solvency II was finally “agreed” at the top level after a few years of debate and wrangling between the Council, Commission and Parliament.
Ironically, it was also the year when economically based regulatory capital was to some extent de-emphasised as the PRA published on Early Warning Indicators (see IERM, 4 October) and the FSB announced its G-SII list (see IERM, 19 July) and kicked off a project through the IAIS to come up with a global metric for regulatory capital (see IERM, 12 December.)
But also the year that many insurers – especially life insurers – rebalanced their focus away from Solvency II and regulatory capital and turned to looking for the best opportunities for value creation in their business. The refocus on product development and investment in infrastructure stand out as examples of areas that insurers have re-focused onto value creation.
What will be the biggest ERM challenge of 2014?
Cantle: I think many firms are still struggling to bring ERM to life and make it truly operational. If ERM is done simply as a compliance exercise then it can cost a lot of money and simply be a burden. If it is done to bring insights to the business and improve the opportunity for discussion about performance uncertainty then it can improve resilience and add significant long-term value to the business. The challenge is therefore to look beyond templates and documentation and make it strategic. Concepts like risk appetite require a multi-variate view of performance, so that indicators are seen in context, and many firms still cannot do that.
As advances in enterprise risk management (ERM) continue, insurers will encounter new strategic challenges. This Insurance News article highlights Josh Corrigan’s discussion on ERM strategy at the 2013 Actuaries Institute summit in Sydney.
Here is an excerpt:
“During the 1990s [risk management] captured balance sheet interactions, combined with the acceleration of financial risk techniques,” he said. “In the past 10 years the concept of risk appetite has developed and there is a focus on management and governance.”
ERM is now moving towards embedding and understanding how risk fits into an organisation’s culture, Mr Corrigan says.
It is also concerned with risk dynamics and the way various components relate to one another.
“Risk governance is largely focusing on the regulatory framework in which insurers work.
“But organisations need to think about the social structure around ERM and how to deliver risk insight and value to executives and boards.”
Actuaries will play a significant role developing ERM strategies and must engage with people outside the profession as part of that process, Mr Corrigan says.
“We still have a way to go to develop ERM in insurers, and operational risk still needs a lot of work.”
The reductionist approach is so embedded in actuarial training that the thought of accessing a complex problem holistically may seem daunting. However, a holistic systems thinking approach to enterprise risk management can produce a more complete picture of how business components interact in a non-linear way.
In this InsuranceERM.com article (subscription needed), Milliman’s Matt Cocke and Richard See-Toh provide an asset allocation example featuring two historical statistical models with significant risk management shortcoming. The authors also give an overview of the systems thinking approach that takes into account underlying drivers which determine a portfolio’s performance.
Here is an excerpt from the article:
These systems are adaptive, where the nature of the components and their interactions often change over time and have the capacity to produce quite exotic behaviours. These interconnections and feedback loops preclude holding some subsystems constant in order to study the others in isolation. It is therefore necessary to describe such systems at multiple scales in order to identify how emergent properties are produced.
In the asset allocation example, to apply a systems approach, we would seek to capture the underlying interactions and relationships between components driving the asset returns. The system that we would model would take into account factors such as market competitors, regulation, international markets, the level of confidence of investors and institutions and economic productivity, with direct and indirect connections between these factors and others being clearly acknowledged.
…By understanding the underlying structure and relationships we can better identify how such events ripple through the whole system, and recognise under what circumstances the interaction of elements of the system would behave differently. This can then be reflected in our analysis which will manifest itself through the calibration of underlying probability distributions used in the modelling process. Traditional approaches would typically ignore these dynamics.
The interaction of system factors would allow us to drill down, acknowledging any paradigm shifts, and see the possible impact on markets and how this potentially alters the overall success of asset selection.
As Solvency II priorities move out, it’s time to refocus enterprise risk management (ERM) back on strategic issues, says Milliman’s Neil Cantle. But he warns of regulators’ increasing focus on liquidity and resolution as a new trend that firms will need to incorporate into their thinking.
In this recent InsuranceERM (subscription required) interview, Cantle talks about the developments of Solvency II in 2012, the biggest challenges facing ERM in 2013, and more.
Here is an excerpt from the interview:
What will be the biggest ERM challenge of 2013?
Many firms have now tackled the obvious parts of their risk frameworks and are back to the traditionally difficult areas like emerging risk, operational risk, risk appetite and limit frameworks and the whole area of risk culture. These are less mechanical or quantifiable due to their fundamental complexity and inherent interactions with people. Traditional methods simply break down when applied to these areas.
Solvency II provided a useful imperative, which has helped firms to focus on improving the maturity of their ERM frameworks. Although some had higher aspirations, many firms had aimed to have a workable basic solution in place by the Solvency II launch date with improvement programmes running thereafter. There is a danger that delays in Solvency II could weaken their resolve to move ahead and leave many companies with only adequate solutions in place for much longer than they had intended. However, it seems likely that many of the major markets will press on with the risk management requirements ahead of full implementation, so perhaps all is not lost.
The continuation of subdued economic conditions also poses a serious challenge. The hope of a return to pre-crisis market levels is no longer realistic in the medium term, so firms are having to think creatively about how to deliver attractive products without historical return levels to support them. This needs to be achieved without taking unduly high risk onto the balance sheet or passing risks back to policyholders that they are not expecting.
Neil Cantle and Elliot Varnell are among the ten actuaries to receive the Chartered Enterprise Risk Actuary (CERA) qualification from the Institute and Faculty of Actuaries “in recognition of their exceptional roles as thought leaders in the field of enterprise risk management.”
Here is an excerpt from the official press release:
Philip Scott, President of the Institute and Faculty of Actuaries said:
“This award not only recognises the major contribution these individuals have made to thought leadership in the field of Enterprise Risk Management, but also their commitment to embedding ERM within industry practice.
“There are now 108 CERA qualified actuaries working in a wide variety of roles. From regulators and consultants to insurers and asset managers, the CERA qualification is proving an invaluable asset to actuaries as they apply their skill-sets to new challenges
“Our new ERM thought leaders will act as ambassadors for both ERM and the CERA qualification, impressing on both actuaries and the wider business community the value of the qualification.”
The discussion on yield curve dynamics fell a bit short of my expectations hypothesis! This was more my fault than a fault of the speakers . A review of the past is often a requirement for a forecast of the future, or to paraphrase, “the past is not a guide to the future, but it’s not a bad start”.
There is a need in the actuarial/ERM community to see a greater focus on management of interest rate risks and modelling tail events. These issues generally don’t get much airtime as discussions invariably end up being about pricing and trend analysis which is more in the realm of traders in my view. It was interesting to note how benign the QIS5 upward yield shock looks set against even quite recent yield levels.