Tag Archives: reverse stress testing

What scenarios pose the greatest risks to the Pension Protection Fund?

The U.K.’s Pension Protection Fund (PPF) will be taking over an insolvent pension plan for the first time. This news brings the following question into focus: Are there scenarios that may render the organisation unviable?

A team from the PPF and Milliman recently performed a reverse stress test of the fund to identify risks that could result in organisational failure. This aiCIO article highlights the results from their subsequent paper. Here is an excerpt:

Lucy Currie, an actuarial practice leader at the PPF, was tasked with finding out under which scenarios the institution could-and would-fail.

“We looked at what a successful PPF was, and what could go wrong,” Currie told aiCIO after presenting a paper she co-authored on the study last month. “We looked at the definition of failure and realised there was no single one. There were various routes, including reputational and political issues, but none of them were financial.”

…She, along with a team from consultants and actuaries Milliman, set about interviewing a range of these stakeholders at the PPF. This ranged from the press relations and human resources departments to board members at the institution. Across a series of meetings, the team built up a cognitive map using the responses they gathered that showed the routes to failure.

“We talked about specific scenarios to make it real for stakeholders so they could draw on past experiences,” Currie said. “It was also a good way to validate what we are getting right.”

The map used the same language as had been reported in the stakeholder interviews, as the results had to be meaningful and relatable to all parties.

These responses fed into “critical nodes”, an impact upon which could trigger a tipping point to failure for the PPF.

The six scenarios identified included staffing and administration issues, or outside forces impeding the institution’s proper function.

“We worked back and looked at how they could all happen,” said Currie. “We created something that would feel real for the board and ran a ‘scenario day’.”

The scenarios identified were not just present day potential failures, but also looked to the future.

“We looked at underlying issues that pervade across the entire organisation,” said Currie, “and we did not identify any new risks. We did make new connections to how scenarios could occur, however-the board was reassured.”

The exercise offered new insight if not new risks, the team said, and made connections between the “owners” of the risks and those with power to monitor and manage them.

The article also poses another interesting question. With Solvency II-type governance for pensions delayed, is it time for European funds to conduct comparable exercises to comply with IORP Directive regulations?

To read the entire paper on reverse stress testing at the PPF, click here.

Stressing the tipping point

Reverse stress testing focuses on the sustainability of a business model and may help identify obscure underlying risks. Neil Cantle is quoted in this Risk.net (subscription needed) article discussing the importance of recognizing “tipping point” scenarios that could damage a business. Here is an excerpt:

It is also important not to focus on only big events. “It is possible for non-viability to arise from a slow buildup of smaller events too,” says Cantle.

… An important element of the detailed analysis can be identifying tipping points at which a slow build-up of events or circumstances reaches a critical mass and undermines the business. “An organisation can be apparently operating quite normally, but slowly becoming more sensitive to a particular stimulus. When that trigger happens, the company could unravel very quickly indeed,” says Cantle of Milliman.

This is a key insight from the science of complex systems, so understanding how these types of scenarios occur is crucially important for reverse stress testing, Cantle says. “If an insurer is close to a tipping point, it is unlikely that it will be able to avoid it and so it should focus its resources on resilience. If it is sufficiently far from the tipping point and the speed of onset permits it to take action in the time remaining, then it may be able to devote resources to avoidance or mitigation. Knowing which path to follow is a key learning exercise,” he adds.