Thomas C. Wilson, Chief Risk OfficerRisk Management:One CRO’s thoughtsCASS-CAPCO Fourth Annual Risk Management ConferenceL...
How does Risk Management add value?                   Asking the right questions…Risk                • Is Allianz’s risk p...
How does Risk Management add value?Questions…         … answering them correctly,                     acting on the decisi...
Standard Committee Structure                                                                    © Allianz SE 2009* For det...
Target Operating Model for OE Risk Organization     Standard operating model to ensure that responsibilities and     autho...
Group Risk Appetite and Limit FrameworkAllianz Group’s Risk Appetite consists of three pillars outlined below:§ Allocating...
Risk Identification and Assessment processes             Top Risk            Assessment                       COSO framewo...
Example: L/H product approval process          Local OE product approval and                                              ...
Embedding risk management in medium termplanning                                                              Financial & ...
RAI - System Architecture Framework  Central Risk Platform Algorithmics    Market data                          Valuation,...
Qualitative Reporting§ Standardized quarterly reporting on:                                                               ...
Addressing the issues                                              - Examples -ExamplesRisk          • Regulatory filingsc...
Asking the right questions, answering them and actingon the decisionsExamplesRiskcommunication                            ...
Outward signs of ERM: Necessary. . .but not sufficient!Warren Specter, co-COO Bear Stearns, to the Senate Financial Crisis...
Signs of a dysfunctional risk culture:Golden RuleSymptom: Make the gold, make the rules (and should not be challenged!)Cas...
Signs of a dysfunctional risk culture:„Dancing while the music is playing“Symptom: Following the market, even when standar...
Signs of a dysfunctional risk culture:Arbitraging the systemSymptom: Building a business based on the flaws in our modelsC...
How much can we rely on compensation to steerculture?•   „Dick Fuld (CEO) is also, in some sense, a victim. He’d held on t...
Three lines of defense   First line of    Second line of      Third line of    defense:          defense:           defens...
Three lines of defense   First line of        Second line of         Third line of    defense:             Management has ...
What does „risk management“ really meanin the context of the second line of defense?Management lever     Risk controlling ...
Culture…the missing pieceExamples                                         ProcessesRisk                             Govera...
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Risk Management: One CRO’s thoughts

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This presentation was presented at the fourth annual conference of the Cass-Capco Institute Paper Series on Risk in London on April 14, 2011.

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Risk Management: One CRO’s thoughts

  1. 1. Thomas C. Wilson, Chief Risk OfficerRisk Management:One CRO’s thoughtsCASS-CAPCO Fourth Annual Risk Management ConferenceLondon, 14 April, 2011
  2. 2. How does Risk Management add value? Asking the right questions…Risk • Is Allianz’s risk profile and strategy understoodcommunication by the market and reflected in our valuation multiple and required capital?Risk strategy • Does Allianz have a clear risk and solvency strategy and optimize its risk / reward profile accordingly? • Are delegated authorities set consistent with this strategy?Risk controlling • Is the risk profile of Allianz transparent to management? • Is it within delegated authorities? © Allianz SE 2009Risk • Are the risks which we want to take appropriatelyunderwriting structured, underwritten and priced? • Are all other risks (e.g. operational / reputational risk) appropriately identified and managed? 2
  3. 3. How does Risk Management add value?Questions… … answering them correctly, acting on the decisionsRiskcommunication ProcessesRisk strategy GoveranceRisk controlling InformationRisk & Systems © Allianz SE 2009underwriting 3
  4. 4. Standard Committee Structure © Allianz SE 2009* For details of standard local RiCo agenda see Appendix Page 4
  5. 5. Target Operating Model for OE Risk Organization Standard operating model to ensure that responsibilities and authorities of Risk function are adequate 3 Blueprint for risk management and recommendation for department organization 3 Risk Management Risk Management Risk Insurance Financial Risk policies ORM/SOX Credit risk and guide- controlling risk risk lines § Scope of § Exposure § SOX and § Management § Management § Management § Risk policy activities and limit ORM and develop- and develop- and develop- and mandatory controlling – Design ment of credit ment of in- ment of Fin- guidelines under the § Satisfaction central risk models surance risk ancial risk development governance of of Reporting processes and mea- models and models and § Risk the CFO requirements – Setup surement measurement measure- commi ttee § Split by – Group annual § Risk capital ment facilitation department interfaces control plan calculation § Limit setting into sub- – Local re- and allocation departments quirements § Risk recommended, aggregation but not § Reconcilia- tion of input Life/Health mandatory and P&C and output § Solvability moni toring § In-depth understanding of risk profile © Allianz SE 2009 § Control of large risk acceptance, critical positions § Commentary to risk reports Source: OTP Finance 23* For details please see separate TOM and relevant OTP documentation Page 5
  6. 6. Group Risk Appetite and Limit FrameworkAllianz Group’s Risk Appetite consists of three pillars outlined below:§ Allocating capital and defining minimum (target) capital ratios§ Defining risk tolerance and quantitative limits§ Managing liquidity to ensure flexibilityExamples Group limits OE limits set by GroupSolvency limits Solvency target & corridor Solvency Capital: Economic,Capital limits OE Risk Capital Rating agency, RegulatoryConcentration limits Counterparty/Obligor exposure and VaR (Market and Credit Risk)Investment limits Strategic Asset Allocation Strategic Asset Allocation Group-wide OE specificNat Cat limits © Allianz SE 2009 Nat Cat limit Nat Cat limits
  7. 7. Risk Identification and Assessment processes Top Risk Assessment COSO framework 1. Risk identification 2. Prioritization Emerging Risk Initiative 3. Assessment (frequency, severity) Risk Controlled 4. Mitigating controls Self-Assessment © Allianz SE 2009 5. Testing
  8. 8. Example: L/H product approval process Local OE product approval and ExistingStart products monitoring processes with a low or negative NBM* Gate 1: Acceptability Gate 2: Profitability Checks on NBM* check certain products against Launch new All new products (VA, EIA) and thresholds and products / retain PASS approval of PASS or modify features (AL mismatches, limits if existing riders, …)* appropriate products FAIL FAIL © Allianz SE 2009 Escalation Escalation option option * VA = Variable Annuities, FIA = Fixed Index Annuities, AL = Asset / liability, NBM = New Business Margin
  9. 9. Embedding risk management in medium termplanning Financial & Risk TDI SD PD Controlling§ Capital § CapCo approval § SD decisions § On-going requirements of Group cumul reconfirmed monitoring of projected on a risk limits § Lower level capital positions statutory, segment SAA and limit economic and approved by adherence as rating agency FiCo and CapCo part of basis controlling§ Guidance for cumul risk limits: © Allianz SE 2009 NatCat, Country Risk, SAA risks, etc.
  10. 10. RAI - System Architecture Framework Central Risk Platform Algorithmics Market data Valuation, Risk Capital, Scenarios, Sensitivities MinD Risk Engine: MC-Simulation - Inter / Intra Risk-Aggregation Model Web-based User Interface § Market Value § Balance Sheet Market Risk Insur. Risk Credit Risk Oper. Risk Cost Risk § Available Capital Replicating Marginal Marginal Marginal Marginal § Limits portfolio tool/ dist. / dist. / dist. / dist. / Greeks Parameters Parameters Parameters Parameters § Hierarchies § Tax calculation § Minorities Feeder Systems Local Systems ˜ Partially locally developed © Allianz SE 2009 ALIM CF and parameterized models PRISM MKMV OR System Replicating Models ˜ Centrally developed, parameterized and Scenarios Life/P&C PRISM R/I Investment Business controlled models Asset Input Data System Risk ˜ Centrally developed, locally parameterized models 10
  11. 11. Qualitative Reporting§ Standardized quarterly reporting on: XXX Risk report – Q1 2009 - Governance & Compliance with Group XXX Risk report OE Contact: XXX – Q1 2009 Standards Group Risk Contacts: Stuart Robinson, Ioannis Kotsianos XXX Risk report – Q1 2009 1. Governance & Group Standards Compliance - General Risk Issues 2. General Risk Issues R Y Reserve Governance Update (Yellow in Q4) Internal Transactions Update Actuarial has raised concerns that reserving decisions are effectively made at BU n Group (Red in Q4) level and the Reserve Committee role and authority to challenge decisions needs to be n Several XXX insurance entities have purchased shares of AZ money market funds at the strengthened. - Regulatory & Legal Issues Y Life Cancellation Option (New NAV price to support fund liquidity. n official Issue): – Action 1: Completion of the Finance Unit organization project in order to better enhance Deficiencies in the In a secondprovided toefficiency, life policyholders in the past and bonds (floaters) from these n information stage, AGF Vie purchased EUR 600mn of corporate a new individual including non-life actuarial reserving processes. insurance law enacted at at the mark-to-model price in December 2008, with unit-linked delta versus funds the end of 2005 will require AGF to contact existing a significant contributed option to Q1 (the difference between the Finance Unitprice and the project price prices Status: Presentation on official NAV organization model to union policyholders and give them anmarket– cancel their policies. Policyholders will have 30 representatives completed, enforcement decision still subject to union representative days to request a refund of their originalAGI). being subsidized by premium. - Market Environment & Competitive Risks n answer. Update on implementation to be included in Q2. The worst case exposure, assuming 100% cancellation was estimated in March 2009 duethe growing n Further support from AGF Vie was provided again at EUR 315 mn at to end of Q1. AGF has booked a reserve of to an 9.6 mn as purchase of EURa492mn of corporate bonds fromEnd of Q4 2009 redemptions, leading EUR additional of Q1, assuming 3.6% Owners: XXX cancellation rate would apply to a worst case exposure of EUR 260 mn (this value is lower these funds. Due Date: than total unrealized losses on unit linked because policyholders have been identified to Y action plan to send suitable information whom a letter had beenliquidation Product Approval Update (Yellow in Q4)to policyholders ultimate estimated n Full sent). An of the AGI France Money Market funds could lead to an by registered mail is being prepared. The plan may trigger higher cancellations in current need for EUR 733mn of additional liquidity support. - New Product & Underwriting Approvals n market conditions ; therefore it willn A risk review of new products is always carried out, but process governance needs to be need to be monitored carefully. Group Risk is concernedStrategy actual Issue) rate after the mailing campaign may be far formalized sign-off process, further reinforced in 2009 (risk review before launch, Y Crediting that the (New lapse independent actuarial review). higher than the expected 3.6%, although no action would potentially leave the worst case loss at much higher levels if markets deteriorate. 2: Global process for new product design to be reengineered by Technical Area, Action n XXX has indicated to Group Risk that the current internal working assumption is for an – average bonus of 3.50% in 2009. This assumptionreviewsmean paying out c. EUR 1,450mn including Risk and Actuarial would before launch. - Financial Risk Exposure & Limit Adhere G Regulatory Fines (Newto policyholders relative to a minimum guarantee cost of c. EUR 950mn. n Issue): – Q1 Status: Presentation on the new Product Process to Executive Committee SOCA (an Oddo subsidiary) received a EUR 50k penalty for failing to comply set-up competitive and AGF is under n Group Risk recognizessuccessfully completed. Practical withis to be rolled-out. Update on implementation to that the French life insurance market insurance law while acting aspressure to maintain bonuses to attract new business and minimize surrenders. a broker. There is no immediate consequence for AGF entities. be included in Q2. n However, Group Risk is concerned that AGF may have reached a tipping point on bonus Owners: XXX Due Date: End of Q2 2009 - Solvency II Implementation 4. Market Environment sustainability given the current market environment. In order to make the planned 3.50% R & Competitive Risks payment, XXX would need to reduce current UAR reserves by EUR 500 mn (42% based on Y Partnerships Update (Red in Q4) Financial Crisis Impactyear-end 2008 UAR figures). This will have a material adverse impact on O&G costs, Update (Red in Q4) MCEV, NBM figures, Risk Capital, Statutory Solvency and the general sustainability of the n n Control of life JVs needs to P&C and L&H businesses. high for L&H business, and real estate risk for be strengthened so that XXX can effectively monitor compliance Equity risk remainstraditional business. Liquidity is also under pressure due toand ensure governance is robust. Regulatory and reputational risks are the main concern. money market fund support and surrenders for UL - L&H appendix: new product approvals, business where illiquid Action 4: Group Risk and UL products. Structured with AGFplanned with 1 FTE. Agreement reached that – assets are backingQ1 Status: Local internal control position to quantify the impact on the – some Group Actuarial to work credit exposures in the Allianz Banque trading portfolio are still on the balance sheet (with the risk mostly above items of different crediting strategies.approval process will apply for JVs. Update on implementation the general XXX product realized). The independent asset valuation review performed by Moody’s will be maintained in 2009 at the request of AGF and ABRM. to be included in Q2. Owners: Philippe Léglise CRO, GR, GA Due Date: End of Q2 2009 negative margin products, guarantee levels & Y n Owners: XXX Hospitaliers Pension Scheme Update (Green in Q4) G Madoff Exposure Update (Red in Q4) Initial decisions have been taken on 2009 annuity revaluation under planned targets and Due Date: End of Q2 2009 G General Governance (Green in Q4) according to agreement governance. Projection updates to has remained almost unchanged, estimated at n Exposure in various AZ French entities be produced in June. At present, new money rates equity losses and low interest raten No have2008), mainly through the AAAM Policy EUR 47mn (30 levels major deviations from the Group Riskof the November seriously damaged the capacity alternative funds “Phenix pension scheme toAlternativelife annuity coverage by 2028 also through thoughAM “GAP” an reach full Holding” and “Licorne”, and as planned, Oddo this is not funds. About half of XXX liability (annuity rights generated before 2008 are currently limited to and AVIP), and half for various Life this exposure is for UL assets (mostly Generation Vie 8 years). n AGF Vie exposure and P&C portfolios.also increased due to the low interest rate and equity to market risks has environment, and transfer of buffers generated by new pension rights toward in-force ones. n Decisions have been made during Q1 to notify UL clients of their entitlement to any§ Progress on resolution of issues is tracked recoverable assets from Madoff defeasance (side-pockets) extracted from some of their UL 5. New Products & Group Insurance Committee Approvals closed Madoff funds (Luxalpha, Thema). No funds, and of the disappearance of several subsidization of losses should be supported by Allianz Life Operating Entities in principle. R New Product Process Failure (New Issue) seen as moderate, but could increase due to some complaints already n Reputational risk is§ Reports are circulated to OE and Group © Allianz SE 2009 n registered, as surrenders cannot be paid for a few suspended funds. Subsidization of The new “Fipavie Diversifié” product (Generation Vie / Life Partnerships) was launched before risk review /Madoff losses insufficient prior evidence that an appropriate process had in all cases, which approval with even in one case might be an argument used for payment been established to manage this completely new product. 24mn for AGF France. would result in a worst case loss of EUR – Action 7: Product review to be completed post-launch with a local RiCo opinion. Proper controls to be put in place before the next version of the product is launched. management ensuring transparency – Q1 Status: Review is now 90% complete. The main risks identified to date are: (1) the
  12. 12. Addressing the issues - Examples -ExamplesRisk • Regulatory filingscommunication • Rating agency disclosures • Public disclosures: Annual Report, Investor DayRisk strategy • Risk appetite: EaR, CaR, Risk Capital • Strategic Planning, not Budgeting: TDI, SD, PDRisk controlling • Capital solvency, EaR and CaR reporting • Individual risk reporting • Associated limit systems • Separation of dutiesRisk • Product approval processesunderwriting • A/L or Strategic Asset Allocation processes © Allianz SE 2009 • Pricing guidelines, u/w minimum standards • Risk Controlled Self-Assessment, Top Risk Assessment 12
  13. 13. Asking the right questions, answering them and actingon the decisionsExamplesRiskcommunication Processes GoveranceRisk strategyRisk controlling Information & SystemsRisk © Allianz SE 2009underwriting Focusing on the foundations of good ERM is an important first step…but is it sufficient? 13
  14. 14. Outward signs of ERM: Necessary. . .but not sufficient!Warren Specter, co-COO Bear Stearns, to the Senate Financial Crisis Inquiry CommitteeYou have also asked me to address risk management practices.Risk at Bear Stearns was managed through a system of checks and balances. Each business unit wasresponsible for managing its risk, and the head of each division was then responsible for managing theaggregate risk within its units. The Executive Committee approved explicit limits for all areas of the firm- at the trading book level, and also by unit and by department - which were monitored by departmentheads. These limits were reviewed and monitored by the Risk Management Group, which was anindependent unit that reported to the Executive Committee and met regularly with the Boards RiskCommittee. This group, headed by Bear Stearns Chief Risk Officer, served as an independent check onthe business units own risk management function. It distributed daily P&L statements that highlightedany significant gains and losses. It also provided daily written reports to senior managementcommenting on changes in exposure, any unusual trades, and any concentrated positions. The RiskCommittee held weekly meetings, and the Risk Management Group made monthly presentations to theExecutive Committee. At the weekly meetings, trading managers reported on their positions and theirrisk, and the risk management teams were present to verify the accuracy of these reports and to expresstheir views. In this way, the Risk Committee and the business units served as constant checks on eachother. There was an active dialogue among senior management about the firms overall risk appetite,which we reviewed during both weekly and monthly meetings.In my opinion, Bear Stearns risk management practices were robust and © Allianz SE 2009effective. During my tenure on the Executive Committee I found the RiskManagement team to be highly trained and very experienced. Overall, I thoughtBear Stearns was well-managed, and I was saddened and disappointed whenthe firm collapsed.
  15. 15. Signs of a dysfunctional risk culture:Golden RuleSymptom: Make the gold, make the rules (and should not be challenged!)Case study: AIG FP• PwC, AIGs auditor, concluded that the ability to access AIG FP by the risk management and other control functions "may require strengthening".• Federal Office of Thrift Supervision (OTS), AIG FP’s regulator, sent a letter which said that the unit "was allowed to limit access of key risk control groups while material questions relating to the valuation of the [swap portfolio] were mounting".• Rep. Gary Peters (D., Mich.) asked AIG CEO Edward Liddy during a congressional hearing, "Where was the risk management of your company? Where was the failure of your own internal risk-management procedures?" © Allianz SE 2009 Mr. Liddy’s response, "We had risk-management practices in place. They generally were not allowed to go up into the financial-products business.”
  16. 16. Signs of a dysfunctional risk culture:„Dancing while the music is playing“Symptom: Following the market, even when standards are deterioratingCase study: US mortgage market• Chuck (Charles) Prince, ex-CEO of Citigroup: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, youve got to get up and dance. Were still dancing.”• When compared to the behaviour of a lemming at an FCIC hearing, Mr. Prince’s reply was, "It would have been impossible to say to bankers, we’re not going to participate … and expect to have any people left." © Allianz SE 2009
  17. 17. Signs of a dysfunctional risk culture:Arbitraging the systemSymptom: Building a business based on the flaws in our modelsCase study: Lehman Brothers• ‘Repo 105’ transactions were considered a sale of the assets under English law.• Court appointed examiner’s report said these deals created "a materially misleading picture of the firm’s financial condition in late 2007 and 2008” and were “actionable balance sheet manipulation” and “nonculpable errors of business judgment”,• Condoned by senior management of the firm, as the email excerpt illustrates: - “It’s basically window-dressing.” - “I see … so it’s legally do-able but doesn’t look good when we actually do it? Does the rest of the street do it? Also is that why we have so much BS [balance sheet] to © Allianz SE 2009 Rates Europe?” - “Yes, No and yes. :)”
  18. 18. How much can we rely on compensation to steerculture?• „Dick Fuld (CEO) is also, in some sense, a victim. He’d held on to 10 million shares of Lehman stock until the end and lost almost $1 billion“• „Mr Prince, whose exit was sealed late last week, already owns 1.61 million shares in Citi“ which decreased in value from USD 50 to USD 5 between 2007-2009.• On March 14, 2008, CNBC reported that „the value of Jimmy Caynes (CEO) holdings in Bear Stearns had declined from $993 million to … less than $15 million as a result, effectively removing him from the list of the wealthiest individuals in the country.“ © Allianz SE 2009
  19. 19. Three lines of defense First line of Second line of Third line of defense: defense: defense: Business is Functions which Ensure that the responsible for define framework framework is both profit and within which adhered to loss, risk and business is returns allowed to work Risk, Legal, Audit OEs Compliance © Allianz SE 2009 19
  20. 20. Three lines of defense First line of Second line of Third line of defense: Management has to take defense: defense: responsibility, our frameworks Business is Functions whichplace, but that the have to be in Ensure responsible for definethe next crisis, our models will In framework framework is both profit and within which probability 1 to be wrong with adhered loss, risk and business is All frameworks can (and will) be returns allowed to work arbitraged OEs Risk, Legal, can anticipate all No framework Audit new businesses Compliance © Allianz SE 2009 e.g. pricing & underwriting guidelines, risk measures & limits, capital allocation 20
  21. 21. What does „risk management“ really meanin the context of the second line of defense?Management lever Risk controlling Risk managementRisk communication Risk controlling § Define frameworks within which business can be doneRisk strategy § Control risk and limits and provide transparency § Provide technical analysis to support business decisions Risk managementRisk controlling § Have a deep, professional understanding of the business (not just the models!) § Be close to the business, discussing key © Allianz SE 2009 decisions before they are takenRisk underwriting § Exercise professional judgement, occasionally saying „no“ if our frameworks are inadequate, if they are being arbitraged 21
  22. 22. Culture…the missing pieceExamples ProcessesRisk GoverancecommunicationRisk strategy Culture Information & SystemsRisk controlling US Supreme Court Justice Potter Stewart (on riskRisk culture??), 1964 Jacobellis vs. Ohio “I shall not today attempt further to define the kinds of © Allianz SE 2009underwriting material I understand to be embraced within that shorthand description; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it…” 22
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