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Risk Treatment Standard-ASB

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A presentation on the proposed ERM risk evaluation standard by the US Actuarial Standards Board. …

A presentation on the proposed ERM risk evaluation standard by the US Actuarial Standards Board.
Présentation de la norme ERM du Actuarial Standards Board des USA

Published in: Economy & Finance

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  • 1. Session 28PD Mr. Michel RochetteEnterprise Risk Advisory,LLC September 10th, 2012 Enterprise Risk Advisory, LLC 1
  • 2. Topics Context Two proposed risk standards:  Risk Evaluation – covered in this presentation  Risk Treatment – see ASB web site Reactions Discussion Questions Enterprise Risk Advisory, LLC 2
  • 3. Risk Evaluation in Enterprise Risk Management Enterprise Risk Advisory, LLC 3
  • 4. ContextEnterprise Risk Advisory, LLC 4
  • 5. ContextSource: INGRAM, Dave(2009), “ERM and Actuaries”, Casualty Actuarial Society E-Forum, WinterEdition, p.386-395 Enterprise Risk Advisory, LLC 5
  • 6. Context Risk Controlling: – Creation of comprehensive risk models: establish and monitor risk tolerance and limits – Some existing ASOPs fall in this category but actuaries mostly absent Risk Trading: – Pricing and valuation of risks – Most ASOPs pertain to this goal, mostly insurance Risk Steering: – EC, Risk-adjusted performance, Value Enterprise Risk Advisory, LLC 6
  • 7. Context RISK EVALUATION RISK TREATMENTCopyright 2010 by the Society of Actuaries, Schaumburg, Illinois. . Enterprise Risk Advisory, LLC 7
  • 8. Context Most ERM standards usually apply at the company level Most other ASB ASOPs are very specific, although they also reference risk issues: – #7: Analysis of life, health, or property/casualty insurer cash flows – #12: Risk classification (All practice areas) – #19: Appraisal of insurers – #35: Selection of demographic and other non economic assumptions for measuring pension obligations Enterprise Risk Advisory, LLC 8
  • 9. ContextSource: INGRAM, Dave(2011), “ERM Standards of Practice: A SocraticDialogue”, SOA Annual Meeting, p.11-22 Enterprise Risk Advisory, LLC 9
  • 10. Context Other ERM Standards of practice” being considered: – IAA: global standards initiative: Ex. Social Security – Asset management industry: some initiatives at the industry level – Auditors: some very specific individual risk standards: risk audit and SOX. Enterprise Risk Advisory, LLC 10
  • 11. Standards in general Enterprise Risk Advisory, LLC 11
  • 12. Standards in general Enterprise Risk Advisory, LLC 12
  • 13. Ex. Components of StandardsIndividual Risk Standards Enterprise Risk Advisory, LLC 13
  • 14. Risk standards Lets listen to Dave Ingrams presentation of the context at the 2012 ERM Symposium http://www.ermsymposium.org/2012/audio/C9.mp3 Source: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 14
  • 15. Risk standardsSource: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 15
  • 16. Risk standardsSource: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 16
  • 17. Risk standardsSource: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 17
  • 18. Risk standardsSource: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 18
  • 19. Risk standardsSource: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 19
  • 20. Risk Evaluation Standard Purpose: Provide guidance – not guidelines – to actuaries – for the moment – as it pertains to risk evaluation – broader than measurement, quantification but smaller than analysis – systems: - not just a framework - – Design or Implement – Use or Review Scope: apply to actuaries for any ERM phases: ERM control or compliance cycle, trading or steer objectives Enterprise Risk Advisory, LLC 20
  • 21. Risk Evaluation Standard Different categories of risk evaluations: – Risk evaluation models: apply to 3 ERM phases – Economic Capital: mostly steer phase – Stress testing: trading & steer phases – Emerging risk: steer phase – Other risk evaluations: all 3 phases Applies to an ERM type work, not pricing nor valuation as there are particular ASOPs. Q: What about MAD in principles-based reserving? Enterprise Risk Advisory, LLC 21
  • 22. Risk Evaluation Standard: some definitions Risk Evaluation System — A combination of practices, tools, and methodologies within a risk management system used to measure the potential impacts of risk events on the performance metrics of an organization. Risk—The potential of future losses or shortfalls from expectations due to deviation of actual results from expected results. Economic Capital—The amount of capital needed for an organization to survive or to meet a business objective over a specified period of time at a selected confidence level, given its risk profile. Enterprise Risk Advisory, LLC 22
  • 23. Standard doesnt use “standard” definitions for some componentsEx. Standard uses counterparty risk: risk that the party providing a risk offset or accepting a risk transfer does not fulfil its obligations. Missing some components. A counterparty is larger than credit risk. Risk Management Terms Survey, SOA, 2007 SOA (2006): Enterprise Risk Management Specialty Guide May 2006, SOA CCRO (2002): Committee of Chief Risk Officers; Volume 6 of 6 Glossary, Nov 2002 Enterprise Risk Advisory, LLC 23
  • 24. More “standard” risk definitionsSource: Risk Management Terms Survey, SOA, 2007 Enterprise Risk Advisory, LLC 24
  • 25. Risk standard definitionsSource: Risk Management Terms Survey, SOA, 2007 Enterprise Risk Advisory, LLC 25
  • 26. Risk standard definitions Standard risk definition: deviation from expectations only. What about the average losses? Source: Risk Management Terms Survey, SOA, 2007 Enterprise Risk Advisory, LLC 26Source: Risk Management Terms Survey, SOA, 2007
  • 27. Potential improvements Adopt industry specific risk definitions: – Ex.http://ec.europa.eu/internal_market/insurance/docs/sol vency/impactassess/annex-c08d_en.pdf  ISO Guide 73: Risk management vocabulary Rephrase the standard to propose that the evaluation be adapted to the context of how risk definitions are actually used by practitioners Create a risk taxonomy adapted to the context:  Ex. If risk is evaluated and treated as a system – systemic risk -, different from risk evaluation by source or cause – economic capital calculation-. Enterprise Risk Advisory, LLC 27
  • 28. Risk Evaluation Standard considerations Financial resources and risk profile: – Financial strength of the organization – broader than just capital – Risk profile, nature, scale and complexity – Current and long-term risk environments: internal and external, own assessment or based on managements – Organizations strategic goals including risk tolerance – desired volatility – of value – Interests of various stakeholders Enterprise Risk Advisory, LLC 28
  • 29. Risk Evaluation Standard considerations Financial resources and risk profile: – External risk evaluations: Ex., as done by rating agencies ERM evaluation – Extent of dependencies, correlations, interactions of risks – Fungibility of capital resources Organizations own risk system: – Risk appetite, tolerance & management involvement – Enterprise Risk Control Effectiveness: management actions toward unexpected events Enterprise Risk Advisory, LLC 29
  • 30. Risk Evaluation Standard considerations Interaction of financial resources, risk profile and risk system: – “If in the actuary’s professional judgement, as appropriate to the assignment, a significant inconsistency exists, then that inconsistency should be reflected in the risk evaluation.” – Important element to consider but criteria could be expanded to include other specific considerations like: • Looking at existing recent losses and how it was managed, other professionals report like Audit, financial analysts instead of only professional judgement Enterprise Risk Advisory, LLC 30
  • 31. Risk Evaluation Standard considerations Risk Evaluation models: “Fit for the purpose:” – Sophistication of models & materiality of risks – Models reproducible & adaptable to new risks – Practical considerations: usability, reliability, timeliness, process, cost effectiveness – Limitations: inherent & statistical. Ex. VAR – Model validation, calibration, sensitivity – Approaches to model correlations Aspect missing: as in Solvency II, no “use test” Enterprise Risk Advisory, LLC 31
  • 32. Risk Evaluation Standard considerations Risk Evaluation models: Assumptions – Assumptions supportable, documented & allow for deviations from the expected – Regularly revisited to assess effectiveness – If assumptions reflect anticipated management & actions are supportable by facts. Standard should capitalize on other work in this area, particularly in the valuation area. Could also have assumptions as to the risk control effectiveness, not just gross risk. Enterprise Risk Advisory, LLC 32
  • 33. Risk Evaluation Standard considerations Risk Evaluation: Economic Capital models – Components: timeframe, basis to measure risk – regulatory, reputation, earnings loss,.. -, confidence level – Reflection of significant risks in a consistent and comprehensive manner – Appropriateness of method to measure each risk Standard could capitalize on the many economic capital requirements being developed for Solvency II, ICAP, Rating Agencies EC requirementsEnterprise Risk Advisory, LLC 33
  • 34. Risk Evaluation Standard considerations Risk Evaluation: Economic Capital models – Reliance on consistent accounting framework – Somewhat inconsistent as the idea of an “economic” capital model is to measure risks on an “economic”, not an accounting approach! – Choice of appropriate methods: • Stochastic, stress tests, scenarios, standard measures like “add-ons” – Validation of the models – Assumptions: remote & unlikely: historical, market prices, experts, internal consistency, documented Risk Advisory, LLC Enterprise 34
  • 35. Risk Evaluation Standard considerations Risk Evaluation: Stress & Scenario testing – Extent to which stress tests reflect similar degree of adversity. Ex. 1 in 200 year event – How an organization will function during a catastrophic event – I think it is the link to business continuity planning, if any - – Extreme event may be part of many extreme events – all correlations go to one -. In other words, when things go bad, they all go bad at the same time and reactions by all stakeholders – How to quantify non readily quantifiable risks and their potential total impact. Op risk + Enterprise Risk Advisory, LLC 35 reputation
  • 36. Risk Evaluation Standard considerations Risk Evaluation: Stress and Scenario testing – Methods and models to actually assess impact on all organizations must be ascertained – Integrate disparate systems or build one integrated model – Assumptions: Tests themselves. • Effect on other assumptions • Management responses • Regulatory and market reactions • Risk mitigation and time horizon – Scenarios: limited considerations Enterprise Risk Advisory, LLC 36
  • 37. Risk Evaluation Standard considerations Risk Evaluation: Emerging risks – Impact of emerging risks over time – Limited considerations in the standard Risk Evaluation: other risk evaluations – Used in risk monitoring, mitigation: compliance and control ERM – Apply same considerations as in general risk evaluation and risk evaluation models Data quality: ASOP 23 Documentation: ASOP 41 Enterprise Risk Advisory, LLC 37
  • 38. Risk Evaluation Standard considerations Risk Evaluation: Document and disclosure – Economic capital: models, results, limitations, timeframe, measurement basis, confidence – Stress & scenarios: results, intended use & limitations – Emerging risks: methods and sources – Major assumptions: as before – Risks included: risks excluded? – Model validation results – If major deviations from this standard: ASOP 41 – What about other disclosure standards Enterprise Risk Advisory, LLC 38
  • 39. Risk Evaluation Standard Potential applications IAIS Core Principles:16 and 20 NAIC ORSA NAIC Form F: Enterprise risk reports Solvency II, Pillar II, Pillar III and ORSA Rating agencies ERM and EC assessments ComFrame IAA Care report Enterprise Risk Advisory, LLC 39
  • 40. Reactions Questions asked by the task force: Enterprise Risk Advisory, LLC 40
  • 41. Reactions Questions raised: – Sufficient guidance for risk evaluation? – Flexible enough? – Explicit enough about the reliance on the work of others? – ERM scope clear enough so that it doesnt extend to other actuarial work? 25 comments, mostly by individuals, companies and two organizations Review comments and get your input Enterprise Risk Advisory, LLC 41
  • 42. Reactions Comments so far: – Pierson: guidance question. Should consider joining the two proposed standards as the risk evaluation and risk treatment are related. What is relevant is the net risk to the organization – Bakos: scope questions. • Doesnt see difference between evaluation of risks net of expectations covered by this standard and other “common actuarial tasks” like reserving and pricing, which also involve risk classification & evaluation. • Only applies to CERA doing ERM work or any actuary? Enterprise Risk Advisory, LLC 42
  • 43. Reactions Blanchard III: guidance questions – Comments on definitions and ERM cycle – Replace emerging by environmental scan – Risk modelling should be done only after understanding materiality of risks, data sources and mitigation initiatives Koller: guidance question – Align definitions with other more standard definitions Zher: good start for guidance, flexible enough, area of concern on the reliance on others Enterprise Risk Advisory, LLC 43
  • 44. Reactions Bradley: – Make link with ORSA as risk evaluation will contribute to this process – Should standard be rephrased ERM evaluation and not just “risk” evaluation as ERM considers risks and gains? – Align “stress-test” definition with external definitions Pfluger: – More emphasis on correlation, required capital, not flexible enough to handle new standards, inevitable to integrate others Enterprise Risk Advisory, LLC 44
  • 45. Reactions Rochette: – Is the purpose more “risk assessment” within ERM than an evaluation, which is a broader term? – View proposed standard as a good start if goal is to review, not complete enough is goal is to design, implement, use – To make it more flexible, should be more- principles based – Inevitable to work with others. EC section should refer to that explicitly, otherwise, silo EC – Should standard be ERM-context dependent? Enterprise Risk Advisory, LLC 45
  • 46. Reactions Hay: not enough guidance, flexible enough, reliance inevitable as ERM is team-work, division of standard arbitrary – why exclude pricing, reserving, claims – not realistic to separate ERM from other “actuarial” activities Financial Reporting Council: UK regulator for governance and reporting – Board responsible to assess risks – Risk evaluation is part of that role of Boards Enterprise Risk Advisory, LLC 46
  • 47. ReactionsEnterprise Risk Advisory, LLC 47
  • 48. Reactions North American CRO Council: – “We strongly believe that ERM is not an actuarial process and goes beyond an actuarial function.” – “We believe it may be premature to develop a standard related to ERM and that expressing the ERM principles in the form of guidance document may be more appropriate at this time.” – “This standard would be adding to existing and growing compliance requirements in the ERM landscape.” Enterprise Risk Advisory, LLC 48
  • 49. Your reactions?Outstanding issues related to any new ERM standards: Source: ERM Symposium, 2012, session C9 Enterprise Risk Advisory, LLC 49
  • 50. Your reactions? Should we have such a standard? Do you agree with the ERM standard task forces earlier conclusions or do you agree with NACROs conclusions? Your reactions to the standard itself: guidance, scope, flexible enough, interactions with non actuaries? Other issues? Do you think that the actuarial profession should develop its own theoretical ERM Framework to position itself in the ERM space? Should standards reflect “existing”50 Enterprise Risk Advisory, LLC practice or “best” practice?

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