risk appetite in enterprise risk management framework

8/13/2019 Risk Appetite in Enterprise Risk Management Framework

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RISK APPETITE IN ERM FRAMEWORK

How can we define the Risk Appetite?

How can we use the Risk Appetite in day-to-day business?

What does the Risk Appetite give in terms of ERM?


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Business Plan / Objectives

Risks identified

Risk appetite set

Risk appetite embedded

Day-to-daybusiness

Strategicdecisions


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

Qualitative Quantitative

??

??

??


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite


How shall the Company

treat the risks?

Qualitative statements

Etc.

Catastrophe Risk

Mortality Risk

Currency Risk

Equities Risk

Interest rates Risk

SeekNeutralAvoid


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

Values that could be measured

Earnings at Risk the gross profit in the statement of the comprehensiveincome

Embedded Value at Risk market consistent economic value of in-forcebusiness (PV of future earnings)

Economic Capital Required analogous to SCR but based on economicmodel

Etc.

What are the values under the risk?



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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How much of the risk could theCompany tolerate?


Quantitative statements

Tolerance levels are:

Embedded Value at Risk shall not exceed xx EUR.

Earnings at Risk shall not exceed xx EUR.

Here: xx shall be determined based on value itself and actual VaR.

In addition alert and targeted levels can be set.

1 in 25 yearsevent

96.0 %1 yearGross profitEarningsat Risk

EaR

1 in 200years event

99.5 %1 yearMarket consistentembedded value

Embedded Value at

Risk

EVaR

InterpretationConfidence level

Timehorizon

Value at riskMetric


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How shall the metrics be calculated?


Example: calculating the particular metric

Metric:Earnings at Risk

Purpose:Measuring the short term volatility of earnings

Definition:Earnings at Risk = Best Estimate of Earnings 96th percentile confidencelevel of Earnings (can be expressed as % from Best Estimate of Earnings)

Scope:Including new business


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

Quantitative

How shall the Company dealwith the risk?

Qualitative statements

Interest rates risk: the Company shall work on the matching of assets andliabilities

Equities: the Company shall limit investments into equities

Catastrophe: the Company shall reinsure catastrophe events

Etc.

Qualitative


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How to shall the company calculatethe risk metrics for each of the

risks?


Calculation of the individual risk metrics

Calculating the baseline (best estimate) value + Calculating the

stressed value by applying only one scenario for each of the risks thatis consistent with confidence level + Calculating the difference

Calculating the baseline (best estimate) value + Modeling the

scenarios stochastically to get the distribution of the values (includingvalue at certain percentile) + Calculating the difference

Simple

Tricky


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How to define the extremely adverse scenario(shock) occurring with the certain probability?

If we had 1000 scenarios (ranked from the best to theworst ) what would be the 960th scenario?


Calibration of the shocks

Adjusting the shocks provided for the standard SCR formula using

approximations, e.g. assuming that shocks are normally distributedshock adjustment coefficient" can be calculated from: (2.57) =

0.995 and (2.57 shock adjustment coefficient) = 0.96.

Calibrating the shocks based on own company (e.g. lapses), countryor world wide experience (e.g. catastrophe)

Calibrating the shocks using the scenarios generator (assumptions

about distributions and correlations are needed)

Etc.

Simple

Tricky


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So what do we have so far?


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite


Tolerated levels are set for the

risk metrics: EVaR, EaR, etc.for the whole business

Attitude towards risks is

determined in scale Avoid -Neutral Seek

--

Extremely adverse scenariosare defined

Tolerated levels are set each of

the separate risks in terms ofEVaR, EaR, etc.

Approach of dealing witheach of the separate risk is

determined


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How shall the Companymonitor the exposure to risk?

Monitoring (quarterly)

The actual value compared with:

The targeted value

The alert levels

The tolerance levels


Time

Metric

(VaR)

Actual VaR

Target level

Alert level

Tolerance level


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How could Key Risk Indicators(KRI) help in monitoring?

Key Risk Indicators

E.g. One of the monitored KRI could be the interest ratecurve for European sovereign bonds, in particular the yieldfor 10 years.

If the change of 250 bps is defined as the extremelyadverse scenario, it shall be monitored if KRI does not

change in such amount.



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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How to translate the risk levelrisk appetite into the limits for day-

to-day business operations?

Qualitative restrictions

The restriction for each of risks coming from risk appetite shall be embedded intocurrently existing or new strategies, policies, etc.



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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite

How to translate the risk level

risk appetite into the limits for day-

to-day business operations?

Example of quantitative restrictions

What is the maximum allowed mismatch between the duration of the assets andthe liabilities?

Steps:

Defining the extremely adverse scenario, e.g. the change of the interest ratesby 250 bps.

Deciding on the approximation of the impact, e.g.

Seeking for the duration that would result in the impact that is not tolerated.

Communicating the risk limit by embedding it into currently existing or new

strategies, policies, etc.

=



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And what do we have right now?


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... Yep! We have the table filled in


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Risklevel

appetite

Risk

levellimits

Overallrisk

appetite


Risk strategy

(approved by the Board)

.

Risk policy (-ies)

(approved by the Board)

.

Regular risk monitoring reports

(provided to the Board)

.

Risk reports analysingthe impact of the decisions

(used by the Board)

.


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And a final look: how does this RiskAppetite framework fit into the ERM?


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Risk Appetite and ERM

Risk Appetite shall be integrated into the organisational and decision making processes:

Launching products/business lines

Hedging/reinsurance strategies

Capital allocation

Pricing

Risk Appetite shall be used for monitoring and reporting:

Performance measurement

Internal and external reporting

Setting the Risk Appetite framework is a starting point of the ORSA process.


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Questions / discussion

risk appetite in enterprise risk management framework

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