RCM-4: From Enterprise Risk
Management to Ratemaking
Don Mango, FCAS, MAAA
Director of R&D, GE Insurance Solutions
Vice President of R&D, CAS
CAS Annual Meeting November 2004
GE Insurance Solutions protects people,
property and reputations. With over $50bn in
combined assets, the GE Insurance Solutions
group of companies is one of the world’s leading
providers of commercial insurance, reinsurance
and risk management services.
PROPRIETARY INFORMATION NOTICE
The information contained in this document is the property of Employers
Reinsurance Corporation, a member of the GE Insurance Solutions group of
companies. It should not be reprinted, redistributed or disclosed to others
without the express written consent of ERC.
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June 7, 2004
Bottom Line Message (“Takeaway”)
1) Actuaries are already practicing ERM
2) Actuaries must learn about ERM
3) Actuaries must reframe our traditional roles
as part of the larger ERM context
4) Actuaries must prepare to be part of the
new Risk Profession (whatever it looks like)
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Benchmarking ERM Practices
in a Derivatives Firm
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June 7, 2004
Model Standards
and Risk Management
ERM Best practices from leading industries
Resource: The Practice of Risk Management, Goldman
Sachs (GS), Risk Books, 1996
> Securities firm risk management market standard
reference
Insurers and reinsurers sell derivative-like products
> Long-dated, illiquid, OTC derivatives on untraded
underlyings
Learn from GS how to manage risk of a derivatives portfolio
Not taking any position regarding the accounting treatment
of insurance products and embedded options
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GS: Structure and Skills of
Centralized Risk Mgmt Group
1.
2.
3.
4.
5.
Risk Monitoring and Analysis
Quantitative Analysis
Price Verification
Model Development
Systems Development and Integration
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June 7, 2004
Derivatives Risk Management
Role
Responsibility
In Insurance and
Pensions
Risk Monitoring and
Analysis
•Monitor position and price
data
•Evaluate risk exposures
•Identify and monitor limit
violations
•Analyze potential
scenarios
•Summarize and report on
risk exposures
•Reconcile with other areas
•Perform backtesting
•Monitor reserve and price
data
•Evaluate risk exposures
•N/A (usually UW risk
mgmt)
•Analyze potential
scenarios
•Summarize and report on
risk exposures
•Reconcile with other areas
•Perform backtesting (e.g.,
reserve run-off, actual
versus expected)
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Derivatives Risk Management
Role
Responsibility
In Insurance and
Pensions
Quantitative Analysis
•Determine modeling for
new products
•Design new quantitative
models
•Test new models
•Determine modeling for
new products
•Design new quantitative
models
•Test new models
Price Verification
•Verify prices of complex
derivatives
•Track changes in pricing
models
•Verify prices of complex
policies, treaties, or
books of business
•Track changes in pricing
models and rates
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June 7, 2004
Derivatives Risk Management
Role
Responsibility
In Insurance and
Pensions
Model Development
•Develop new models for
system
•Develop risk analysis
tools
•Maintain historical return
data
•Develop new models for
system
•Develop risk analysis
tools
•Maintain historical
reserving and pricing
data
Systems
Development and
Integration
•Develop infrastructure to
support processing
•Accept feeds from other
systems
•Automate data scrubbing
and translation
•Develop database to
support risk data
•Develop infrastructure to
support processing
•Accept feeds from other
systems
•Automate data scrubbing
and translation
•Develop database to
support risk, pricing and
reserving data
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GS Risk Management Principles
No Self-Marked Portfolios
Self-marked (to market) = self-valued portfolios
Where there may be conflict of interest, incentives to
overstate profitability
Sound corporate governance and controls
Peer review from expert source increases credibility
GS has Derivative Price Verification Group
> Specialized pricing support to areas with difficultto-value derivatives
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Next Steps Implied By This?
1) Actuaries are already practicing ERM
2) Actuaries must learn about ERM
3) Actuaries must reframe our traditional roles
as part of the larger ERM context
4) Actuaries must prepare to be part of the
new Risk Profession (whatever it looks like)
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Operational Risk
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Operational Risk – Defined
•Per Basel II, Operational Risk is what is left over in a
bank when you have eliminated market and credit
risk.
•Risk of loss due to failures of internal processes or
controls, or external events
•Property-Casualty actuaries are experts in “insured
operational risk” (at least in commercial insurance)
•Banks are looking for insurance to cover operational
risk, so they can reduce their Basel II required capital
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Operational Risk – Opportunity for
CAS Leadership
•Article from January 2005 issue of Operational Risk magazine
(see www.operationalriskonline.com), by THE thought leader in
operational risk in financial services, Dr. Ali Samad-Khan.
•Presents a serious challenge to the COSO ERM framework
(COSO = Committee of Sponsoring Organizations; see
www.coso.org). The COSO framework is the most highly
visible ERM document in the public domain.
•COSO’s recommended operational risk assessment measure
is “likelihood-impact” = product of likelihood and impact as the
key determinant of “riskiness.”
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Operational Risk – Opportunity for
CAS Leadership
•Dr. Khan explains why this metric is so flawed, and why an
actuarial approach is superior: he mentions evaluation of
historical loss information by risk experts, development of
frequency and severity distributions, and convolution to get an
aggregate distribution.
•This article represents an unsolicited endorsement of the
profession and its value in properly assessing operational risk.
•It highlights how actuaries, and casualty actuaries in
particular, may actually be de facto professional leaders in the
operational risk space, because of core franchise values:
training, experience, and techniques.
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June 7, 2004
Thank you for your attention
Q&A