Agenda Topic Issue ORSA & ERM Context Linking business strategy and risk strategy How practically can I use them interactively? Performance measurement Lots of performance metrics, so how do I make decisions? Risk appetite How do I generate risk appetite statements? Operationalising risk appetite How do I set risk limits / budgets? Strategic Approach Business strategy What are our competitive advantages? Are we generating value for our members? Strategic risk management Which risks do we want to take and why? How much risk do we want to take? Enterprise risk and capital management framework Risk & capital models What risks do we face? What is the range of potential impacts? How do our risks interact? Emerging risk mgt What are the threats & opportunities to our business? Are events likely to invalidate our model? What is the plan to manage threats? What are the triggers? Solvency & capital management How much capital do we need to hold in each entity? How do we manage risk-taking? Culture How do we behave in managing our business? Embedded through business processes Strategic planning Products & pricing Governance & controls Performance mgt Capital mgt Reporting Articulate the business model The business model Outlines what the business does, and How it makes money doing it Helps stakeholders to Understand where the return is expected to come from, and The sort of risks the business is expected to take. LONG TERM PROFITABILITY OF FIRM = PROFIT POTENTIAL OF INDUSTRY or MARKET SEGMENT +/- COMPETITIVE ADVANTAGE OF FIRM IN THAT SECTOR Qualitative risk strategy/risk appetite statements Overarching principles: • We do not wish to take unrewarded risks • We do not want to take risks that are not consistent with the delivery of our strategy as an insurer. • We will take on risks dependent on the expected return exceeding the cost of capital • We will charge a price for accepting risk that seeks to optimise our risk/reward profile and that fully reflects the cost of taking that risk By risk category - market risk: The Group has no appetite for market risk exposures except where exposures arise as a consequence of core strategic activity (principally as a consequence of exposure of revenue streams to market risks). Business units are expected to limit market risk exposures by matching the features of liabilities to features of assets. Exposures may be incurred where there is an overriding business need and specific appetites will be established as necessary. Example evidencing challenge Business strategy …… Implications for Risk and Validating strategic alignment Return We have appetite for taking Questions as to how strategies [xxxx] risk as we believe align or may appear mis-aligned that we can achieve [return] on this risk We do not want to take [xxxxx] risk as we believe the upside to be limited. Return Context of risk and return Target return Impact of balancing multiple appetite statements. Zone bounded by target tolerances controlled by limits Target risk appetite Risk Risk-adjusted ‘primary’ performance measures Franchise value Economic Value Creation (EVC) = Net assets • EVC is a measure of + Present value of potential transfers to members from in-force business + Goodwill for new business member valueadd capability value created less the explicit cost of holding the required economic capital • Cost of capital used is not the same for all products / projects • Capital allocated reflects diversification benefits • If EVC is greater than zero, value has been generated for members Other metrics (constraints) New business strain IFRS profit Risk-Adjusted Return on Lifetime Economic Capital (RARLEC) • RARLEC is a measure of how much value is generated for members relative to the risks being taken on • Simple way of ranking products when making capital allocation decisions • EVNB/PV(ECap) • Economic value of new business (EVNB) is the EVC at point of sale of a policy Solvency II profit Payback period Distributable cash ……. Common risk appetite dimensions Dimensions 1 Capital Definitions Buffer above regulatory diversified Solvency Capital Requirement (SCR) in a 1-in-10 event 2 Earnings 3 Liquidity 4 Franchise value Pre-defined 1-in-10 event results in, at worst, zero Group operating profit BAU cash flows Ability to meet BAU cash outflows on a day-to-day basis In a stressed scenario Coverage of liquid assets over net cash flows in a 1-in-10 Brand & reputation Reflection of how our brand is perceived by our major Operational & capability Tracking events that could occur and result in shock event stakeholders, e.g. customers, employees & regulator operationally being unable to deliver the strategic plan Setting risk limits using risk appetite • • The target capital level has been established at 140% of the SCR Amber trigger level established at the capital position of being able to cover 170% SCR. Risk category Regulatory capital requirement Total Financial - Equity - Interest rate Business Operational 1000 500 100 400 300 200 Economic Capital target (140% coverage) 1400 (=1000 * 1.4) 700 140 560 420 280 Amber trigger level (170% coverage) 824 (=1400 / 1.7) 412 83 329 246 165 Limits move over year in line with plan numbers SCR multiples are implied solvency levels and therefore risk capital limits are inverted Then refine to assess how RAG statuses should change to reflect earnings risk appetite and risk strategy output RAG for each risk proportionately allocated from central target Setting risk limits using risk appetite • • The target capital level has been established at 140% of the SCR Amber trigger level established at the capital position of being able to cover 170% SCR. Risk category Regulatory capital requirement Total Financial - Equity - Interest rate Business Operational 1000 500 Risk category Marginal contribution (base) 45% 75% 60% 45% 25% 60% Total Financial - Equity - Interest rate Business Operational 100 400 300 200 Economic Capital target (140% coverage) 1400 (=1000 * 1.4) 700 140 560 420 280 Marginal contribution (scenario) 48% 80% 62% 50% 24% 63% Amber trigger level (170% coverage) 824 (=1400 / 1.7) 412 83 329 246 165 Scenario: business operating at the upper red limit for particular risk type Scenario tests whether limits reasonably protect diversification benefit Summary : linking risk and reward under Solvency 2 Performance metrics have explicit allowance for risk that is appropriately costed This means creating value greater than zero is creating value for shareholders Define primary metrics and identify other metrics that act as constraints Risk appetite is multi-dimensional It focuses on what the Board is concerned about in running the business Derived from stakeholder expectations Capital risk appetite and risk limits link together Limits set to preserve benefit of diversification Economic (risk) capital is allocated appropriately to those products that create the risk exposure Ensures products are charged appropriately for capital usage Projections of the risk profile are appropriate as business mix and volume change Ensures the assessment of return from taking risk is appropriately allocated to products to ensure we grow the right parts of the business Questions and comments? Christopher Chappell E-mail: cichappell@live.com