CS-19: Risk Tolerances and Limits
Fred Tavan, FSA FCIA
Assistant Vice President, Canada Life
ERM Symposium, Washington DC
July 29, 2003
1
Introduction
•
•
•
•
Net Risk
Uses of Exposure Limits
Application types
Determination of Limits
2
Net Risk
•
•
•
•
Net Risk = Inherent Risk mitigated by Controls
Inherent Risk = Severity * Probability
Both Severity and Probability are levers
Can put exposure limits on the severity
and/or probability
3
Exposure Limits
• RM technique of placing limits on risk
exposure metrics to achieve strategic or
operational objectives
• Used to reduce expected cost of risk
• May also be used to reduce variance of cost
of risk
• Can be applied in many different ways
4
Application Types
• Limit cost of specific event by setting max.
acceptable loss
• Limit exposure to a specific risk type as a %
of total risk
• Limit exposure in any specific instance of a
risk type
• Limit exposure in contractual agreements
5
Application Types
• Limit exposure by placing a cap or floor on
a specific risk metric
• Limit exposure through pricing by adjusting
prices up or down
• Limit operational risk
6
Limiting Specific Event(s)
• Example:
– Company should not expose itself to any loss
on any one risk in an amount exceeding more
than 10% of its surplus
7
Limits that vary by Mgmt. Level
• Examples:
– Exposure to any one risk exceeding 8% of
surplus requires Board approval
– Exposure to any one risk exceeding 5% of
surplus requires Sr. Mgmt. approval
– Exposure of any one risk exceeding 1% of
surplus requires approval of Business Line
Mgmt.
8
Limits on specific instance
• Examples:
– Company shall not acquire more than 3% of its
admitted assets in investments of all kinds
issued or guaranteed by a single person
– $10 million acquisition limit on investment
grade and $5million on high yield bonds
• Limit is on management actions and not on
actual exposure
9
Contractual Limits
• Examples:
–
–
–
–
Retention limits on life insurance
Cap on disability benefits
Cap on dental benefits
Exclusion clauses
10
Limits on various Risk Metrics
• Examples:
– Limit on exposure to interest-rate risk set in
terms of duration mismatch
– May have separate limits for key rate duration
– Limit may involve combination of duration and
dollar duration
11
Limits on Product Exposure
• Example:
– Co. has a certain planned target risk-based
capital ratio
– Co.’s plan based on certain amount of capital
being allocated to the GIC line
– The GIC line has a minimum ROC target
– If sales are better than expected then ROC
target raised and vice versa
12
Limits on Operational Risk
• Examples:
– No more than 24 hour downtime for critical
systems used in day-to-day operations
– Systems can include cheque writing systems,
call center, web site
– Turnover of key staff limited to no more than
20% per year
– No more than 5 unsigned reinsurance treaties at
any one time
13
Determination of Limits
• Depends on a number of factors:
–
–
–
–
Are there any regulatory limits?
At what level of management will limits apply?
What are the company’s competencies?
What is the company’s tolerance for publicly
reporting large losses?
– What is the purpose of setting the limit?
14
Determination of Limits (cont’d)
–
–
–
–
How bad can things get?
What are the available data and resources?
How do limits impact capital requirements?
What is the impact on operations?
15
SOA Website
• Detailed paper can be found at:
– http://www.soa.org/sections/rmtf/exposure_limi
tations.
16