Risk Tolerances and Limits CAS/SOA Enterprise Risk Management Symposium Washington, DC July 29, 2003 Zafar Rashid Executive Vice President and CFO Prudential Annuities

Enterprise Risk Management “The discipline by which organizations in all industries assess, control, exploit, finance and monitor risk from all sources for the purpose of increasing the organization’s short and long-term value to its stakeholders” “The discipline by which organizations in all industries assess, control, exploit, finance and monitor risk from all sources for the purpose of increasing the organization’s short and long-term value to its stakeholders”

Role of a Chief Risk Officer Risk Policy Risk Policy Governance Issues Governance Issues Organization and implementation Organization and implementation Risk analytics and modeling Risk analytics and modeling Data development and management Data development and management Risk monitoring Risk monitoring Control and management Control and management

Risk Management Policy Define objectives Define objectives Risk definition Risk definition Risk standards Risk standards Establishing risk appetite Establishing risk appetite

Risk Governance Management/Board approval of policy Management/Board approval of policy Approval of risk standards and appetite Approval of risk standards and appetite Establish and manage reporting structure Establish and manage reporting structure Management of risk committees Management of risk committees

Categories of Risk Market Risk Market Risk Credit Risk Credit Risk Pricing Risk Pricing Risk Legal/Regulatory Risk Legal/Regulatory Risk Operations Risk Operations Risk Strategic Risk Strategic Risk

Risk type Systematic Risk Systematic Risk Non-systematic Risk Non-systematic Risk

Creating Transparency Local management of risk Local management of risk Enterprise view of risk profiles Enterprise view of risk profiles Improving capital and tax efficiency Improving capital and tax efficiency Monitoring concentration Monitoring concentration Managing counter-party exposure Managing counter-party exposure

Establishing Risk Tolerance Managing extreme tail outcomes Managing extreme tail outcomes Reducing the variability of earnings Reducing the variability of earnings Managing capital requirements Managing capital requirements Preserving ratings Preserving ratings

Establishing Risk Tolerance Deterministic Models Deterministic Models Stochastic Models Stochastic Models Modeling contagion effects Modeling contagion effects Liquidity testing Liquidity testing Diversification Diversification

Establishing Limits Single event limits Single event limits Aggregate exposure limits Aggregate exposure limits Concentration management Concentration management Managing risk assessment Managing risk assessment

Measurement Varies by nature of risk Varies by nature of risk VaR VaR Present Value of Distributable Earnings Present Value of Distributable Earnings Sharpe ratios Sharpe ratios Traditional measures of exposure Traditional measures of exposure Economic value at risk Economic value at risk

Monitoring Quarterly updates of exposures Quarterly updates of exposures Periodic reporting on maximum limits Periodic reporting on maximum limits Judgmental self-assessment at least quarterly Judgmental self-assessment at least quarterly Regular meetings of divisional RMC’s Regular meetings of divisional RMC’s

The Goal of an Effective Limit System Facilitate BU risk/reward choices Facilitate BU risk/reward choices Enterprise wide consistency Enterprise wide consistency Careful selection of global parameters Careful selection of global parameters Recognition of contagion/diversification impacts Recognition of contagion/diversification impacts

Lessons learned from experience Implementing Enterprise-wide Risk Management Implementing Enterprise-wide Risk Management Creating a risk management culture Creating a risk management culture Overcoming fear and suspicion Overcoming fear and suspicion Broad organizational buy-in Broad organizational buy-in Empowerment and control Empowerment and control Trigger events Trigger events

Role of a Chief Risk Officer Use caution to enhance, not impede, progress. - Chinese Fortune Cookie