Oct-06 Zvi Wiener Risk Management in Insurance

© Zvi Wiener, 2006RM Insurance slide 2 The School of Business Administration The Hebrew University of Jerusalem. The Barbara and Richard Rosenberg fund. PRMIA - The Professional Risk Managers’ International Association, The Ministry of Finance.

© Zvi Wiener, 2006RM Insurance slide 3 The goal of the conference An in depth discussion of risk management and measurement methods in the insurance industry. Roadmap of future developments Presenters from Canada, France, UK, Israel. Regulators, Academia, Insurance companies. Today (16-Oct): presentations Tomorrow (17-Oct): panel (discussion with Q&A)

© Zvi Wiener, 2006RM Insurance slide 4 Financial Intermediaries Banks, exchanges, mutual funds, brokers, insurance companies, pension funds, … Typically take money and promise something in the future. As soon as assets and liabilities are not identical there is risk involved. Appropriate measuring and managing of the risks is the key role of the financial intermediaries. Regulators: BoI, ISA, MOF.

© Zvi Wiener, 2006RM Insurance slide 5 IAIS International Association of Insurance Supervisors 1. Roadmap for a common structure and common standards for the assessment of insurer solvency. 2. A new framework for insurance supervision: Towards a common structure and common standards for the assessment of insurance solvency. 3. Towards a common structure and common standards for the assessment of insurer solvency: cornerstones for the formulation of regulatory financial requirements.

© Zvi Wiener, 2006RM Insurance slide 6

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© Zvi Wiener, 2006RM Insurance slide 8 Situation in Israel A variety of traditional insurance products. New protected (guaranteed) investment plans. Annuities, pensions (DB, DC). Credit market. Investments in illiquid assets. High concentration of local risks. Investment management. Underdeveloped securitization.

© Zvi Wiener, 2006RM Insurance slide 9 Insurance (including pensions) Crossroad of actuarial approach to liabilities, accounting reporting principles, and managing financial assets according to market (economic) rules.

© Zvi Wiener, 2006RM Insurance slide 10 What is Risk? “Risk – the chance of something happening that will have an impact upon objectives. It is measured in terms of consequences and likelihood.” “Risk management is as much about identifying opportunities as avoiding or mitigating losses.” Risk is a combination of exposure to risk factors and volatility of these factors.

© Zvi Wiener, 2006RM Insurance slide 11 Is risk bad? Risk is the main source of profits! It should be measured understood managed

© Zvi Wiener, 2006RM Insurance slide 12 How to manage risk? Keep enough capital to cover potential losses. Buy a reinsurance. Match assets and liabilities. Diversify. Transfer (cat bonds). Hedge market and credit risks by using advanced financial instruments.

© Zvi Wiener, 2006RM Insurance slide 13 Main Steps Identify risk Quantify risk Decide on hedging or mitigation of risk Execute the decision

© Zvi Wiener, 2006RM Insurance slide 14 Main Steps Identify risk Quantify risk Decide on hedging or mitigation of risk Execute the decision

© Zvi Wiener, 2006RM Insurance slide 15 Approaches to Measuring Risk SPAN method – used by exchanges, traders Standardized approach – RBC, CAD Rating agencies – PD, LGD VaR, T-VaR – economic capital, fair value, embedded value, DAC, ERM.

© Zvi Wiener, 2006RM Insurance slide 16 Main Choices Horizon – one year, 10 days in banking Definition of Capital - GAAP, economic, regulatory Measure of Risk – risk of ruin, VaR, T-VaR Main risks to include – market, credit, insurance, … Quantification method – stress, Monte Carlo, factors Aggregation – additive, correlations, stochastic

© Zvi Wiener, 2006RM Insurance slide 17 Risk mean st. dev VaR 95% T-VaR 95% losses probabilities

© Zvi Wiener, 2006RM Insurance slide 18 Major Types of Risks Market Underwriting Credit Operational Liquidity

© Zvi Wiener, 2006RM Insurance slide 19 Aggregation of Risks

© Zvi Wiener, 2006RM Insurance slide 20 Insurance versus banking Banks started the process earlier, have internal models for some risks. Financial side is similar. Insurance has a significant component of actuarial exposure which is difficult to measure and it can be hardly mitigated. Extreme events can be hardly estimated.

© Zvi Wiener, 2006RM Insurance slide 21 Important The change is NOT technical, but involves senior management of insurance companies. It is NOT enough to appoint a risk manager and to buy a software. Investment decisions, new products, the use of capital, pricing, embedded options – all this should be based on risk assessment.

© Zvi Wiener, 2006RM Insurance slide 22 Insurance Risk Management