7. Proprietary risk frameworks Flashcards
What is a credit rating?
- Rating issued by credit rating agency as indication of creditworthiness or lack thereof
- Assigned for issuers and the issue
What is a drawback of credit ratings?
Paid for by companies the credit agency is assessing so under pressure to give good ratings to companies.
Whar are factors thart affect the assessment of ERM capability?
- Complexity of insurer’s risks
- Available capital and ease of access
How does the S&P work?
- Assign one person to each firm that it assigns ratings for
- Subjective combination of factors arising from the rating framework
Which 3 risk elements are in the S&P framework?
- Sovereign risk analysis
- Business risk analysis
- Financial risk analysis
What are the elements of soverign risk analysis?
- Tax
- Currency controls
What are the elements of business risk analysis?
- Industry prospects
- Lack of diversification
- Diseconomies of scale
- Operational risks
- Management quality and structure
What are the elements of financial risk analysis?
- Profit level
- Cashflow
- Capital structure and flexibility
What are the 5 areas the S&P considers when measuring ERM capability
- Risk management culture
- Risk control
- Extreme event management
- Risk and capital models
- Strategic risk management
Define risk management culture
Degree to which risk and risk management are NB considerations across all business decision-making
What are the dimensions of risk management culture
o Risk and risk appetite philosophy
o Governance and organisational structure of RMF
o External and Internal risk and risk management disclosures + communication
o Degree to which there is understanding and participation in RM across company
How does S&P assess risk management culture?
- Has developed suite of favourable and non-favourable indicators
- Only assess as effective if they judge every manager to contribute to RM culture without direction from RM staff
How does S&P assess risk control?
- Assess by considering:
o How well risk identification procedures are carried
o How well risks are managed on an ongoing basis
o Limits set for retained risks, how limits are adhered to and consequences or actions taken when limits not met
o Execution of RM process
What are extreme events?
Low frequency, high impact events that can seriously affect org’s financial health
How does S&P assess extreme event management
- S&P looks for evidence of:
o Org considers different events e.g., terrorism, natural disasters …
And adopts appropriate way to measure impact (reputation, liquidity, financial strength)
o May look at stress testing and scenario analysis
o Early warning-indicators and cat insurance can be risk mitigators
o “Post-mortem” analyses of problems and risk mitigators that feeds into contingency plans
How would S&P assess risk capital models
- S&P might assess:
o Range, quality and use of indicative, predictive and sensitivity risk measures
o Degree to which chosen risk measure is consistent with complexity of risk and intended usage
Indicative may be suited for simple risks and/or low cost and time constraints
More complex risks/usage»_space; more sophisticated techniques to produce range of risk measures
o Appropriateness of choice of projection approach. Single scenario vs stochastic simulation
o Degree to which models reflect all of org’s NB risks
o Associated operational issues:
Assumptions used
Treatment of risk mitigation activities in models
Infrastructure to feed data to models
Procedures followed to run models
Validation of models
o If models assess risk and capital consistently throughout org»_space; enables aggregate capital requirements to be determined
o If single or separate models are used and how they’re co-ordinated
o Modification of any standard formulae used for appropriateness to particular business lines in which org operates
o Degree to which economic capital is used in day-to-day management, business planning and strategic decision making
o Amount and quality of available capital held against economic capital requirement
What are the 6 positive features of strategic risk management?
o Clear decision-making wrt org’s retained risks and if company’s business must refocused to avoid or diversify risks
o Clear investment strategy for company’s assets, focusses on broad categories (equity/bonds) and across countries
o Risk/return payoff is reflected in product pricing and clear standards set risk/reward payoffs acceptable to company
o Appropriate capital allocation between diff business units based on capital model
o Appropriate dividend policy, which is influenced by risk-adjusted return on retained capital- a strong company will be able to discuss how dividend decision was made
o Good risk-adjusted returns must be rewarded within company
What are the strengths of S&P
- Overall emphasis on ERM, ie managing all NB risks together instead of having separate silo for each risk
- Focus on use of economic capital or “risk” capital measures
- Consideration of operational performance in light of risk choices and tolerances
- Useful breakdown into components of ERM analysis, which can be helpful to organisations when implementing their own ERM processes
- Encourages greater transparency of ERM processes
- Introduction of a classification system that should make outsomes of rating agency analysis easier to communicate
- Same criteria applied to all insurance companies, but also tailored ‘The paper argues that a high rating may help orgs attract and retaining increasingly sophisticated customers
What are the weaknesses of S&P?
- Paper relates only to view of Standard & Poor’s – not credit ratings in general
- Limited to insurance and reinsurance companies
- Document is part of company’s marketing literature, and yone could be argued to be overly optimistic
- Limited description is given on actual procedures, or details of how investigations will be carried out and how certain aspects will be measured
- No explicit mention of agency risk
- There is reference to “complicated and powerful simulation models”; this is highly subjective and may be problematic
- Risk management was already considered in S&Ps when rating companies. Unclear if additional formalised approach had significant impact on their views of insurance and reinsurance models
- Reliance should not be placed solely on opinion of rating agencies; may have missed risks that a company takes and that co may have also missed. Company may have better understanding of risks than rating agency
