Chapter 3 Flashcards
Regulatory regimes and capital adequacy standards vary due to:
Operating in various territories Different industry segments Different areas within same sector Portfolios in same segment have different requirements Different life stages
Credit rating strengths
Focus on ERM Focus on Economic Capital and Risk measures Performance relative to risk Transparency Communication Universally applied Can attract sophisticated customers
Credit rating weaknesses
S&P view only Insurances only (applies to) Optimistic marketing Limited description of actual procedures Agency risk? Subjectivity around internal models Opinion not be all Was previously considered - and got it wrong
Credit risk definition
The risk that a counterparty to an agreement fails to make the payments required under the agreement
Market risk definition
Risk arising from changes in investment market values or other features correlated with investment markets (interest / inflation rates)
Operational risk definition
Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. includes legal risk, but not strategic & reputational risk
ORSA
Own Risk and Solvency Assessment, required by Solvency II
Requires each insurer to:
1) Identify risks it is expsoed to
2) Identify risk management processes and controls in place, and
3) quantify its ongoing ability to continue to meet its solvency capital requirements (SCR and MCR)
BASEL II overview
Three pillars:
1) Minimum regulatory capital requirements
i. Credit - Risk weighting applied to assets, or Internal Ratings Based (IRB) approach
ii. Market - Multiple of 10 day 99% VaR or standard approach
iii. Operational - Function of gross income held over previous three years
a) Basic Indicator Approach (BIA) - Multiple of 15%
b) Standardised Approach (SA) - Calculation split into eight business lines, multiple between 12% and 18%
c) Advanced Measurement Approach (AMA) - business lines, 7 loss types, internal models
Criticisms of Basel II
1 CHIMP DO
1 number C Cost H Herding (risk herding) I ignores some risks M Market values may under value P Pro-cyclicality D Difficult to quantify O Overconfidence and false sense of security
COSO ERM Framework
Committee of Sponsoring Organisations of teh Treadway Commission
Three dimensions:
Risk process (8 components)
Objective
Business level
Key principles: Upside and downside ERM is parallel and iterative process Everyone has role any RM process is imperfect Balance cost with benefits
COSO risk process components
IOEA RCCM
Internal environment Objective setting Event identification Assessment of risk Respond Control activities Communicate Monitor
Sarbanes-Oxley Act
Key features: Inspect accounts Increased accountability for CEOs and CFOs Internal Control Report (ICR) External auditor review Illegal to interfere in audit process Illegal to destroy documents
COSO levels of business
Subsidiary
Business unit
Division
Entity
COSO objectives
Operations
Reporting
Compliance
Strategic
Types of regulation
Unified - single regulator covers broad range of activities
Functional - different authorities oversee different activities
