StressTestingAndScenarioAnalysis

Question 1

What is solvency testing?

Answer 1

Examine the severity of the financial effect of scenarios on a firm’s solvency. Type of stress testing, type of financial strain a firm can withstand and remain a going concern. Often viewed if the firm meets regulatory capital requirement

Question 2

Shareholder financial objective

Answer 2

Achievement of a desired level of financial return on their investment and of sufficient, yet not excessive, equity.

Question 3

Risks concerned by shareholders

Answer 3

1. Presumably covered by regulatory capital 2. Also include risks related to successful growth and profitability (e.g. new business, the ability to price its products and manage inforce), which demand assessment of different types of scenarios

Question 4

Objective of risk management

Answer 4

Identify, quantify and transparently communicate to the appropriate stakeholders the types and extent of risk.

Question 5

How to accomplish the objective of scenarios?

Answer 5

1. Formulate scenarios (stochastically or deterministically determined) of firm potential risk exposure 2. Evaluate effects of scenarios on financial position of firm 3. Discuss results with senior management and the Board, find extent to which they are consistent with firm’s risk appetite 4. Identify and recommend

Question 6

Discussion of effectiveness of action against potential risk

Answer 6

1. Effectiveness may differ if it is entire industry taking a similar action versus the firm is the only one 2. Factors such as company history and philosophy, actuarial and desired position and policyholders’ reasonable expectations can have significant effect on timing of proposed action

Question 7

risk management action types

Answer 7

1. Avoid 2. Elimination(transfer or hedge) 3. Mitigation 4. Future discretionary management actions 5. Operational measures 6. Raising additional capital or reducing shareholder dividend

Question 8

Uncertainty vs. Risk

Answer 8

uncertainty: non-quantitative

Question 9

When the effect of certain risks an insurance company faces may not be adequately quantified?

Answer 9

Likelihood of occurring is highly uncertain or if there is no supporting scientific insight, e.g. reputation risk(while the probability of loss is impossible to calculate, financial consequence can be expressed numerically, e.g. changes in policyholder behavior (lapse rates), adverse selection(only the worse risk would continue), new business volume, employee turnover, reduction in

Question 10

Scenario test for operational risk

Answer 10

Operational risk is usually not quantifiable (amateur models and vague definition), thus use of scenario test is a more effective way to understand and plan for the effect of operational risk relevant to a specific firm

Question 11

Why scenario test is useful for senior management and board involvement?

Answer 11

Scenarios used as a communication tool should be intuitively clear and understandable so that non-specialist can make appropriate decisions based on the drivers of the scenarios and their consequences for the firm.

Question 12

Why scenario testing can meet regulators’ needs

Answer 12

1. For specific risk events a range of scenario results can be analyzed to quantify an individual firm’s exposure to those events 2. For systemic risks, the regulator might require all firms to test the same scenario so their results are comparable, and both individual and systemic risk can be assessed by assessing major companies 3. Global condition 4. Quality of risk management and risk culture of a supervised firm

Question 13

How is scenario testing help assessing internal model?

Answer 13

Reasonableness check. The use of scenarios provides a reality check for a given internal model can be useful even where the probability of the scenario cannot be reliably estimated

Question 14

What is a firm’s risk appetite

Answer 14

Underpin many firms’ strategy and implementation of an appropriate governance and risk management framework. Preference for potential profit against possible loss.Types of risks or contributing causes will also be considered

Question 15

What does risk appetite depend on?

Answer 15

There is no unique best choice; rather it depends on such factors as type of business, business model, its current financial condition and risk tolerance, and its competitive environment

Question 16

Illustrate different types of scenarios

Answer 16

1. Reverse 2. Historical 3. Synthetic 4. Company-specific 5. Single-event 6. Multi-event 7. Global

Question 17

What to consider related to scenario testing governance?

Answer 17

1. Behavioral factors, the purpose of scenario is to stimulate the firm and management to be prepared of potential disruptive event, thus it needs to be developed in an unbiased manner. 2. Time frame. Scenario test does not represent a prediction, but rather a reasonableness test of a firm’s financial strength. 3. Interdisciplinary approach. Wide range of input from multidisciplinary team makes it more likely to

Question 18

Illustrate typical dependencies of several risk

Answer 18

1. Immediate dependencies 2. Time-lagged dependencies 3. Feedback 4. Phase-shift

Question 19

What to consider when evaluating scenarios?

Answer 19

1. Secondary consequences 2. Scenario rollout overtime, evaluation should include a quantification of the effects of the scenario over its entire period 3. Risk mitigation, take into account realistic risk mitigation program in two forms a. Those inherent in assets held and less adversely affected to change in conditions b. Those involving management discretion.