MBCi Insurance RM

RISK MANAGEMENT INTHE INSURANCE

INDUSTRY

Harokhava Aliaksandra, Halada Martin

2008: The largest government bailout of a private company in theUS history

Sources: http://www.propublica.org/special/government-bailouts, http://www.ritholtz.com/blog/2013/01/the-true-cost-of-the-aig-bailout/

> 180 000 000 000 USD bailoutby the US Treasury and the Federal Reserve

Agenda

1 Insurance companies at a glance

2 Main risks

3 Risk management

4 New challenges for risk management in insurance

5 Innovation in insurance

Agenda


2 Main risks

3 Risk management



Business model of the insurance companies

Insurance company

Reinsurancecompanies

Investments

Insurance compaies make money from the insurance premiums and investment returns

Insurance companies’ business model is quite risky…

Sources: https://www.allianz.com/v_1426595532000/media/investor_relations/en/results_reports/annual_report/ar2014/ar2014_group.pdf ,http://www.vig.com/fileadmin/web/Investor_Relations/Annual_Reports/Group_Annual_Reports/150414_-_VIG_Group_Annual_Report_2014_Internet__final_.pdf ,http://www.generali.com/info/download-center/risultati.html#2014

Loss ratio, %

Combined ratio, %

in selected countries, %

ROE, %

all data for the whole Group, 2014

105%

97%

66%

Romania

120%

94%

66%

USA

94%

67%

113%

Latin America

10% 11% 13%

…. that is why they diversify their income sources

Income split, %

Balance sheet structure

Sources: companies’ Annual Reports and IFRS Financial statements for 2014


13%

87%Other income

Net earned premiums

34%

66%

27%

73%

Equity 12%

Other 25%

Reserves63%

Other32%

Investments68%

Equity 8%

Other35%

Reserves58%

Other25%

Investments75%

Equity 5%Other15%

Investments85%

Other18%

Reserves77%

…. and tend to invest in rather safe fixed-income securities

Investment structure, %

AFS assets structure, %

Sources: companies’ Annual Reports and IFRS Financial statements for 2014


34%

66%Financial instrumentsAvailable for sale

Other

96%

4%

65%

35%

8%4%

19%

52%

17%

Other

Equity securities

Corporate bonds

Other fixed income

Government bonds

5%

45%

8%

41%

11%11%

10%5%

64%88% fixedincome

securities92% 85%

Agenda


2 Main risks

3 Risk management



Insurance companies face a number of risks:

Underwriting

Operational

Credit

Liquidity

Market

Strategic risk

Others

Different business segments are exposed to all abovementioned risk categories.The Asset Management business segment is mainly exposed to the market, creditand operational risk.

Sources: insurance companies’ Annual Reports

Underwriting and Operational risks are determined both by

the external environment and the internal operations

Underwritingrisk

Risk of a loss on the underwriting activity.Key challenge: difficult predictability, changing demographics. Normally higherfor the P&C insurance.• Property-Casualty insurance businesses are exposed to premium risk

related to the current year’s new and renewed business as well as reserverisks related to the business in force. Premium risk is subdivided into naturalcatastrophe risk, terror risk and non-catastrophe risk.

• Underwriting risks in Life/Health operations (biometric risks) includemortality, disability, morbidity, and longevity risks.

Increasing role of the actuaries

Operational risk

Risk resulting from the errors in business processes, controls or projectscaused by technology, employees, organisation or external factors,including legal and compliance risk, but excluding the losses from strategic andreputational risk.

Sources: insurance companies’ Annual Reports, The Actuary

Credit and Liquidity risks are related mainly to the

investments portfolios

Credit risk

Liquidity risk

Quantifies the potential loss due to a deterioration of thesituation of a counterparty against which claims exist.First of all concerns sovereigns to which insurance company hasexposure. Treatment of sovereign is partly regulated by Solvency II.

The risk that an Insurance company may not have sufficientassets that can be liquidated at a short notice to satisfy itspayment obligations. Can arise primarily if there are mismatches inthe timing of cash-flows on the asset and liability side.


Market risk is mostly represented by the interest rate risk,

Srategic risk – by changing regulatory environment

Risk of changes in the value of investments caused by unforeseenfluctuations in interest rate curves, share prices and currency rates, andthe risk of changes in the market value of real estate and participations.• Generally Includes interest rate, inflation, credit spread, equity, real estate

and currency risks.• Normally higher for the Life/Health isurance.

Market risk

Strategic risk

Risks arising from changes in the economic environment, case law, orthe regulatory environment.Includes also unexpected negative change in the company’s value arisingfrom the adverse effect of management decisions regarding businessstrategies and their implementation.Strategic controls are carried out by monitoring respective business target.


Quantifying the risk

Allocated Risk according to Internal Risk profile

4.1805.1465.32111.311

11.018 38.42728.102

Tax Total

18.291

Market Credit Underwriting Business Operational Diversification

Base capitalization ratio

Interest rate up by 0,5%

Combined scenario

205%

199%

191%

Interest rate down by 0,5%

179%

158%

-17%170%

Equity prices up by 30%

Equity prices down by 30%

Allianz Group: Solvency II regulatory capitalization ratios, different scenarios

Sources: Allianz’s Annual Report 2014, http://www.bain.com/Images/BB_Solvency_II.pdf

Agenda


2 Main risks

3 Risk management



Risk management structure - Vienna Insurance Group

example

Source: http://www.vig.com/en/vig/strategy/risk-management.html

Risk assessment

Historical simulation

Value at risk (VaR)

Collective models

Aggregate models

Stress analysis or stochastic modelling techniques

Source: http://www.actuaries.org/EVENTS/Seminars/New_Delhi/Chapters/page-112to133.pdf

Solvency assessment

Source: https://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/solvency-II.pdf

Solvency II

Source: https://www.kpmg.com/US/en/IssuesAndInsights/ArticlesPublications/Documents/solvency-II.pdf

Risk mitigation strategies

Risk reduction

Risk integration

Risk diversification

Risk hedging

Risk transfer

Source: http://www.actuaries.org/EVENTS/Seminars/New_Delhi/Chapters/page-112to133.pdf

Risk mitigation - Hedging

Options

Futures

Source: https://www.pwc.com/us/en/audit-assurance-services/valuation/publications/assets/pwc-risk-management-and-insurance-hedging.pdfhttp://www.vig.com/fileadmin/web/Investor_Relations/Annual_Reports/Group_Annual_Reports/150414_-_VIG_Group_Annual_Report_2014_Internet__final_.pdfhttp://www-111.aig.com/AIG_Internet/AIG_2014_Annual_Report.pdf

Risk mitigation - Transfer

Indemnification reinsurance

Used to reduce volatility, uncertainty and extreme event risk

Reinsurance contracts specify which party holds actuarial reserves for the business being reinsured

Subject to regulation and supervision similar to that applied to direct writing companies

Source: http://www.actuaries.org/LIBRARY/Papers/Global_Framework_Insurer_Solvency_Assessment-members.pdf

Enterprise risk management in insurance

Source: http://www.mckinsey.com/client_service/financial_services/latest_thinking/insurance

Agenda


2 Main risks

3 Risk management



New challenges for the risk management in insurance

Tightening regulations

Political changes

Changes in the market environment (e.g. low interest rates)

Cyber threats

Changing world of risk

New challenges squeeze additionally insurers’ margins.As a result, M&A activity is increasing to solve this issue.

Sources: http://www.mckinsey.com/insights/financial_services/what_drives_insurance_operating_costs, http://www.swissre.com

Terrorist attacks: a limited and short-term impact on the stock price

Sources: http://finance.yahoo.com

All data as of November 17th 2015

Agenda


2 Main risks

3 Risk management



Innovation in insurance

New types of insurance (e.g. cyber risk insurance)

Digital innovation (e.g. SaaS solutions)

Telematics (Health-tracking wearable devices)

Mobile phone insurance

Big data

Bancassurance (e.g. Allianz with Erste)

Sources: Allianz’s Annual Report, http://www2.deloitte.com/us/en/pages/strategy/solutions/d-rive-powered-by-deloitte-mobile-telematics-solution-for-auto-insurers.html,http://www.prnewswire.com/news-releases/digital-innovation-in-insurance-market-insights-2015-report-520129841.html

Thank you for your attention!Stay safe.