Download ppt - Property Casualty Aspects Of ERM - Sommerfeld

Property / Casualty Aspects of ERM

Frank SommerfeldEMB

Köln (Cologne), Germany

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Agenda

• Cash-Flows in P&C insurance

• Liquidity risk

• Risk Matching

• Example Risk-Matching

• Summary


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1 2 3 4 5 62003 74,0% 15,0% 5,0% 3,0% 2,0% 1,0%

2004 74,0% 15,0% 5,0% 3,0% 2,0% 1,0%

2005 74,0% 15,0% 5,0% 3,0% 2,0%

2006 74,0% 15,0% 5,0% 3,0%

2007 74,0% 15,0% 5,0%

2008 74,0% 15,0%

development years

acci

den

t ye

ars

Cashflows in P&C insurance

• The expected CF in a calendar year is the sum of the diagonal. Assuming a constant ultimate per origin year it is 26%.

• No new accident year would implicate– no new business– no renewals– no unearned premium

• A new accident year does pay out 74% and does reserve the other 26% the expected reserves remain unchanged. the expected cash-flow balance is 0

• Additionally the cash-flow is highly volatile• Matching strategies (Duration, cash-flow,..) don’t make sense

2009 74,0%

unrealistic


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Example - Volatility of cash flows at „going concern“

Expectation close to zero and very volatile


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Duration of cash flows at „going concern”

You will not match this duration!


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Cash flow P&C

• Cash flows of P&C insurance are totally different to the cash flow of life insurance:

– Considerably more volatility• Large claims• Catastrophe claims• Adverse run-off

– The expected cash flow is usually small

• A liquidity risk is not arising form a mismatch in duration but rather due to the volatility

• How can liquidity risk be assessed?

• How can the liquidity risk be managed?


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Agenda


• Liquidity risk

• Risk Matching


• Summary


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Example of the liquidity risk on the basis of three paths

Liquidity gap arises from one extreme negative u/w cash flow or from two

medium negative cash flows.

uw. CF 2009 2010 2011 2012 2013Path #1 29 m€- 37 m€- 133 m€ 3 m€- 50 m€ Path #2 126 m€ 24 m€ 116 m€- 99 m€- 123 m€ Path #3 80 m€ 186 m€- 55 m€ 59 m€ 87 m€

Asset CF 2009 2010 2011 2012 2013Path #1 29 m€ 28 m€ 28 m€ 30 m€ 28 m€ Path #2 27 m€ 36 m€ 35 m€ 40 m€ 24 m€ Path #3 38 m€ 26 m€ 30 m€ 28 m€ 32 m€

CF total 2009 2010 2011 2012 2013Path #1 0 m€ 10 m€- 161 m€ 27 m€ 78 m€ Path #2 153 m€ 61 m€ 81 m€- 59 m€- 147 m€ Path #3 118 m€ 160 m€- 85 m€ 88 m€ 119 m€

fungible Assets 2009 2010 2011 2012 2013Path #1 117 m€ 90 m€ 109 m€ 74 m€ 90 m€ Path #2 99 m€ 66 m€ 94 m€ 48 m€ 111 m€ Path #3 121 m€ 115 m€ 134 m€ 110 m€ 168 m€

Liquidity gap 2009 2010 2011 2012 2013Path #1 - € - € - € - € - € Path #2 - € - € - € 11 m€- - € Path #3 - € 45 m€- - € - € - €


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Example - Volatility of cash flows at „going concern“

The ERM models we will not run with 3, but e.g. 100,000 simulations.

The results will be measured in probabilities


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Example liquidity risk

Liquidity risk

0,85% 0,96% 1,20%0,10% 0,35%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2009 2010 2011 2012 2013

calendar year

% S

ce

na

rio

s

0%

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120%

140%

co

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% Liquidity gap % neg. CF % neg. u/w CF Ø Asset not fungibel / Liquidity gap


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Strategies on managing liquiditiy risks

• The liquidity risk is an asset/liability matching risk – market value of fungible assets < payment obligations

– The liquidity risk can arise out of• Decreasing market values• Insufficient fungibility• Increasing payment obligations

– The liquidity risk is a timing problem and due to this fact it can not be capitalized

• Strategies to decrease the risk can be set at the asset and the liabilites side– Asset side

• Matching of the asset cash flow can not lead to the target• Market values: Investments in less volatile assets• Fungibility: Investments in more liquid markets

– Liabilities side• Arrangements of the reinsurance contracts • Implementation of „Cash-Calls“

• The handling of liquidity risks defines a constraint but does not determine a whole strategy


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Agenda


• Liquidity risk

• Risk Matching


• Summary


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Risk Matching

• The insurer is exposed to underwriting and market risks

• The ERM models calculates both profit profiles

• The risk capital can be calculated from the profit profiles

– VAR– TVAR– …

Profit Profile

-800

-700

-600

-500

-400

-300

-200

-100

0

100

200

300

400

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Perzentil

m€

Profit Passiv

Profit Aktiv


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Risk Matching

• The asset and liability risks have a only a small dependency

• There is a strong diversification effect between both sides

– Bad results on the one side are often balanced by good ones on the other side

– This diversification effect can be measured

• In this example the worst case scenarios are caused by the liability side

Profit Profile

-300

-200

-100

0

100

200

300

400

-800 -700 -600 -500 -400 -300 -200 -100 0 100 200 300

Profit Passiv

Pro

fit A

ktiv

Total result < - 400


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Risk capital

-

100

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500

600

Stand alone Diversification Diversified

m€ assets

liabilities

Risk capital

-

100

200

300

400

500

600

Stand alone Diversification Diversified

m€ assets

liabilities

Risk Matching

• „Stand alone“ adds both risk capitals which were calculated separately • „Diversified“ determines the risk capital on the aggregated risk profile

– Sub-additivity RK(A+B) ≤ RK(A)+RK(B)

– With capital allocation methods (here TVAR) the diversified capital can be allocated back

• How can you find the optimal diversification?

Net of RIGross of RILiabilities dominates the total

Risk capital is allocated

more equally


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Risk Matching

• To compare different risk strategies a comparison of the risk capitals is insufficient

• The (expected) return has to be compared against to calculate the performance/efficiency of the capital

– Economic Value Added (EVA™) =return – cost of capital * risk capital

– Return On Risk Adjusted Capital (RORAC) =return / risk capital

• Other constraints have to be considered additionally

– Business policy

– Accounts

– …

Higher

risk

capit

al

Higher

exp

ecte

d re

turn

A

B

C

D

Risk liabilities (Reinsurance)

Ris

k A

sset

(S

AA

)

Strategy exp return risk capital EVA @10% RORACA 120 1.000 20 12%B 65 500 15 13%C 110 1.000 10 11%D 55 500 5 11%


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Agenda


• Liquidity risk

• Risk Matching


• Summary


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Dichte: vt. Bruttoergebnis

0

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1.000

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-800 -700 -600 -500 -400 -300 -200 -100 0 100 200 300

m€

Fre

quenz

Risk Matching – simplified example

Dichte

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1.000

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-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100% 120%

Rendite

Fre

quenz

Aktien

Renten

• Asset risk– FI and equity– Managing via equity share

• Liabilities risk– Stochastic gross result– NatCat exposed– Managing via reinsurance


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Asset "Standalone"

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0% 5% 10%

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Equity

Ris

k ca

pit

al (

m€)

-20

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Risk capital Return EVA™


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,9%

From 15 % equity the risk capital increases faster than the expected return


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Gross of RI

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Equity

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pit

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m€)

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all. Capital Liab. all. Capital Asset EVA™


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,2%

For lower equity exposure the asset risk is overlain by the u/w risk. There is a large diversification potential on the asset side.


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Net of RI

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Equity

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k ca

pit

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m€)

-5

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25

,7%

The diversification potential for the asset side decreases if the risk is mitigated on the liability side.


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Net of RI (more RI)

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Equity

Ris

k ca

pit

al (

m€)

-15

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-5

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14

,7%

If the risk on the liabilities side is decreased even more the risk on the asset side has to be reduced as well.


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0,0%

5,0%

10,0

%

15,0

%

20,0

%

25,0

%

30,0

%

35,0

%

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%

45,0

%

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%

55,0

%

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%

high RI protection 1RV 3

RV 5RV 7

RV 9low RI protection 11

0123456789

10111213141516171819202122

EV

A™

(m

€)

Equity

EVA™ (m€) by different reinsurance and equity scenarios


16

,1%


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Agenda


• Liquidity risk

• Risk Matching


• Summary


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Risk Matching - Summary

• Use the diversification potentials between risks– Between asset and liabilities– Within the asset side between the asset classes– Within the liabilities side between the lines of business

• The whole balance between several risk operators is important– A balanced influence on the overall result– Dependent on the risk aversion– In practice: Optimum at given risk capital

• Changes in the risk strategy have always consequences in all areas– Holistic ERM should be integrated in the company

• BUT: No blind trust in the models– Techniques are helpful to support decisions but not to replace them– Understanding the effects is essential – no Black-Box!– ERM must be lived – clear communication within the whole company is

necessary


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Your contact for questions

Frank Sommerfeld

EMB

Tel.: +49 (0)221 35 66 26 41

[email protected]

emb.com