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© 2010 The Actuarial Profession www.actuaries.org.uk

GIRO conference and exhibition 2010Joseph Lo, Aspen Insurance UK Limited

Reverse Stress Testing

12-15 October 2010

Workshop Objectives

By the end of the workshop, …

… we shall be able to discuss current issues …

… surrounding reverse stress testing …

… in the context of a general insurance company.

2© 2010 The Actuarial Profession www.actuaries.org.uk

Contents

Case Study

• Context

• Regulator’s views

• RST v1.0

• RST v2.0

• Capital Model

Open Discussion


Context: Aspen

Bermuda domiciled Specialty Insurer and Reinsurer

• London Market (a UK company and Syndicate 4711)

• Bermudan company and US companies

• Branches

Listed on the NYSE

• Common equity, hybrids and debt

Insurance classes of business include:

• Property, Casualty, Marine and Aviation, Financial and Professional Lines


Regulator’s views

FSA’s Policy Statement PS09/20

• Complements stress and scenario testing (SST)

• Risk management tool

• Assess vulnerability of business model– Market losing confidence in the firm– Scenarios most likely to cause failure of business model

• Decisions regarding risk mitigations / triggers for future actions

• Qualitative & quantitative


RST v1.0Background

Early 2009

• Subprime Crisis / Credit Crunch / Financial Meltdown

• FSA’s CP 08/24

• Internal stochastic model


-1,000,000 -800,000 -600,000 -400,000 -200,000 0 200,000 400,000 600,000 800,000 1,000,000

RST v1.0Analysis

Steps

• Ruled out events that are less likely than the “most likely” ones

• Considered causes of actual illiquidity in a reverse manner

• Considered feared illiquidity such as inability to renew banking facilities

• Capital considerations – from BCAR’s perspective

• Assuming loss of confidence from a P&L event and unable to raise capital

• Used internal model to consider drivers of these P&L events


RST v1.0Outcomes

Example outcomes

• Some drivers were deemed important to control:– Catastrophe risk with retrocession placement– Clash risk with a company-wide assessment of clash

potential between classes

• Some were seen as unlikely, and no further action was recommended:– Actual illiquidity without a P&L event


RST v1.0Some lessons

Granularity of internal model

Framework for testing how risk sources interact

• Although the framework is biased towards the downward paths

Framework for communicating risk sources

• Giving a sense of cause and effect

Group level exercise


RST v2.0Background

2010

• Enhanced Stress and Scenario Testing

• FSA PS 09/20

• More intensive Solvency 2 work

• Internal working party – chaired by UK CRO, together with underwriters, actuaries, cat modellers, risk managers, a financial modeller; entity CROs

• Analysis performed in v1.0


RST v2.0Stress and Scenario Testing

SST is a main tool

• 40+ scenarios

– Insurance risk (clash, reserve deteriorations, catastrophes)

– Market risk (adverse economic scenarios)

– Operational risk

– Credit risk (failure of reinsurers or brokers)

– Group risk (failure of individual companies within Aspen)

• Support role of the internal model

• Various severities and probabilities

• Documentation of narratives, discussions and assumptions


RST v2.0Broadening the Definition of Failure

Failure is broader than Regulatory Insolvency

• Loss of confidence– Investors, rating agencies, policyholders

• Actual lack of liquidity

• Large share price falls

A failure can happen much earlier than “destruction”


VaR 99.5

Failure can happen here

RST v2.0Chain of Events

Adverse Consequences

“Unfortunate” Coincidences

Most likely


RST v2.0Example following major catastrophe event


Three large Windstorms

Large market loss

Model underestimating results

1 in 250 AEP

Posting Collaterals

Trigger of net worth covenants re banking facility

Illiquidity

Forced asset sale

Major reinsurers default

Company specific issue(s)

Inability to raise capital

Inability to pay claims on time

…

Loss of credit rating …

Other possible unfortunate coincidences:

Adverse forex

General 1 in 20 non cat P&L

or or

Loss of investor confidence

RST v2.0Another Potential RST Candidate

Downgrade of Major Sovereign

• Fiscal consolidation credibility compromised

• Market loses confidence in sovereign

• Collapse of values of sovereign’s bonds held by company

• Feared illiquidity of the company

• Possible high levels of insurance losses from financial lines

As much about thought process and qualitative input as quantitative assumptions


AppendixLinkages with Internal Capital Model


SST / RST

Capital Model

Use opportunities:

Quantification: probabilities and severities – especially with modelled P&L events

E.g. catastrophe losses, reserve deteriorations, investment losses

Validation opportunities:

E.g. Do we see implied economic scenarios in the ESG?

E.g. Are unmodelled clash events adequately represented by the copulas?

Open Discussion

Possible Topics

• What other issues do you see?

• Concepts of business failures

• “Most likely” scenarios

• Quantification difficulties

• Implementation challenges

• Links with Solvency 2

• Non London Market companies


Documents

© 2010 The Actuarial Profession Colour palette for PowerPoint presentations Actuarial Bright Green R148 G166 B31 Actuarial Slate