Enterprise Risk ManagementCase Study 5: Earnings-at-Risk

Ron HarasymSun Life Financial

Casualty Actuarial Society / Society of ActuariesEnterprise Risk Management SymposiumApril 14, Chicago Illinois

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Outline of Presentation

• Market Risk Tolerance Limits (MRTLs)• Progression to Earnings-at-Risk (EaR)• Comparison with other tools• Sample Earnings-at-Risk report• ERM moving forward

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Development of Market Risk Tolerance Limits

• Senior management was surveyed as per risk tolerance.• Limits were established on interest, equity, and currency

risk at the company and business group level.• Stylized capital market shocks were defined.• An income sensitivity testing standard was developed.• Income sensitivity is now tested against these limits.• Business groups must explain and justify if beyond these

limits.• Compliance report is presented to the Executive Risk

Committee and the Risk Review Committee of the Board.

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Progression to Earnings-at-Risk• Quantifies both the frequency and severity of scenarios• Forward looking:

• can identify exposures• can act as an early warning system

• High information density:• identification of cross-operation risk diversification• identification of intra-operation risk diversification

• Complex stochastic modeling required• heavy computational demands• use of representative scenarios helps

• Communication challenges

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Comparison: Business Plan, MRTL, EaR(1) Business Plan: consists of a single projection

(2) Market RiskToleranceSensitivities:

• 4 interest scenarios• 4 equity scenarios

-30%

-20%

-10%

0%

10%

20%

30%

-200 bps -100 bps 0 bps 100 bps 200 bpsInterest Movement

Equi

ty M

ovem

ent

(3) Earnings-at-Risk,,,,,,Sensitivities:

• Additional 16+,,joint interest/equity,,scenarios

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-40%

-20%

0%

20%

40%

60%

-300 bp -200 bp -100 bp 0 bp 100 bp 200 bp 300 bpInterest Movement

Equi

ty M

ovem

ent

(4) Earnings-at-Risk Simulation• simulation of typically 10,000 economic scenarios via interpolation into the earnings surface

Comparison of Approaches (Continued)

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Comparison With Other Tools

Tool Number ofScenarios

ProjectionPeriod Purpose

BusinessPlan 1 base scenario 1-3 years detailed (precise) projection

of base scenario

MRTL 4 interest scenarios4 equity scenarios 1 year inderdstanding of stylised

shocks

Earnings-at-Risk

10,000 fittedscenarios 1 year probabalistic measure of

risk

DCAT 5-10 scenarios 5 years severe deterministic stresstesting

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Sample Earnings-at-Risk ReportCTE [95%] Uncorrelated Correlation

Risk Originator Interest Equity Currency Total Effect Total EaR

Country A $88 $24 $0 $112 ($22) $90

Country B $23 $68 $14 $105 ($18) $87

Country C $44 $42 $17 $103 ($5) $98

Country D $56 $9 $55 $120 ($35) $85

Uncorrelated Total $211 $143 $86 $440 ($80) $360

Correlation Effect ($140) ($51) ($5) ($196) $37 ($159)

Total EaR $71 $92 $81 $244 ($43) $200

Risk Category

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Sample Earnings-at-Risk Chart

Interest Rate

Equity

Currency

Country ACountry B

Country CCountry D

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

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ERM Moving Forward

• MRTL & EaR are decisions support tools, directed atsupporting risk based decision making by senior management

• It will take a number of years to:• to include other risk factors such as mortality/morbidity,

credit risk,....• to fully embed in the organization with

• greater drill down• greater linkage between decisions made in

front/operational lines and resultant impact on riskexposure

• Finally, the process is still evolving.