Risk Management in Life Insurance-Part-1

Sonjai Kumar, Vice President (Business Risk) Aviva India Life Insurance

Disclaimer: Opinion expressed in this presentation are mine and not necessarily of my employer.

Birla Institute of Management Technology (BIMTECH)

Introduction

Agenda ( Risk Landscape)Why Risk ManagementWhat is Enterprise Risk Management

(ERM)Global position in Risk ManagementHow India is Placed in term of Risk

ManagementFuture of Risk ManagementSuccess Factors to be risk professional

Why Risk Management Minimize losses and unpleasant surprisesBetter risk transfer arrangementUnderstand the link between business growth,

risk and returnBetter allocation of CapitalImpact on valuation of the CompanyRegulatory requirement Reduce earning volatility- Stable flow of

incomeShareholder’s value addition

Why Risk Management- Now 2008 economic crisis- Trigger point Overall Control failureBoard room failureInnovative productsEasy available creditPoor financial underwriting practiceOthersQuestion: What can done to protect

another economic crisis?

No risk management can totally protect the another crisis but it can prepare the world better to reduce the adverse impact or delay the crystallization of risk

What is Enterprise Risk Management “ERM” Silo risk management- Insurance sector- 100s of years Disadvantage-limited to few people/departments ERM: Ownership- Board-CEO-CRO Risk Policies owned by the Board Each department have risk objectives to meet Implementation of risk policies-CRO and Risk Team Annual risk monitoring exercise ERM is integration of Risk strategies and risk

management across the Company. Instead of defensive control oriented approach of downside

risk and earning volatility, the idea of ERM is to optimize business performance by optimally allocation of resources through risk based decision making to make risk management as an offensive tool.

Benefit of ERM: Diversification effect

Where the World is moving Towards ERM CRO is becoming important position in Financial institution Key positions are CEO,CFO and CRO CRO has a big role to play in the implementation of risk

management framework. Key findings of 2015 UK CRO Insurance Survey

Regulators are taking keen interest in the implementation of risk management

World is moving towards Risk Based Capital-Developed Market

Basel-II/III in Banking side Solvency-II in Insurance side-European CountriesQuestion: Why capital is needed?Question: What is risk based capital?

Risk Based Capital-I Capital is scares – Not infinite How currently capital is currently determined?- Formula

approach How risk based capital is different?- Capital is determined

based on risk presented to the business What are the risks? What does this do?- Lower the risk lower the capitalQuestion: Two companies with exactly everything

similar such as products, strategy, management etc- Should they have same Solvency Capital?

Risk Based Capital-II There is an incentive for risk management Risk Management optimizes the use of capital- also with

diversification effect Risk Management also improves the profits Its more objective in nature What are the Challenges? Operational Risk Model dependents Complicated Regulatory intervention/model approval Expensive

How Capital is Calculated Value at Risk-VaR VaR is a statistical tool that uses the historical market trends

and volatilities to estimate the maximum loss to the portfolio or to the Company within a given time frame and within certain level of probability confidence level

The time frame could be one day, or one year The probability confidence level could 99%, 99.5% etc. History: 1989, JP Morgan Chairman, Dennis Weatherstone

use to have “4.15 pm Report” everyday. The report used to combined all the firms data on market

risk in one place, the intention was to collect the information sufficient to answer the question: “ How much could the bank loss if tomorrow turns out to be a relatively bad day”

Question: What are the challenges in the calculation of VaR?

Basel-II (Banking) From 1997 onwards, VaR became accepted within the

regulatory community, first with US securities and Exchange Commission (SEC) and subsequently with Basel Committee Supervision (BCBS) in the implementation of Basel-IIBasel-II is three pillar approach

Pillar-1: Quantitative requirement-Market risk, Credit Risk, Equities risk, Operational risk

Pillar-2: Qualitative requirement-Supervisory review, Risk Management

Pillar-3: Disclosure

Solvency Capital discussed above is a part of Pillar-I of Solvency-II regime.Solvency-II is shaped into three pillars;

Pillar-IQuantitative part of

capital calculatio

n

Pillar-IIRisk

Management

Pillar-IIIdisclosur

es

Interaction Interacts both the pillars

Solvency-II (Insurance)

Capital Business

Interest Rate Risk Equity Risk Credit Risk

Mortality Risk

Persistency Risk

Expense Risk

Operational and Regulatory Risk

Liquidity Risk

Profit

Insurance and Ops.Risk

Financial Risk

Pillar-I ( SCR)

Pillar-IIRisk

Management Framework

Risk Management

Cycle

Risk Culture

Risk Policies & Standards

Three lines of Defence

Risk Governance

Risk Appetite

Risk Management Strategy

Pillar-II (Risk Management)

What does this mean? Risk Management is going to play key role in the optimization

of risk and return There is a direct correlation between incentive to invest in risk

management that is going to impact capital and profit both CRO role is becoming critical for the organization and to some

extent success factor for the Company Certain clear roles are defined for all the three line of defence Board owns all the risk policies and there is a clear weight of

risk management in CEO’s reward structure Risk management become the part of decision making

exercise especially whether any new decision fits within the risk appetite of the Company or not

Question: What are the challenges in managing risk and how risk management can be made effective?

Solvency-I

Free Assets

Book Value of Assets

Solvency Capital

Liability (Reserve)

Prudent Basis with margins in assumptions

Formula Approach

To write New Business and meet expenses to fund overrun

Free Assets

CapitalSCR

MCR

Market Value of Assets

Risk Margin

Best Estimate Liability

Risk Based capital

Market Value of Liabilities Calculated at risk free rate

Regulatory Action

Supervisory Intervention

Solvency-II

India EU

% of SCR 30% to 40%

Using VaR @ 99.5% CI Or Stress TestX% of Reserve + y%

of Sum at Risk

Extra margin of future turns out to be worse

Solvency Position

How India is Placed (Regulatory)

Regulatory point of view, we are following Solvency-I regime

This means Capital is based on formula approach- What does this mean? Little incentive for risk management

However, IRDA has made the CRO position mandatory IRDA has made it necessary to have disclosures on

quarterly basis on its website IRDA has also started asking life companies to calculate the

risk based capital on an annual basis and report to IRDA- however this is only for reporting purpose

There is a growing interest towards the risk management and ask companies to submit the Assets and Liability position on quarterly basis

Have developed some features of three pillar apprach

India: Companies Landscape Mostly JV with 26% and 74%, Some companies are following the risk management of

their parent companies but this depends whether the JV is from European countries or elsewhere

Risk management in the Indian insurance market is in a very infancy stage

All the Companies have ALCO and RMC as a part of IRDA Governance

So have some oversight on risk management, but not sure used in decision making purpose which has become key in Solvency-II

Some life companies have risk management in the operational risk, Fraud, Financial Crime

Future of Risk Management Mostly JV likely to move towards 49% and 51%, Risk management oversight likely to be increased as a part

of more governance from parent companies Influence of Risk management will increase even if IRDA go

slow towards Solvency-II IRDA may eventually move towards Solvency-II regime that

will increase the application of risk management Banks are already in the mode of Basel-II, so have

oversight on the risk management Other financial institutions such as Non-Banking Financial

institution are also using the risk management Key risks in other financial institutions are Liquidity Risk,

Credit Risk, Interest rate risk

Success Factors Understanding of the risk tools Understanding of the Business and products Development/Knowledge latest tools and skills Upgrading the information on Risk Opportunity to do pioneer work in risk management Developing the thought process of what can go wrong,

what if approach Communication skills Risk management is a tough job- how to communicate to

send the message across Be a partner in the Game and not a police man. Attitude and interpersonal skills Dedicated, Sincere and Honest.

Key findings of 2015 UK CRO Insurance Survey

Standing of CRO is consistently increasing across the market

All the firms have three line of defence governance structure

Regulatory intrusiveness and uncertainty has been and will continue to be “distractions” to the role of CRO

ORSA adds value to their organization but efficiency, effectiveness and embedding remain a challenge

People and skills remain key priorities for investment

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To be continued….