Risk Metrics CS-18

Max J. Rudolph, FSA CFA RHU FLMI MAAAVice President and Actuary

Mutual of OmahaEnterprise Risk Management

July 29, 2003

Risk Metrics Audience

•Key individuals have differing backgrounds, education, perspectives and goals• internal audiences

• senior corporate management• actuarial, accounting and investment professionals

• external audiences• securities analysts, rating agencies, regulators

•Absence of common risk management language•Graphics are the key…but not always

Risk/Return Profile

-

10,000

20,000

30,000

40,000

50,000

60,0001 4 7 10

13

16

19

22

25

28

31

34

37

40

43

46

49

52

55

58

61

Ranked Scenario

OAVDE42,296

Alternative Investment Strategy

-

10,000

20,000

30,000

40,000

50,000

60,0001 4 7 10

13

16

19

22

25

28

31

34

37

40

43

46

49

52

55

58

61

Ranked Scenario

OAVDE27,000

Deferred Annuity - Value of X% Interest Guarantee

-

10

20

30

40

50

60

70

80

90

100

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

Cumulative Probability

9/30/98

12/31/98

6/30/99

Risk/Return Profile

•Strengths• distribution of returns

• identify challenging scenarios

• tail of distribution is “THE RISK”

• test hedges

• compare against deterministic scenarios

• provide summary statistics• mean, median, quartiles

•Weaknesses• scenarios must cover

universe - do they?

• model run time

• accuracy doesn’t always follow large volumes of data - GIGO (garbage in, garbage out)

Economic Surplus

•Difference between the market value of cash inflows and outflows• asset and premium cash flows are combined

• liability cash flows

•Spirit of fair value accounting

•DS = DL + (DA-DL) * MVA/MVS

•DS,DA,DL duration of surplus,assets,liabilities

•MVA,MVS market value of (all) assets,surplus

•Mismatch DA-DL

•Leverage MVA/MVS

Price Behavior Curves

1 , 1 0 0 , 0 0 0

1 , 1 5 0 , 0 0 0

1 , 2 0 0 , 0 0 0

1 , 2 5 0 , 0 0 0

1 , 3 0 0 , 0 0 0

1 , 3 5 0 , 0 0 0

1 , 4 0 0 , 0 0 0

1 , 4 5 0 , 0 0 0

1 , 5 0 0 , 0 0 0

1 , 5 5 0 , 0 0 0

1 , 6 0 0 , 0 0 0

-300 -200 -100 0 100 200 300

Yield Shift (bp)

Op

tio

n A

dju

sted

Val

ue

($,0

00)

Assets w / Premium Liabilities

-

5 0 , 0 0 0

1 0 0 , 0 0 0

1 5 0 , 0 0 0

2 0 0 , 0 0 0

-300 -200 -100 0 100 200 300Yield Shift (bp)

OA

V($

,000

) Economic Surplus

Economic Surplus

•Strengths• drives duration/convexity

• puts assets and liabilities on level playing field

• you can’t eat a rate - based on cash flows

• create values at lowest level - can roll up

• intrinsic value - starting point for market value discussion

•Weaknesses• learning curve

• see David Babbel papers

• model run time

• sensitive to interest rates

• reliance on canned software

Additional Risk Metrics

•Internally measured liquidity ratio

•RBC diversification ratio

•Key Rate (Partial) Durations

The key is to use multiple tools, leverage off of what you are already doing and know your audience (graphics)