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    Defines risk metrics and risk appetite in terms of those metrics. Using risk metrics to define a limit framework

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    Defines risk metrics and risk appetite in terms of those metrics. Using risk metrics to define a limit framework

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    283 views27 pages

    Risk Appetite in Enterprise Risk Management Framework

    Uploaded by

    jfrankparnell
    Defines risk metrics and risk appetite in terms of those metrics. Using risk metrics to define a limit framework

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as pdf or txt
    of 27

    RISK APPETITE IN ERM FRAMEWORK

    How can we define the Risk Appetite? How can we use the Risk Appetite in day-to-day business? What does the Risk Appetite give in terms of ERM?

    Swedbank

    Business Plan / Objectives Risks identified Risk appetite set Risk appetite embedded

    Day-to-day Strategic business decisions

    Swedbank

    Risk appetite how it could be structured?

    Swedbank

    Qualitative

    Quantitative

    Overall risk appetite

    Risk level appetite

    Risk level limits

    Swedbank

    Qualitative

    Quantitative

    Overall risk appetite

    How shall the Company treat the risks?

    Risk level appetite


    Interest rates Risk Equities Risk Currency Risk Mortality Risk Catastrophe Risk Etc.

    Qualitative statements
    Avoid Neutral Seek

    Risk level limits

    Swedbank

    Qualitative

    Quantitative

    Overall risk appetite How shall the Company measure the risk? Risk level appetite

    Risk measures
    VaR (Value at Risk) maximum loss that is not exceeded with the certain probability TVaR (Tail Value at Risk or Expected Shortfall) the expected loss (conditional on loss) exceeding VaR
    Simple

    Tricky

    Risk level limits

    Etc.

    Swedbank

    Qualitative

    Quantitative

    Overall risk appetite

    What are the values under the risk?

    Values that could be measured


    Risk level appetite Earnings at Risk the gross profit in the statement of the comprehensive income Embedded Value at Risk market consistent economic value of in-force business (PV of future earnings) Economic Capital Required analogous to SCR but based on economic model Risk level limits Etc.

    Swedbank

    Qualitative How much of the risk could the Company tolerate?

    Quantitative

    Overall risk appetite

    Quantitative statements
    Metric EVaR Embedde d Value at Risk Earnings at Risk Value at risk Market consistent embedded value Gross profit Time horizon 1 year Confidenc e level 99.5 % Interpretation 1 in 200 years event 1 in 25 years event

    Risk level appetite

    EaR

    1 year

    96.0 %

    Risk level limits

    Tolerance levels are: Embedded Value at Risk shall not exceed xx EUR. Earnings at Risk shall not exceed xx EUR. Here: xx shall be determined based on value itself and actual VaR. In addition alert and targeted levels can be set.

    Swedbank

    Qualitative

    Quantitative

    Overall risk appetite

    How shall the metrics be calculated?

    Example: calculating the particular metric


    Risk level appetite Metric: Earnings at Risk Purpose: Measuring the short term volatility of earnings Risk level limits Definition: Earnings at Risk = Best Estimate of Earnings 96th percentile confidence level of Earnings (can be expressed as % from Best Estimate of Earnings) Scope: Including new business

    Swedbank

    Qualitative

    Quantitative

    Overall risk appetite

    How shall the Company deal with the risk?

    Risk level appetite

    Qualitative statements
    Interest rates risk: the Company shall work on the matching of assets and liabilities Equities: the Company shall limit investments into equities

    Risk level limits

    Catastrophe: the Company shall reinsure catastrophe events Etc.

    Swedbank

    10

    Qualitative

    Quantitative

    Overall risk appetite

    Where is the link between the overall and the risk level risk appetite?

    Risk level appetite

    Aggregation of the risks


    Summing up values of individual risks Manual aggregation with correlation matrices (e.g. using SCR matrices) Modeling structural scenarios (e.g. modeling market developments where one scenario covers developments of interest rates, equities prices, currencies exchange rates, etc. and manual aggregation is not needed) Aggregation with joint distribution of risks (copulas) Etc.

    Simple

    Risk level limits

    Tricky

    Swedbank

    11

    Qualitative

    Quantitative

    Overall risk appetite

    How to shall the company calculate the risk metrics for each of the risks?

    Risk level appetite

    Calculation of the individual risk metrics


    Calculating the baseline (best estimate) value + Calculating the stressed value by applying only one scenario for each of the risks that is consistent with confidence level + Calculating the difference Calculating the baseline (best estimate) value + Modeling the scenarios stochastically to get the distribution of the values (including value at certain percentile) + Calculating the difference
    Tricky Simple

    Risk level limits

    Swedbank

    12

    Qualitative

    Quantitative

    Overall risk appetite

    How to define the extremely adverse scenario (shock) occurring with the certain probability?
    If we had 1000 scenarios (ranked from the best to the worst ) what would be the 960th scenario?

    Risk level appetite

    Calibration of the shocks


    Adjusting the shocks provided for the standard SCR formula using approximations, e.g. assuming that shocks are normally distributed shock adjustment coefficient" can be calculated from: (2.57) = 0.995 and (2.57 shock adjustment coefficient) = 0.96. Calibrating the shocks based on own company (e.g. lapses), country or world wide experience (e.g. catastrophe) Calibrating the shocks using the scenarios generator (assumptions about distributions and correlations are needed) Etc.
    Tricky Simple

    Risk level limits

    Swedbank

    13

    So what do we have so far?

    Swedbank

    14

    Qualitative

    Quantitative

    Overall risk appetite

    Attitude towards risks is determined in scale Avoid Neutral Seek

    Tolerated levels are set for the risk metrics: EVaR, EaR, etc. for the whole business Extremely adverse scenarios are defined

    Risk level appetite

    Approach of dealing with each of the separate risk is determined

    Tolerated levels are set each of the separate risks in terms of EVaR, EaR, etc.

    Risk level limits

    Swedbank

    15

    Now lets move on further

    Swedbank

    16

    Qualitative

    Quantitative

    Overall risk appetite

    How shall the Company monitor the exposure to risk?

    Monitoring (quarterly)
    Risk level appetite The actual value compared with: The targeted value The alert levels The tolerance levels Risk level limits
    Metric (VaR)

    Time
    Swedbank

    Actual VaR Target level Alert level Tolerance level


    17

    Qualitative

    Quantitative

    Overall risk appetite

    How could Key Risk Indicators (KRI) help in monitoring?

    Risk level appetite

    Key Risk Indicators


    E.g. One of the monitored KRI could be the interest rate curve for European sovereign bonds, in particular the yield for 10 years. If the change of 250 bps is defined as the extremely adverse scenario, it shall be monitored if KRI does not change in such amount.

    Risk level limits

    Swedbank

    18

    Qualitative

    Quantitative

    Overall risk appetite

    Qualitative restrictions
    Risk level appetite The restriction for each of risks coming from risk appetite shall be embedded into currently existing or new strategies, policies, etc.

    Risk level limits How to translate the risk level risk appetite into the limits for dayto-day business operations?
    Swedbank 19

    Qualitative

    Quantitative

    Overall risk appetite

    Example of quantitative restrictions


    What is the maximum allowed mismatch between the duration of the assets and the liabilities?

    Steps: Risk level appetite Defining the extremely adverse scenario, e.g. the change of the interest rates by 250 bps. Deciding on the approximation of the impact, e.g.

    Impact = Value Duration Change of interest rate


    Seeking for the duration that would result in the impact that is not tolerated. Risk level limits Communicating the risk limit by embedding it into currently existing or new strategies, policies, etc.

    How to translate the risk level risk appetite into the limits for dayto-day business operations?
    Swedbank 20

    And what do we have right now?

    Swedbank

    21

    ... Yep! We have the table filled in

    Swedbank

    22

    Qualitative

    Quantitative

    Overall risk appetite

    Attitude towards risks is determined in scale Avoid Neutral Seek

    Tolerated levels are set for the risk metrics: EVaR, EaR, etc. for the whole business Extremely adverse scenarios are defined

    Risk level appetite

    Approach of dealing with each of the separate risk is determined

    Tolerated levels are set each of the separate risks in terms of EVaR, EaR, etc. Tolerated levels are translated into the risk limits that are embedded into the internal regulations

    Risk level limits

    The risk appetite principles are embedded into the internal regulations

    Swedbank

    23

    Qualitative

    Quantitative

    Overall risk appetite

    Risk strategy (approved by the Board)

    .
    Risk level appetite

    Regular risk monitoring reports (provided to the Board)

    Risk policy (-ies) Risk level limits (approved by the Board)

    Risk reports analysing the impact of the decisions (used by the Board)

    Swedbank

    24

    And a final look: how does this Risk Appetite framework fit into the ERM?

    Swedbank

    25

    Risk Appetite and ERM


    Risk Appetite shall be integrated into the organisational and decision making processes: Launching products/business lines Hedging/reinsurance strategies Capital allocation Pricing

    Risk Appetite shall be used for monitoring and reporting: Performance measurement Internal and external reporting

    Setting the Risk Appetite framework is a starting point of the ORSA process.

    Swedbank

    26

    Questions / discussion

    Swedbank

    27

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