30 Risk Culture Beliefs

Welcome to our RISKVIEWS blog series on the 30 Risk Culture Beliefs, a comprehensive exploration of the core principles that should guide any organization’s approach to effective risk management. Over the course of this series, we will delve deep into each belief, unpacking their significance and practical implications for businesses, especially those in high-stakes industries like finance and insurance.

Risk management is often viewed through the narrow lens of mitigation and compliance. However, these 30 Risk Culture Beliefs challenge us to see risk management as a multifaceted tool that not only safeguards but also strategically enhances organizational capabilities. From fostering a proactive risk-aware culture to aligning risk management with corporate strategy, these beliefs serve as pillars that support robust decision-making frameworks.

Each blog post in this series will focus on a single belief, breaking down how it influences organizational behavior, decision-making, and strategic planning. We aim to provide insights into how these beliefs can be integrated into the daily operations of a company, influencing everything from the boardroom to the front lines. By understanding and implementing these principles, organizations can transform their risk management practices from reactive protocols to strategic assets.

We are thinking of these beliefs as a menu, rather than as a prescription. We would not expect any one company to adopt all 30. If fact, you might find that some of them might be a little contradictory. Each company’s risk management culture will consist of a different set of choices from this list with different hierarchy of importance for the chosen beliefs within the organization. Some of the beliefs might be directed towards the entire company while others are focused towards the executive management team and some are pointed at the risk management staff and CRO.

Our journey through the 30 Risk Culture Beliefs will equip you with the knowledge to foster a culture that embraces calculated risks, promotes transparency, and improves resilience. Whether you are a risk management professional, a business leader, or just keen on enhancing your organization’s approach to risk, this series will offer valuable perspectives that can be tailored to your needs.

Join us as we explore how these foundational beliefs can shape risk-conscious strategies that not only protect but also propel organizations towards sustainable growth and stability. Stay tuned for our first post, where we will begin with the belief that “Continuous Learning is Critical to Adapting to an Evolving Risk Landscape,” setting the stage for a thoughtful and proactive approach to enterprise risk management.

1. Continuous Learning is Critical to Adapting in an Evolving Risk Landscape
2. Transparency with Stakeholders Builds Trust and Enhances Risk Management
3. Cross-Functional Collaboration Optimizes Risk Response.
4. Innovation is Equally a Risk and an Opportunity.
5. Risk Management is Everyone’s Responsibility.
6. Risk Management is a Competitive Advantage.
7. Change is Inevitable, Adaptability is Optional.
8. Long-term Stability is More Valuable than Short-term Gains.
9. Technology Enhances Risk Management Capabilities.
10. Ethical Behavior Drives Sustainable Success  and Promotes Employee Well-being
11. Data Driven Decisions Minimize Subjectivity in Risk Management.
12. Strong Governance Strengthens Risk Management.
13. Integrated Risk Management Enhances Organizational Agility.
14. Stakeholder Confidence is Built on Consistent Risk Practices.
15. Stress Testing Builds Resilience.
16. Regulatory Alignment Maximizes Operational Efficiency.
17. Learning from Failures Enhances Future Resilience.
18. Constructive Challenge Strengthens Organizational Plans.
19. Environmental, Social, and Governance (ESG) Risks Are Business Risks.
20. Clear Risk Appetite encourages reasonable risk taking
21. Dynamic Insurance Portfolio Management Balances Stability and Agility
22. Comprehensive Risk Assessment is Fundamental to Financial Stability
23. Risk Reward Optimization Enhances Value Creation
24. Diversification is the Key to long term survival:
25. Loss Prevention is Paramount
26. Reinsurance Optimizes Risk Transfer and Capital Efficiency
27. Rigorous Actuarial Practices for Pricing and Reserves Secure Financial Stability
28. Robust Capital Modeling Enhances Risk Assessment and Management
29. Capital Adequacy Ensures Solvency and Financial Health:
30. Effective Asset-Liability Management (ALM) Balances Returns and Obligations      

Risk Culture Beliefs are one of the three legs that hold up an effective Risk Culture. But Risk Culture Beliefs are by far the least well known of those three legs. Dave Ingram explains the three legs HERE.

Cybercrime – Most Dangerous Risk of 2024

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The leading risk in the 2024 survey is Cybercrime. From phishing scams to ransomware attacks, cybercriminals are constantly evolving, posing new threats to individuals, businesses, and governments alike. Consistently ranked #1 or #2 in the annual Dangerous Risks survey, learn why we think that Cybercrime is here to stay. By Dave Ingram 

Innovation is Equally a Risk and an Opportunity

Risk Culture Beliefs Series

In the landscape of modern risk management, it is essential to recognize that innovation serves dual roles—it propels forward-thinking and growth while also presenting new challenges and uncertainties. The belief that “Innovation is Equally a Risk and an Opportunity” underscores a critical perspective in strategic risk management, urging organizations to evaluate and harness innovation judiciously.

Screenshot

Analytical Overview of Innovation in Risk Management

Innovation, characterized by the introduction of new technologies or business models, inherently carries risk due to its potential to disrupt established processes and market equilibriums. However, when strategically managed, innovation also presents significant opportunities for value creation and competitive differentiation. The RISKVIEWS blog suggests that a balanced approach to innovation involves rigorous risk assessment integrated with the innovation process, enabling organizations to anticipate potential downsides and capitalize on opportunities effectively.

Strategic Implementation Examples

In the insurance sector, for instance, the adoption of telematics in auto insurance represents an innovative practice that introduces both risks and opportunities. From a risk perspective, data security and privacy concerns are paramount, alongside the technological reliability of telematics devices. Conversely, the opportunity lies in the ability to offer personalized insurance products based on real-time driving data, potentially reducing claim costs and enhancing customer engagement. The RISKVIEWS analysis would focus on quantifying these aspects to illustrate the balanced approach to managing such innovations.

Risks incurred throughout the innovation process are, in some ways, at the heart of change, because when managed appropriately, they can lead to significant advances and aid in goal achievement.

İlknur Rodoplu

Proactive Risk Culture Adaptation

Adopting this belief requires cultivating a risk culture that does not shy away from innovation but approaches it with a structured risk management framework. This involves continuous learning, adaptability, and the integration of risk management practices at all stages of the innovation cycle—from conception through to implementation.

Conclusion and Future Discussion

Organizations that embed the principle that “Innovation is Equally a Risk and an Opportunity” into their risk management strategies can achieve a sustainable balance between risk and reward. They are better equipped to leverage the potential of new ideas while mitigating associated risks, thus maintaining robustness and agility in a dynamic business environment.

In our next discussion, we will explore the fifth Risk Culture Belief: “Risk Management is Everyone’s Responsibility”, examining how a decentralized approach to risk management can enhance organizational responsiveness and resilience. Stay tuned as we continue to delve into how these foundational beliefs shape comprehensive risk management strategies in contemporary settings.

Cross-Functional Collaboration Optimizes Risk Response

Risk Culture Belief Series

In the complex and interconnected world of business, addressing risks effectively often requires insights from multiple domains. The belief that “Cross-Functional Collaboration Optimizes Risk Response” highlights the strategic advantage gained when diverse organizational functions unite to tackle risk challenges. This collaborative approach not only enriches the risk assessment process but also ensures comprehensive risk mitigation strategies are employed.

The Imperative of Cross-Functional Collaboration

Risk is a multifaceted concern that impacts various parts of an organization differently. Thus, managing it in silos can lead to gaps in risk response and missed opportunities for mitigation. Cross-functional collaboration brings together diverse perspectives—from finance and operations to IT and human resources—each contributing unique insights that enhance the overall risk management strategy.

Practical Applications and Organizational Benefits

In practice, cross-functional teams work together to identify, assess, and respond to risks. For example, when a financial institution launches a new product, it involves not just the product development team but also compliance, marketing, IT security, and customer service. Each department examines the product from different angles, considering regulatory implications, market risks, cybersecurity threats, and customer impacts. This comprehensive analysis helps in crafting a well-rounded risk response strategy that is robust against multiple scenarios.

The RISKVIEWS Blog provides several case studies where organizations had to collaborate to resolve their problems. These organizations were able to mobilize diverse resources quickly and effectively, addressing crises in a holistic manner that significantly reduced losses and recovery times.

Building a Collaborative Risk Culture

Collaborative risk culture begins with leadership. Leaders must model the behaviors they expect to see throughout the organization. This means not only talking about risk management in abstract terms but embedding it into the daily activities and decision-making processes at all levels. Leaders must ensure that the organization’s risk appetite and tolerance are communicated clearly and understood widely. By setting a clear example and establishing comprehensive guidelines, leaders can create an environment where risk-aware thinking becomes second nature.

Embedding this belief into organizational culture requires structured mechanisms for collaboration. This might include regular cross-departmental meetings, shared risk management platforms, and joint training sessions on risk awareness. Such initiatives help break down silos and build a cohesive team approach to risk management.

Conclusion and Next Steps

“Cross-Functional Collaboration Optimizes Risk Response” is a guiding principle that underscores the importance of leveraging diverse expertise to fortify risk management practices. Organizations that embrace this belief are better equipped to handle the complexities of modern risk landscapes with agility and effectiveness.

Stay tuned for our next post where we will delve into the fourth Risk Culture Belief: “Innovation is Equally a Risk and an Opportunity.” We will explore how organizations balance the dual aspects of innovation, harnessing its potential for growth while managing the inherent risks it brings. Join us as we continue to unpack these transformative insights into risk management.

Transparency with Stakeholders Builds Trust and Enhances Risk Management

Risk Culture Belief Series

When banking regulators looked around at the financial institutions that fared less poorly during the 2008 financial crisis, one of the common themes that distinguished them was their dedication to internal transparency regarding their risks and risk management activities.  The belief that “Transparency with Stakeholders Builds Trust and Enhances Risk Management” underscores the profound impact of openness on an organization’s risk management framework and its overall relationship with stakeholders.

Strategic Significance of Transparency

The executives in central roles at those firms have constant access to the best information available. Those banks tended to react faster when their aggregate level of risk looked like it was headed above their risk tolerance. 

They also seemed to get into less trouble with risk concentration caused by people in different parts of the firm unintentionally piling onto similar and likely highly correlated risks. 

Transparency is just not expected from traditional risk management activities. Insurers that want to have an effective and disciplined ERM program must have Transparency.

In addition, Transparency in risk management fosters trust, not only with regulatory bodies but also with investors, customers, and employees. It involves clear communication about the organization’s risk exposure, risk management processes, and how risks are handled. This belief says that when stakeholders are well-informed, they are more likely to trust the organization’s management and decisions. This trust, in turn, strengthens the organization’s credibility and stability in the market.

Implementing Transparency in Practice

Generally executives are aware of the firm’s risks, but until ERM comes along and forces an actual discussion of risk, there is rarely a spontaneous agreement on priorities. For effective transparency, organizations must ensure that their risk management activities are visible and comprehensible to all stakeholders. This includes regular disclosures of risk assessments, risk management strategies, and the outcomes of such strategies. In the financial sector this might mean publishing detailed risk reports that explain the potential impacts of market changes on the institution’s portfolio and how these are being mitigated.

The RISKVIEWS blog provide examples of how financial institutions that adopted comprehensive disclosure practices not only complied with stringent regulatory requirements but also enhanced investor confidence during volatile market conditions. These institutions used transparency as a tool to manage expectations and provide a clear roadmap of their risk management strategies, which helped in mitigating panic and speculative actions by stakeholders.

Cultivating a Culture of Openness

Adopting this belief requires an organizational culture that values and practices openness at every level.

For over 20 years, some companies have practiced open-book management (OBM), sharing detailed information about their financial statements and business plans. But financial statements rarely provide actionable information about risk. Therefore, even in the OBM firms, there is generally a lack of knowledge about risk. With the transparency of risk and risk management information that comes from ERM, risk communication can become a part of the “Open Book.” 

There may be a paternalist urge to protect employees from scary information about risk, but ERM provides a language for talking not just about bad things that can happen, but also about what is being done about it. By including more employees in the risk discussion, there is also an increased chance that the firm will become aware of critical changes in the risk environment and possibilities for enhancing mitigation activities to better achieve the firm objectives with less disruption from unexpected adverse events. 

From the C-suite to the operational teams, everyone must understand the importance of transparency and its role in effective risk management. Encouraging a dialogue about risks and openly discussing failures as well as successes makes the organization more agile and responsive.

Conclusion and Forward Look

Embracing transparency is indispensable in the contemporary landscape where stakeholders demand more accountability and clarity. “Transparency with Stakeholders Builds Trust and Enhances Risk Management” is a principle that not only supports compliance but also catalyzes stronger, more trusting relationships with all parties involved in the organization’s ecosystem.

In our next post, we will explore the third Risk Culture Belief: “Cross-Functional Collaboration Optimizes Risk Response.” We’ll examine how integrating diverse functional expertise within an organization can lead to more robust risk mitigation strategies, driving home the value of collaborative approaches in contemporary risk management practices.

Continuous Learning is Critical to Adapting in an Evolving Risk Landscape

Risk Culture Belief Series

In the ever-evolving arena of risk management, the imperative for continuous learning stands out as a cornerstone for maintaining relevance and resilience. The belief that “Continuous Learning is Critical to Adapting in an Evolving Risk Landscape” encapsulates the need for organizations to perpetually enhance their risk management capabilities in response to dynamic external and internal variables.

Strategic Importance of Continuous Learning

Continuous learning in risk management goes beyond mere training and development; it involves an organizational commitment to the ongoing enhancement of knowledge, skills, and practices. This belief is grounded in the understanding that the risk landscape is not static. New risks emerge, existing risks evolve, and the tools and methodologies for managing risks advance. Organizations that embed continuous learning into their risk management framework are better equipped to adapt their strategies effectively and efficiently.

Practical Applications and Benefits

Implementing continuous learning can take many forms, from structured training programs and workshops to fostering a culture of inquiry and feedback among employees. For instance, in the financial services sector, continuous learning involves staying abreast of the latest regulatory changes, technological advancements, and market trends. This proactive approach not only prepares organizations to handle emerging risks but also enables them to leverage new opportunities for risk mitigation and value creation.

In addition to the continuous improvement that comes with the risk control cycle, companies should include a deliberate risk-learning process as part of their ERM program.

Here in the RISKVIEWS blog, numerous examples highlight how organizations that prioritize continuous learning exhibit enhanced adaptability and improved risk response mechanisms. These organizations routinely assess their risk management practices and seek out innovations in risk assessment and mitigation strategies, thus maintaining a competitive edge.

Cultivating a Proactive Risk Culture

The integration of continuous learning into risk management requires a shift from a reactive to a proactive risk culture. It demands that all organizational members—from executives to frontline staff—engage in regular learning activities and share insights across departments. This collaborative learning environment supports the development of a more holistic understanding of risk across the organization.

Conclusion and Next Steps

“Continuous Learning is Critical to Adapting in an Evolving Risk Landscape” is not just a guideline but a strategic imperative for modern businesses. Organizations committed to continuous learning are more agile, responsive, and resilient in the face of uncertainties.

In our next post, we will delve into the second Risk Culture Belief: “Transparency with Stakeholders Builds Trust and Enhances Risk Management“. We will explore how openness in communication and operations forms the backbone of trust and effective risk management. Join us as we continue to explore how these foundational beliefs shape robust risk management strategies.

Permafrost

https://www.podbean.com/media/share/pb-mcesh-15f7806

Feedback loops are increasingly seen as important in climate projections. Melting permafrost is expected to accelerate warming of the planet and release pathogens unknown to us today. By Max Rudolph.

Regime Change – Scenarios

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Four scenario examples leading to Regime Change from Neil Howe, Ray Dalio, Peter Zeihan and the IPCC show us how widely the disruptions can differ while consistently ending up with a big regime change in our near-term future. Part 2 of a four-part series. By Dave Ingram and Max Rudolph

The Crucial Role of Context in Risk Management Decision-Making

Another Guest Post by ChatGPT

Whether it’s the regulatory landscape, organizational culture, or market conditions, the context in which an organization operates significantly influences its approach to managing risks. Context shapes every aspect of the risk management process, from identifying potential risks to implementing effective mitigation strategies. In the world of risk management, understanding the context is not just important—it’s essential.

Why Context Matters

Internal and External Environment: The context includes both internal factors, such as an organization’s structure and culture, and external factors, such as economic conditions, technological advancements, and regulatory requirements. These factors affect how risks are perceived, prioritized, and addressed.

Risk Perception and Evaluation: Different stakeholders may perceive the same risk differently based on their individual perspectives and experiences. For example, a risk that seems minor to a financial analyst might be considered significant by a safety officer. Understanding the context helps ensure that all relevant viewpoints are considered in the risk evaluation process.

Risk Mitigation Strategies: The effectiveness of risk mitigation strategies often depends on the specific circumstances surrounding a risk. For example, a strategy that works well in a stable market might be ineffective in a volatile one. Contextual awareness enables organizations to choose and adapt strategies that are appropriate for their particular situation.

Frameworks and Perspectives in Contextual Risk Management

Several frameworks and perspectives highlight the importance of context in risk management:

ISO 31000 Risk Management Framework: This framework emphasizes tailoring risk management to the organization’s context, considering both internal and external factors to ensure the effectiveness of risk management processes.

COSO ERM Framework: The COSO framework highlights the alignment of risk management with an organization’s strategy and performance, underscoring the importance of context in identifying and assessing risks.

Regulatory Requirements: Compliance with industry-specific regulations shapes the risk management context. For example, financial institutions must adhere to Basel III standards, which dictate specific risk management practices.

Organizational Culture: The culture of an organization, including its risk appetite and tolerance, influences how risks are managed. A strong risk culture fosters proactive risk management and open communication about risks.

Stakeholder Expectations: Understanding the expectations of various stakeholders, such as investors, customers, and employees, helps ensure that risk management aligns with their interests and concerns.

Technological Context: The rapid pace of technological change introduces new risks and opportunities. Organizations must consider their technological landscape, including cybersecurity threats and digital transformation initiatives, in their risk management strategies.

Incorporating Context into Risk Management

To effectively incorporate context into risk management, organizations can follow these steps:

Conduct a Contextual Analysis: Start by analyzing both the internal and external environment to identify factors that influence risk management. This includes assessing the regulatory landscape, market conditions, organizational culture, and technological advancements.

Engage Stakeholders: Involve stakeholders from different areas of the organization and external partners to gather diverse perspectives on risks and their potential impact. This helps ensure a comprehensive understanding of the context.

Tailor Risk Management Processes: Adapt risk identification, assessment, and mitigation processes to fit the specific context. This might involve using different risk assessment tools or modifying risk criteria based on the organization’s objectives and environment.

Monitor Changes in Context: Continuously monitor changes in the internal and external environment that could affect the organization’s risk profile. Stay agile and be prepared to adjust risk management strategies as the context evolves.

Communicate Contextual Insights: Share insights about the context and its implications for risk management with relevant stakeholders. Clear communication helps ensure that everyone understands the rationale behind risk management decisions.

Review and Update: Regularly review and update risk management practices to ensure they remain relevant and effective in the current context. This includes revising risk policies, procedures, and mitigation strategies as needed.

Conclusion

In conclusion, context is a critical factor in risk management decision-making. A deep understanding of the internal and external environment enables organizations to develop and implement risk management strategies that are tailored to their specific circumstances. By embracing a contextual approach, organizations can enhance their resilience, adaptability, and overall effectiveness in managing risks.

This post was created with a CustomGPT designed by RISKVIEWS. The GPT is called Risk Personalities Engine. To learn more about the Risk Personalities Engine. visit this page on the RISKVIEWS blog.

Interest Rate RIsk for Insurers

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When rates recently spiked it surprised many with direct and indirect implications. The market value of bonds decreased, and the price of replacement parts for autos increased. There are three ways that insurers can be affected by higher rates. Looking at past events help to prepare for similar tail events in the future. By Max Rudolph.

AI Can Help the CRO

A Guest Post by ChatGPT

For Chief Risk Officers (CROs) navigating the complex and rapidly evolving landscape of risk in financial institutions, artificial intelligence (AI) presents a suite of powerful tools to enhance decision-making, improve risk assessment, and optimize risk management processes. AI’s capabilities can significantly impact various aspects of a CRO’s job, making it a pivotal ally in addressing strategic, operational, and financial risks.

Enhanced Risk Identification and Assessment

AI can process vast amounts of data from diverse sources, including market trends, operational metrics, and social media, to identify and assess risks more efficiently than traditional methods. This capability allows CROs to detect emerging risks faster and with greater accuracy, facilitating proactive risk management. For instance, machine learning models can predict potential default risks by analyzing patterns in credit history, market conditions, and economic indicators, thereby enhancing the accuracy of credit risk assessments.

Strategic Decision Support

AI supports strategic decision-making by providing CROs with data-driven insights into risk-return trade-offs associated with different strategic choices. By simulating various scenarios and analyzing their potential impacts on the organization’s risk profile, AI helps CROs in making informed decisions that align with the company’s risk appetite and strategic objectives.

Operational Risk Management

AI can automate the monitoring of operational risks by analyzing transaction patterns, employee activities, and compliance with procedures, identifying anomalies that may indicate fraud, errors, or inefficiencies. This real-time monitoring capability enables CROs to swiftly address operational risks, reducing potential losses and improving operational resilience. Furthermore, AI-powered process automation can streamline risk management processes, enhancing efficiency and reducing the likelihood of human error.

Financial Risk Analysis

In the realm of financial risks, AI models excel at analyzing market data, economic indicators, and financial trends to forecast future market movements and assess the potential impact on the organization’s financial health. This analysis can include stress testing, value-at-risk (VaR) calculations, and sensitivity analyses, providing CROs with a comprehensive understanding of financial risks and the effectiveness of hedging strategies.

Risk Reporting and Communication

AI can also revolutionize risk reporting and communication by generating dynamic, real-time risk reports that offer insights into the current risk landscape. These reports can be tailored to different audiences, from the board of directors to operational teams, ensuring that all stakeholders have the information they need to understand and manage risks effectively.

Conclusion

For CROs, the adoption of AI in risk management offers a transformative approach to navigating the complexities of risk in the financial services industry. By enhancing risk assessment, supporting strategic decision-making, improving operational efficiency, and facilitating effective risk communication, AI enables CROs to manage risks more proactively and strategically. As the risk landscape continues to evolve, leveraging AI will be crucial for CROs aiming to foster a strong risk management culture and drive their organizations towards sustainable growth and resilience.

Dangerous Risks 2024: Return to Normal Concerns

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The 2024 survey sees respondents react to recent increases in specific risks as technology evolves and the environment moves away from the pandemic. The top 4 risks are the same as those seen in 2019. By Dave Ingram and Max Rudolph.

No Free Lunch

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New asset classes like junk bonds and subprime mortgages initially promised high returns without too much risk. Many investors were surprised to find that the risk premium was insufficient to provide for actual losses when they came. Modelers need to adjust for incomplete investment cycles that include only the positive part (e.g., high spreads) but not the defaults and liquidity crises typical at the end of a cycle. By Max Rudolph

RiskMaster Cheat Code

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Has any of your ERM program has been written down? Or is it at risk of being lost when a key player leaves the insurer?  The Risk Management Framework document provides the RiskMaster Cheat Codes for understanding the overall ERM system and for specific topics like stress testing and risk reporting to allow a new risk team to start from a solid base should that be needed. It also can act as a cheat sheet for the Board to be able to participate in ERM discussions even though they do not live in the system. By Dave Ingram.

Water, Water Everywhere

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Climate change and population growth have stressed fresh water sources, leaving agriculture and coastal residents with opposing issues. While aquifers and rivers struggle, extreme weather and sea level rise provide an overabundance of water. Insurers increasingly are dealing with these extreme weather events that highlight the presence of too much water (hurricanes, inland flooding) or too little water (drought, fire).  Today Max covers some existing issues while others will be emerging at a later time. By Max Rudolph

2024 Most Dangerous Risks

Again at the beginning of 2024, we polled a large group of insurance executives and asked them which of 48 risks taken from their risk registers do they expect will be more dangerous in the coming year.

Here is their response:

Down the full report:

Dangerous Risks 2024 Report

Last Year’s Report:

Most Dangerous Risks of 2023

Achieving Resilience

 

https://www.podbean.com/media/share/pb-78duc-155b765

Resilience can be described as bending without breaking. There are four aspects of ERM that all need to be fully adopted to achieve this important result. By Dave Ingram.

Using Risk Appetite: Contrarian Views

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It is commonly assumed that higher returns require higher risk to be accepted. Fear and greed may outperform over the short term but often the last investor in does poorly. Long periods of stimulus provide warning that economic cycles come to an end eventually. By Max Rudolph.

Top 10 ERM Podcasts of 2023

Have you listened to these ten popular Crossing Thin Ice Podcasts of 2023?

https://crossingthinice.podbean.com/

Title	Released	Downloads
Spillover Diseases	Apr 07, 2023	207
Telling Your ERM Story to Rating Agency	Jul 10, 2023	186
Concentration	Aug 07, 2023	163
Inflation – Most Dangerous Risk of 2023	May 08, 2023	159
Six Futures for ERM	Sep 11, 2023	156
Super Volcano	Aug 21, 2023	153
Three Levels of Stress	Jun 07, 2023	150
Risk and Capital	Nov 06, 2023	136
Fear vs. Danger	Apr 24, 2023	134
Microplastics	Jun 19, 2023	126

Spillover Diseases – As humans encroach on new ecosystems diseases found in animals and birds can jump to a new home inside us. We think about coronavirus and influenza but should monitor closely diseases like bird flu and Ebola.
Risk Reporting to Rating Agencies – Insurers view interactions with rating agencies with trepidation, but a strategy can be implemented for your presentation that gives the rating agency what they need to know to give a fair review.
Concentration Risk – Concentration is added by doubling down on things you do well. This two-part article considers strategic drivers that add to concentration and tactical methods to mitigate these risks.
Inflation – Emerging risks sometimes seem like they come out of a science fiction movie. Solar storms are more than just pretty northern lights. An impactful solar storm happened as recently as 1859. While some problems with telegraph wires were reported, just imagine how much more we depend upon electronics now than we did then.
Six Futures for ERM – Scenario based planning is good for forming company strategy and it can also be good for planning risk management. There are a number of ways that the future might play out for risk management and the likelihood of each of the six possibilities mentioned here has probably changed significantly because of our experiences over the past two years. Which future will you be prepared for and which would have been a total surprise if you hadn’t read this article?
Super volcano – A volcano erupts somewhere, on average, every week. Eruptions large enough to impact the global environment happen much less frequently, but they have happened. The “Year without a Summer” in 1815 affected crops and immigration, and similar events will happen again. These Super Volcanoes tend to have numerous knock-on effects.
Stress Testing – Three levels of Stress – Stress tests come in various levels of adversity; normal volatility, realistic disasters and worst case scenarios. Aligning the situation to the appropriate stress test is very important when managing an insurer. Regulators are less interested in how you manage day-to-day, more in scenarios that might result in insolvency.
Risk and Capital – Stakeholder perception about the appropriate level of risk and the corresponding capital level varies. Some insurers focus on optimizing income and disbursements, while others find their goals aligned by holding redundant capital. Here we consider the available options and the pros and cons of each.
“Fear vs. Danger” – Using rational thought to balance fear and danger, with an appropriate response, is hard. Having a process to think about how to react improves the likelihood of success.”
Microplastics – Tiny pieces of plastic are found in the ocean, soils and the human body. This can’t be good. Scientists are still learning about the implications of microplastics, but it’s clear that better recycling and reduced use of plastic bottles, fishing nets, micro beads and nurdles are a start.

Regime Changes lead to New Normal

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Radical changes in our Physical, Political, Economic and Social systems have been and will continue to buffet humanity. Every so often the combined result is a major change of regime in which new patterns for each of these systems develops and persists for some time creating a new normal.  We make the case that this is coming in our world. By Max Rudolph and Dave Ingram

Leverage: The Flip Side of Risk Management

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It is quite tempting, when interest rates are so very low, to take on debt just because you can. But that might not be the best thing for an organization, especially from a risk/reward perspective.  Leverage, or borrowing, can have a major impact on the risk profile of an organization that is not usually considered when talking about risk management. Leverage, it turns out, is actually the flip side of risk management. By Dave Ingram

Climate Migration

A Crossing Thin Ice Podcast – Sponsored by Actuarial Risk Management

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No one is arguing anymore that the planet is not getting hotter, but what are the limits to temperature rise for humans survival? The ramifications for those who live in poverty in tropical zones is that they will need to move because of the heat. The alternatives are unacceptable. The world needs a plan to deal with massive climate migration. By Max Rudolph.

Risk and Capital

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Stakeholder perception about the appropriate level of risk and the corresponding capital level varies. Some insurers focus on optimizing income and disbursements, while others find their goals aligned by holding redundant capital. Here we discuss several broad choices for the level of capital and the pros and cons of each based upon common business objectives. By Dave Ingram.

Top 10 ERM Podcasts

Crossing Thin Ice ERM podcast series started in March 2023. Through the end of October 2023, there have been over 2300 downloads.

Here are the ten most popular:

These are all available at https://crossingthinice.podbean.com/ along with links to Apple, Google, Spotify, Amazon and 5 more podcast distributors.

Interactions between risks: Implications for building scenarios

https://crossingthinice.podbean.com/e/interactions-between-risks-implications-for-building-scenarios/

Historically, scenarios have focused on one assumption at a time but that is not realistic in today’s quickly evolving world. Risk interactions are very important considerations and impact scenario assumptions dynamically. Three narrative scenarios that interact between financial and non-financial risks are discussed. By Max Rudolph.

Why Insurers Do ERM

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Enterprise Risk Management is practiced in different ways by insurers. Some focus on the basics while others consider ERM as a strategic strength. In a recent survey, ARM asked what is most important to them about ERM.

The findings are that what S&P thought of as the most advanced ERM objective, Strategic Risk Management, is a lower priority to many insurers.  Perhaps this is a sign of the (very uncertain) times.

For more on Strategic RIsk Management 

After COVID

https://www.podbean.com/media/share/pb-vzfk7-14a3809

Prior to 2019, Pandemic was the most studied emerging risk. And now that one has happened, it is time to study our reactions to COVID. In this podcast, we look at the reactions that people typically have to near death experiences and find that they are similar to the reactions that companies are having to COVID. Several very different reactions have been observed, but only one has a lasting favorable impact on the risk management program. By Dave Ingram 

Six Futures for ERM

https://www.podbean.com/media/share/pb-553wy-149ed71

Scenario based planning is good for forming company strategy and it can also be good for planning risk management. There are a number of ways that the future might play out for risk management and the likelihood of each of the six possibilities mentioned here has probably changed significantly because of our experiences over the past two years. Which future will you be prepared for and which would have been a total surprise if you hadn’t listened to this podcast? By Dave Ingram

Super Volcano

https://www.podbean.com/media/share/pb-5g9b6-14789a1

A volcano erupts somewhere, on average, every week. Eruptions large enough to impact the global environment happen much less frequently, but they have happened. The “Year without a Summer” in 1815 affected crops and immigration, and similar events will happen again. These Super Volcanoes tend to have numerous knock-on effects. By Max Rudolph

Concentration

https://www.podbean.com/media/share/pb-nfa83-146f322

Concentration is added by doubling down on things you do well. This two-part article considers strategic drivers that add to concentration and tactical methods to mitigate these risks. By Dave Ingram and Max Rudolph.

Cascadia Earthquake

https://www.podbean.com/media/share/pb-83zhp-1457084

When a catastrophic event hasn’t happened since 1700 there is not much historical data to aid those who live there or insure residents. Here are some of the basic concerns. By Max Rudolph

Telling Your ERM Story to Rating Agency

https://www.podbean.com/media/share/pb-che39-144bbd3

There is a story about ERM that most insurers can tell. A story with four chapters: ERM Framework, Individual Risks, Aggregate Risk & Capital and the ERM Journey. Usually there isn’t enough time to tell the the ratings analyst all four chapters, so you have to choose.

This is a story that I have told privately many times over the years based upon my experiences as the first rating agency ERM specialist at S&P and as an advisor to insurers who are preparing to present.

Microplastics

 

New Crossing Thin Ice Emerging Risks Podcast

https://www.podbean.com/media/share/pb-5vz5q-1434294

Tiny pieces of plastic are found in the ocean, soils and the human body. This can’t be good. Scientists are still learning about the implications of microplastics, but it’s clear that better recycling and reduced use of plastic bottles, fishing nets, micro beads and nurdles are a start. By Max Rudolph

Prior Emerging Risks Podcasts

Episode 10. Solar Storms 
Solar storms are more than just pretty northern lights. A high impact solar storm happened as recently as 1859. Then, some problems with telegraph wires were reported, just imagine how much more we depend upon electronics now than we did in 1859. That is exactly what we try to do in this podcast.

Episode 7. Spillover Diseases  
As humans encroach on new ecosystems diseases found in animals and birds can jump to a new home inside us. We think about coronavirus and influenza but should monitor closely diseases like bird flu and Ebola. By Max Rudolph

Episode 5. Bacterial Antimicrobial Resistance 
This podcast is a challenge for you to consider something that is likely not yet on your risk register. Could the spread of bacteria with resistance to antibiotics have an impact on your business plans? We provide some questions that you might ask as well as some preliminary answers. By Max Rudolph

Three Levels of Stress

https://www.podbean.com/media/share/pb-b9eqk-141c0a3

Stress tests come in a wide variety of levels of adversity. This podcast suggests that we all should focus on just three: normal volatility, realistic disasters and worst case scenarios. Aligning the appropriate stress test to the audience is very important when managing risk for an insurer. Management, Boards and Regulators will each find something to like with these three levels of stress. By Dave Ingram

Solar Storms

https://www.podbean.com/media/share/pb-87fck-140cc58

Risk managers have a difficult job, anticipating risk events and interpreting how they interact and aggregate with internal exposures. Emerging risks play a key role in this analysis. One such emerging risk, Solar Storms, is much more than just pretty northern lights. An impactful solar storm happened as recently as 1859. Then, some problems with telegraph wires were reported, just imagine how much more we depend upon electronics now than we did in 1859. That is exactly what we do in this podcast.

Inflation – Most Dangerous Risk of 2023

https://www.podbean.com/media/share/pb-34vde-13e5c6e

A deep dive into the risk selected as the Most Dangerous of 2023.  We compare recent inflation spikes against past events, look at the drivers of the current bout of inflation, the impact on the insurance industry along with the most common responses.  In addition, we also invert the question and consider what would cause future inflation to be very low.  By Dave Ingram and Max Rudolph

Fear vs. Danger

https://www.podbean.com/media/share/pb-xx6kb-13dc9a1

Fear or Danger is a false choice. But using rational thought to balance fear and danger, and find an appropriate response, is very difficult. This repeatable process for thinking through how to react can improve your likelihood of success. By Dave Ingram.

This podcast refers to an article “Risk Intelligence” in the magazine Contingencies.  You can read that article here.

Getting Back to “Normal”

Or is the target the problem?

Central bankers are doing all that they can to get inflation back to NORMAL, where in their minds, NORMAL is 2% inflation.

But what if, as many of us seem to be experiencing, the world is still going through some pretty extensive upheavals. And as those upheavals play out, the “natural” result would be for some major adjustments in the prices of a variety of things, especially the price of an employee’s time, that when measured by our inflation metrics result in a rebalancing which looks like 4% inflation. And what if that rebalancing is a force, like the forces that cause earthquakes, that will happen sooner or later whether we wish them to or not.

Let’s look at the wage thing in this context.

What happened in the US over the past several years to employment is very different from our experience over the history of the country. First of all, the retirement wave of the Baby Boomers had started. During the Pandemic, those retirements started to accelerate, in some situations, retirements doubled over a short time period. Increases in retirements often happen during a recession when unemployment rises as older folks at or near retirement age lose their jobs and decide that they might as well just retire. But the Pandemic was not a normal recession. The shutdowns were very temporary and were followed by rapid reopenings in many sectors. So employers needed to scramble to fill in for the retiring seniors. Meanwhile, many people (as well as businesses, government entities and other organizations) received cash assistance during the pandemic. Which made some less likely to take undesirable positions that they otherwise might have felt compelled to take.

With the openings due to retirements occurring at all levels, unemployed folks would have “moved up” the employment ladder to take as high paying of a job as they could qualify for. And some businesses have shifted to actually hiring people who may have the potential to fill a position, after training. That is an almost totally forgotten way of hiring – most employers have been doing decades of just in time = perfect fit – hit the ground running hiring.

Its a new world out there.

Crossing Thin Ice

A new Insurance ERM Podcast

A discussion of Risk and Risk Management from the perspective of an Insurance company risk manager. Insurers provide products that help everyone to manage their risks. Here you will hear Dave Ingram and Max Rudolph, actuaries from the global consultancy Actuarial Risk Management talk about the sorts of things that keep those insurance company risk managers up at night. Or at least they should.

From Actuarial Risk Management

Available at https://crossingthinice.podbean.com/

And through your favorite podcast service:

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Episodes Available Now:

Episode 1: Narrative Scenarios   https://crossingthinice.podbean.com/e/narrative-scenarios/

The current real life scenario combines a pandemic, weather events, supply chain issues, inflation and a regional war all at the same time. Multi risk scenarios can provide major insights about a firm’s resilience that do not necessarily happen with single risk scenarios or even with stochastic models. You may not agree with all of them. They are meant to encourage you to think rather than to be predictive.

Episode 2: Three Little Pigs  https://crossingthinice.podbean.com/e/three-little-pigs/

When you encounter vastly different risk-taking behaviors at two different businesses, you shouldn’t automatically presume that they are driven by totally different risk tolerances. In some cases they are actually the result of similar risk tolerances and major disagreements in risk assessment. Just ask the Three Little Pigs.

Episode 3: Moderately Adverse Conditions https://crossingthinice.podbean.com/e/moderately-adverse-conditions/

We have generally used a continuation of the current environment as our base assumption. But now, with the encouragement of the NY DFS, that is being treated as worse than “Moderately Adverse” scenario. Insurers need to develop a robust set of stress scenarios to test reserve adequacy that include continuation of current conditions and a variety of variations in experience, not just interest rates.

Episode 4: Learning from Loss  https://crossingthinice.podbean.com/e/learning-from-loss/

A major loss often causes management to question past decisions. They might even reverse some of them, but this may be an overreaction. The Chief Risk Officer improves the discussion by bringing a systematic review of the risk related decisions that preceded the loss. In many cases potential problems can be fixed without taking drastic and dramatic actions. 

Episode 5: Bacterial Antimicrobial Resistance  https://crossingthinice.podbean.com/e/bacterial-antimicrobial-resistance/

This podcast is a challenge for you to consider something that is likely not yet on your risk register. Could the spread of bacteria with resistance to antibiotics have an impact on your business plans? We provide some questions that you might ask as well as some preliminary answers.

Episode 6: Most Dangerous Risks   https://crossingthinice.podbean.com/e/most-dangerous-risks/

Over 200 respondents in the 6^th annual Dangerous Risks to Insurers Survey reordered the top risks of 2023, with Inflation swapping with Cybersecurity and cybercrime for the top spot, and Global/National recession moving into the top 5 at #3.

Episode 7: Spillover Diseases  https://crossingthinice.podbean.com/e/spillover-diseases/

As humans encroach on new ecosystems diseases found in animals and birds can jump to a new home inside us. We think about coronavirus and influenza but should monitor closely diseases like bird flu and Ebola. By Max Rudolph

Episode 8: Fear vs. Danger https://www.podbean.com/media/share/pb-xx6kb-13dc9a1

Fear or Danger is a false choice. But using rational thought to balance fear and danger, and find an appropriate response, is very difficult. This repeatable process for thinking through how to react can improve your likelihood of success. By Dave Ingram.

Episode 9: Inflation – Most Dangerous Risk of 2023 https://crossingthinice.podbean.com/e/inflation-most-dangerous-risk-of-2023/

A deep dive into the risk selected as the Most Dangerous of 2023.  We compare recent inflation spikes against past events, look at the drivers of the current bout of inflation, the impact on the insurance industry along with the most common responses.  In addition, we also invert the question and consider what would cause future inflation to be very low.  By Dave Ingram and Max Rudolph

Don’t miss out.  Make sure that you subscribe – new podcasts will be published twice a month. 

Spillover Diseases

https://www.podbean.com/media/share/pb-mtzhs-13d6861

As humans encroach on new ecosystems diseases found in animals and birds can jump to a new home inside us. We think about coronavirus and influenza but should monitor closely diseases like bird flu and Ebola. By Max Rudolph

Most Dangerous Risks

https://www.podbean.com/media/share/pb-54pkj-13c2ffd

Over 200 respondents in the Dangerous Risks to Insurers Survey reordered the top risks, with Inflation swapping with Cybersecurity and cybercrime, and Global/National recession moving into the top 5 at #3.

Bacterial Antimicrobial Resistance

https://www.podbean.com/media/share/pb-fjc7p-13a4a76

This podcast is a challenge for you to consider something that is likely not yet on your risk register. Could the spread of bacteria with resistance to antibiotics have an impact on your business plans? We provide some questions that you might ask as well as some preliminary answers.

Most Dangerous Risks of 2023

The new risk at the top of the Dangerous Risks poll is not surprise to anyone.

Cybersecurity remains in the top five, while Recession has broken into the number 3 slot.

Here is the entire report.

2023-dangerous-risks-reportDownload

Learning from Loss

https://www.podbean.com/media/share/pb-3347a-139b504

A major loss often causes management to question past decisions. They might even reverse some of them, but this may be an overreaction. The Chief Risk Officer improves the discussion by bringing a systematic review of the risk related decisions that preceded the loss. In many cases potential problems can be fixed without taking drastic and dramatic actions. 

Moderately Adverse Conditions

https://www.podbean.com/media/share/pb-r52jb-138cae5

We have generally used a continuation of the current environment as our base assumption. But now, with the encouragement of the NY DFS, that is being treated as worse than “Moderately Adverse” scenario. Insurers need to develop a robust set of stress scenarios to test reserve adequacy that include continuation of current conditions and a variety of variations in experience, not just interest rates.

Three Little Pigs

https://www.podbean.com/media/share/pb-e8t2j-1375fd9

When you encounter vastly different risk taking behaviors at two different businesses, you shouldn’t automatically presume that they are driven by totally different risk tolerances. In some cases they are actually the result of similar risk tolerances and major disagreements in risk assessment. Just ask the Three Little Pigs.

Variety of Decision Making

Over the past several years, an anthropologist (Thompson), a control engineer (Beck) and an actuary (Ingram) have formed an unlikely collaboration that has resulted in countless discussions among the three of us along with several published (and posted) documents.

Our work was first planned in 2018. One further part of what was planned is still under development — the application of these ideas to economic thinking. This is previewed in document (2) below, where it is presented as Institutional Evolutionary Economics.

Here are abstracts and links to the existing documents:

1. Model Governance and Rational Adaptability in Enterprise Risk Management, January 2020, AFIR-ERM section of the International Actuarial Association. The problem context here is what has been called the “Insurance Cycle”. In this cycle we recognize four qualitatively different risk environments, or seasons of risk. We address the use of models for supporting an insurer’s decision making for enterprise risk management (ERM) across all four seasons of the cycle. In particular, the report focuses expressly on: first, the matter of governance for dealing with model risk; and, second, model support for Rational Adaptability (RA) at the transitions among the seasons of risk. This latter examines what may happen around the turning points in the insurance cycle (any cycle, for that matter), when the risk of a model generating flawed foresight will generally be at its highest.
2. Modeling the Variety of Decision Making, August 2021, Joint Risk Management Section. The four qualitatively different seasons of risk call for four distinctly different risk-coping decision rules. And if exercising those strategies is to be supported and informed by a model, four qualitatively different parameterizations of the model are also required. This is the variety of decision making that is being modeled. Except that we propose and develop in this work a first blueprint for a fifth decision-making strategy, to which we refer as the adaptor. It is a strategy for assisting the process of RA in ERM and navigating adaptively through all the seasons of risk, insurance cycle after insurance cycle. What is more, the variety of everyday risk-coping decision rules and supporting models can be substituted by a single corresponding rule and model whose parameters vary (slowly) with time, as the model tracks the seasonal business and risk transitions.
3. The Adaptor Emerges, December 2021, The Actuary Magazine, Society of Actuaries. The adaptor strategy focuses on strategic change: on the chops and changes among the seasons of risk over the longer term. The attention of actuaries coping with everyday risk is necessarily focused on the short term. When the facts change qualitatively, as indeed they did during the pandemic, mindsets, models, and customary everyday rules must be changed. Our adaptor indeed emerged during the pandemic, albeit coincidentally, since such was already implied in RA for ERM.
4. An Adaptor Strategy for Enterprise Risk Management, April 2022, Risk Management Newsletter, Joint Risk Management Section. In our earlier work (2009-13), something called the “Surprise Game” was introduced and experimented with. In it, simulated businesses are obliged to be surprised and shaken into eventually switching their risk-coping decision strategies as the seasons of risk undergo qualitative seasonal shifts and transitions. That “eventually” can be much delayed, with poor business performance accumulating all the while. In control engineering, the logic of the Surprise Game is closely similar to something called cascade control. We show how the adaptor strategy is akin to switching the “autopilot” in the company driving seat of risk-coping, but ideally much more promptly than waiting (and waiting) for any eventual surprise to dawn on the occupant of the driving seat.
5. An Adaptor Strategy for Enterprise Risk Management (Part 2), July 2022, Risk Management Newsletter, Joint Risk Management Section. Rather than its switching function, the priority of the adaptor strategy should really be that of nurturing the human and financial resources in the makeup of a business — so that the business can perform with resilience, season in, season out, economic cycle after economic cycle. The nurturing function can be informed and supported by an adaptor “dashboard”. For example, the dashboard can be designed to alert the adaptor to the impending loss or surfeit of personnel skilled in implementing any one of the four risk-coping strategies of RA for ERM. We cite evidence of such a dashboard from both the insurance industry and an innovation ecosystem in Linz, Austria.
6. Adaptor Exceptionalism:Structural Change & Systems Thinking, March 2022, RISKVIEWS, Here we link Parts 1 and 2 of the Risk Management Newsletter article ((4) and (5) above). When we talk of “when the facts change, we change our mindsets”, we are essentially talking about structural change in a system, most familiarly, the economy. One way of grasping the essence of this, hence the essence of the invaluable (but elusive) systemic property of resilience, is through the control engineering device of a much simplified model of the system with a parameterization that changes relatively slowly over time — the adaptor model of document (2) above, in fact. This work begins to show how the nurturing function of the adaptor strategy is so important for the achievement of resilient business performance.
7. Adaptor Strategy: Foresight, May 2022, RISKVIEWS. This is a postscript to the two-part Newsletter article and, indeed, its linking technical support material of document (6). It identifies a third possible component of an adaptor strategy: that of deliberately probing the uncertainties in business behaviour and its surrounding risk environment. This probing function derives directly from the principle of “dual adaptive control” — something associated with systems such as guided missiles. Heaven forbid: that such should be the outcome of a discussion between the control engineer, the actuary, and the anthropologist!

Still to be completed is the full exposition of Institutional Evolutionary Economics that is previewed in Section 1 of Modeling the Variety of Decision Making (Item 2 above).

First Quarter GDP

Do you notice anything unusual in the graph above that occurred in the first quarter of 2022? This graph says that in January about 6% of Americans were sick. That is about 25% of all of the COVID infections over the past 26 months. Other than January 2022, COVID infections averaged 2.4 million per month.

First quarter GDP fell by 1.4% in 2022.

I would bet that some of the GDP drop was due to the absolutely extraordinary level of illness in the first quarter.

I hadn’t noticed any commentary that agrees with this point. But I am guessing that since we are all feeling that we have turned the corner on COVID, we are deliberately putting it out of our minds. Which may cause us to draw erroneous conclusions about what is happening with the economy and take actions to fix something that may have been driven to some extant by the pandemic, not some other type of weakness in the economy.

Determining Risk Capital

Knowing the amount of surplus an insurer needs to support risk is fundamental to enterprise risk management (ERM) and to the own risk and solvency assessment (ORSA).

With the increasing focus on ERM, regulators, rating agencies, and insurance and reinsurance executives are more focused on risk capital modeling than ever before.

Risk – and the economic capital associated with it – cannot actually be measured as you can measure your height. Risk is about the future.

To measure risk, you must measure it against an idea of the future. A risk model is the most common tool for comparing one idea of the future against others.

Types of Risk Models

There are many ways to create a model of risk to provide quantitative metrics and derive a figure for the economic capital requirement.

Each approach has inherent strengths and weaknesses; the trade-offs are between factors such as implementation cost, complexity, run time, ability to represent reality, and ease of explaining the findings. Different types of models suit different purposes.

Each of the approaches described below can be used for purposes such as determining economic capital need, capital allocation, and making decisions about risk mitigation strategies.

Some methods may fit a particular situation, company, or philosophy of risk better than others.

Factor-Based Models

Here the concept is to define a relatively small number of risk categories; for each category, we require an exposure metric and a measure of riskiness.

The overall risk can then be calculated by multiplying “exposure × riskiness” for each category, and adding up the category scores.

Because factor-based models are transparent and straightforward to apply, they are commonly used by regulators and rating agencies.

The NAIC Risk-Based Capital and the Solvency II Standard Formula are calculated in this way, as is A.M. Best’s BCAR score and S&P’s Insurance Capital Model.

Stress Test Models

Stress tests can provide valuable information about how a company might hold up under adversity. As a stand-alone measure or as an adjunct to factor-based methods, stress tests can provide concrete indications that reflect company-specific features without the need for complex modeling. A robust stress testing regime might reflect, for example:

Worst company results experienced in last 20 years
Worst results observed across peer group in last 20 years
Worst results across peer group in last 50 years (or, 20% worse than stage 2) Magnitude of stress-to-failure

Stress test models focus on the severity of possible adverse scenarios. While the framework used to create the stress scenario may allow rough estimates of likelihood, this is not the primary goal.

High-Level Stochastic Models

Stochastic models enable us to analyze both the severity and likelihood of possible future scenarios. Such models need not be excessively complex. Indeed, a high-level model can provide useful guidance.

Categories of risk used in a high-level stochastic model might reflect the main categories from a factor-based model already in use; for example, the model might reflect risk sources such as underwriting risk, reserve risk, asset risk, and credit risk.

A stochastic model requires a probability distribution for each of these risk sources. This might be constructed in a somewhat ad-hoc way by building on the results of a stress test model, or it might be developed using more complex actuarial analysis.

Ideally, the stochastic model should also reflect any interdependencies among the various sources of risk. Timing of cash flows and present value calculations may also be included.

Detailed Stochastic Models

Some companies prefer to construct a more detailed stochastic model. The level of detail may vary; in order to keep the model practical and facilitate quality control, it may be best to avoid making the model excessively complicated, but rather develop only the level of granularity required to answer key business questions.

Such a model may, for example, sub-divide underwriting risk into several lines of business and/or profit centers, and associate to each of these units a probability distribution for both the frequency and the severity of claims. Naturally, including more granular sources of risk makes the question of interdependency more complicated.

Multi-Year Strategic Models with Active Management

In the real world, business decisions are rarely made in a single-year context. It is possible to create models that simulate multiple, detailed risk distributions over a multi-year time frame.

And it is also possible to build in “management logic,” so that the model responds to evolving circumstances in a way that approximates what management might actually do.

For example, if a company sustained a major catastrophic loss, in the ensuing year management might buy more reinsurance to maintain an adequate A.M. Best rating, rebalance the investment mix, and reassess growth strategy.

Simulation models can approximate this type of decision making, though of course the complexity of the model increases rapidly.

Key Questions and Decisions

Once a type of risk model has been chosen, there are many different ways to use this model to quantify risk capital. To decide how best to proceed, insurer management should consider questions such as:

• What are the issues to be aware of when creating or refining our model?
• What software offers the most appropriate platform?
• What data will we need to collect?
• What design choices must we make, and which selections are most appropriate for us?
• How best can we aggregate risk from different sources and deal with interdependency?
• There are so many risk metrics that can be used to determine risk capital – Value at Risk, Tail Value at Risk, Probability of Ruin, etc. – what are their implications, and how can we choose among them?
• How should this coordinate with catastrophe modeling?
• Will our model actually help us to answer the questions most important to our firm?
• What are best practices for validating our model?
• How should we allocate risk capital to business units, lines of business, and/or insurance policies?
• How should we think about the results produced by our model in the context of rating agency capital benchmarks?
• Introducing a risk capital model may create management issues – how can we anticipate and deal with these?

In answering these questions, it is important to consider the intended applications. Will the model be used to establish or refine risk appetite and risk tolerance?

Will modeled results drive reinsurance decisions, or affect choices about growth and merger opportunities? Does the company intend to use risk capital for performance management, or ratemaking?

Will the model be used to complete the NAIC ORSA, or inform rating agency capital adequacy discussions?

The intended applications, along with the strengths and weaknesses of the various modeling approaches and range of risk metrics, should guide decisions throughout the economic capital model design process.

Risk Reward Management

In 1952, Harry Markowitz wrote the article “Portfolio Selection” which became the seed for the theory called Modern Portfolio Theory. Modern Portfolio Theory (MPT) promises a path to follow to achieve the maximum return for a given level of risk for an investment portfolio.

It is not clear who first thought to apply the MPT ideas to a portfolio of risks in an insurer. In 1974, Gustav Hamilton of Sweden’s Statsforetag proposed the “risk management circle” to describe the interaction of all elements in the risk management process, including assessment, control, financing and communication. In 1979, Randell Brubaker wrote about “Profit Maximization for a multi line Property/Liability Company.” Since then, the idea of risk and reward optimization has become to many the actual definition of ERM.

In 2005, Standard & Poor’s called the process “Strategic Risk Management”.

“Strategic Risk Management is the Standard & Poor’s term for the part of ERM that focuses on both the risks and returns of the entire firm. Although other aspects of ERM mainly focus on limiting downside, SRM is the process that will produce the upside, which is where the real value added of ERM lies.“

The Risk Reward Management process is nothing more or less than looking at the expected reward and loss potential for each major profit-making activity of an insurer and applying the Modern Portfolio Management ideas of portfolio optimization to that risk and reward information.

At the strategic level, insurers will leverage the risk and reward knowledge that comes from their years of experience in the insurance markets as well as from their enterprise risk management (ERM) systems to find the risks where their company’s ability to execute can produce better average risk-adjusted returns. They then seek to optimize the risk/reward mix of the entire portfolio of insurance and investment risks that they hold. There are two aspects of this optimization process. First is the identification of the opportunities of the insurer in terms of expected return for the amount of risk. The second aspect is the interdependence of the risks. A risk with low interdependency with other risks may produce a better portfolio result than another risk with a higher stand alone return on risk but higher interdependence.

Proposals to grow or shrink parts of the business and choices to offset or transfer different major portions of the total risk positions can be viewed in terms of risk-adjusted return. This can be done as part of a capital budgeting/strategic resource allocation exercise and can be incorporated into regular decision-making. Some firms bring this approach into consideration only for major ad hoc decisions on acquisitions or divestitures and some use it all the time.

There are several common activities that may support the macro- level risk exploitation.

Economic Capital
Economic capital (EC) is often calculated with a comprehensive risk model consistently for all of the actual risks of the company. Adjustments are made for the imperfect correlation of the risks. Identification of the highest-concentration risks as well as the risks with lower correlation to the highest-concentration risks is risk information that can be exploited. Insurers may find that they have an advantage when adding risks to those areas with lower correlation to their largest risks if they have the expertise to manage those risks as well as they manage their largest risks.

Risk-adjusted product pricing
Another part of the process to manage risk reward involves the Consideration principle. Product pricing is “risk-adjusted” using one of several methods. One such method is to look at expected profits as a percentage of EC resulting in an expected return-to-risk capital ratio. Another method reflects the cost of capital associated with the economic capital of the product as well as volatility of expected income. The cost of capital is determined as the difference between the price to obtain capital and the rate of investment earnings on capital held by the insurer. Product profit projections then will show the pure profit as well as the return for risk of the product. Risk-adjusted value added is another way of approaching risk-adjusted pricing.

Capital budgeting
The capital needed to fulfill proposed business plans is projected based on the economic capital associated with the plans. Acceptance of strategic plans includes consideration of these capital needs and the returns associated with the capital that will be used. Risk exploitation as described above is one of the ways to optimize the use of capital over the planning period. The allocation of risk capital is a key step in this process.

Risk-adjusted performance measurement (RAPM)
Financial results of business plans are measured on a risk-adjusted basis. This includes recognition of the cost of holding the economic capital that is necessary to support each business as reflected in risk-adjusted pricing as well as the risk premiums and loss reserves for multi-period risks such as credit losses or casualty coverages. This should tie directly to the expectations of risk- adjusted profits that are used for product pricing and capital budgeting. Product pricing and capital budgeting form the expectations of performance. Risk-adjusted performance measurement means actually creating a system that reports on the degree to which those expectations are or are not met.

For non-life insurers, Risk Reward Management involves making strategic trade-offs between insurance, credit (on reinsurance ceded) and all aspects of investment risk based on a long-term view of risk-adjusted return for all of their choices.

Insurers that do not practice Risk Reward Management usually fail to do so because they do not have a common measurement basis across all of their risks. The decision of many insurers to develop economic capital models provides a powerful tool that can be used as the common risk measure for this process. Economic capital is most often the metric used to define risk in the risk/reward equation of insurers.

Some insurers choose not to develop an EC model and instead rely upon rating agency or regulatory capital formulas. The regulatory and rating agency capital formulas are by their nature broad market estimates of the risk capital of the insurer. These formulae will over-state the capital needs for some of the insurer’s activity and understate the needs for others. The insurer has the specific data about their own risks and can do a better job of assessing their risks than any outsider could ever do. In some cases, insurers took high amounts of catastrophe exposure or embedded guarantee and option risks, which were not penalized in the generic capital formulas. In the end, some insurers found that they had taken much more risk than their actual loss tolerance or capacity.

Risk Reward Management provides insurers with the framework to take full advantage of the power of diversification in their risk selection. They will look at their insurance and investment choices based on the impact, after diversification, on their total risk/reward profile. These insurers will also react to the cycles in risk premium that exist for all of their different insurance risks and for all of their investment risks in the context of their total portfolio.

Sales of most insurance company products result in an increase in the amount of capital needed by the business due to low or negative initial profits and the need to support the new business with Economic Capital. After the year of issue, most insurance company products will show annual releases of capital both due to the earnings of the product as well as the release of supporting capital that is no longer needed due to terminations of prior coverages. The net capital needs of a business arise when growth (new sales less terminations) is high and/or profits are low and capital is released when growth is low and/or profits are high.

The definition of the capital needs for a product is the same as the definition of distributable earnings for an entire business: projected earnings less the increase in Economic Capital. The capital budgeting process will then focus on obtaining the right mix of short and long term returns for the capital that is needed for each set of business plans.

Both new and existing products can be subjected to this capital budgeting discipline. A forecast of capital usage by a new product can be developed and used as a factor in deciding which of several new products to develop. In considering new and existing products, capital budgeting may involve examining historic and projected financial returns.

This multi year view of capital usage does in fact apply to non-life products where the claims are not fully settled in the calendar year of issue.

Pitfalls of Risk Reward Management

In theory, optimization processes can be shown to produce the best results for practitioners. And for periods of time when fluctuations of experience are moderate and fall comfortably within the model parameters, continual fine tuning and higher reliance on the modeled optimization recommendations produce ever growing rewards for the expert practitioner. However, model errors and uncertainties are magnified when management relies upon the risk model to lever up the business. And at some point, the user of complex risk models will see that levering up their business seems to be a safe and profitable way to operate. When volatility shifts into a less predictable and/or higher level, the highly levered company can find it self quickly in major trouble.

Even without major deviations of experience, the Risk Reward Management principles can lead to major business disruptions. When an insurer makes a major change in its risk profile through an acquisition or divestiture of a large part of their business, the capital allocation of all other activities may shift drastically. Strict adherence to theory can whipsaw businesses as the insurer makes large changes in business.

Insurers need to be careful to use the risk model information to inform strategic decisions without overreliance and abdication of management judgment. Management should also push usage of risk and reward thinking throughout the organization. The one assumption that seems to cause the most trouble is correlation. The saying goes that “in a crisis, all correlations go to one”. If the justification for a major strategic decision is that correlations are far from one, management should take note of the above saying and prepare accordingly. In addition, management should study the variability of correlations over time. They will find that correlations are often highly unreliable and this should have a major impact on the way that they are used in the Risk Reward Management process.