Archive for the ‘Risk Environment’ category

Risk Trajectory – Do you know which way your risk is headed?

July 25, 2016

Arrows

Which direction are you planning on taking?

  • Are you expecting your risk to grow faster than your capacity to bare risk?
  • Are you expecting your risk capacity to grow faster than your risk?
  • Or are you planning to keep growth of your risk and your capacity in balance?

If risk is your business, then the answer to this question is one of just a few statements that make up a basic risk strategy.

RISKVIEWS calls this the Risk Trajectory.  Risk Trajectory is not a permanent aspect of a businesses risk strategy.  Trajectory will change unpredictably and usually not each year.

There are four factors that have the most influence on Risk Trajectory:

  1. Your Risk Profile – often stated in terms of the potential losses from all risks at a particular likelihood (i.e. 1 in 200 years)
  2. Your capacity to bare risk – often stated in terms of capital
  3. Your preferred level of security (may be factored directly into the return period used for Risk Profile or stated as a buffer above Risk Profile)
  4. The likely rewards for accepting the risks in your Risk Profile

If you have a comfortable margin between your Risk Profile and your preferred level of security, then you might accept a risk trajectory of Risk Growing Faster than Capacity.

Or if the Likely Rewards seem very good, you might be willing to accept a little less security for the higher reward.

All four of the factors that influence Risk Trajectory are constantly moving.  Over time, anything other than carefully coordinated movements will result in occasional need to change trajectory.  In some cases, the need to change trajectory comes from an unexpected large loss that results in an abrupt change in your capacity.

For the balanced risk and capacity trajectory, you would need to maintain a level of profit as a percentage of the Risk Profile that is on the average over time equal to the growth in Risk Profile.

For Capacity to grow faster than Risk, the profit as a percentage of the Risk Profile would be greater than the growth in Risk Profile.

For Risk to grow faster than Capacity, Risk profile growth rate would be greater than the profit as a percentage of the Risk Profile.

RISKVIEWS would guess that all this is just as easy to do as juggling four balls that are a different and somewhat unpredictably different size, shape and weight when they come down compared to when you tossed them up.

 

Reviewing the Risk Environment

January 14, 2014

The new US Actuarial Standards of Practice 46 and 47 suggest that the actuary needs to assess the risk environment as a part of risk evaluation and risk treatment professional services. The result of that evaluation should be considered in that work.

And assessment of the risk environment would probably be a good idea, even if the risk manager is not a US actuary.
But what does it mean to assess the risk environment?  One example of a risk environment assessment can be found on the OCC website.  They prepare a report titled “Semi Annual Risk Perspective“.

This report could be a major source of information, especially for Life Insurers, about the risk environment.  And for Non-Life carriers, the outline can be a good road map of the sorts of things to review regarding their risk environment.

Part I: Operating Environment

  • Slow U.S. Economic Growth Weighs on Labor Market
  • Sluggish European Growth Also Likely to Weigh on U.S. Economic Growth in Near Term
  • Treasury Yields Remain Historically Low
  • Housing Metrics Improved
  • Commercial Real Estate Vacancy Recovery Uneven Across Property Types

Part II: Condition and Performance of Banks.

A. Profitability and Revenues: Improving Slowly..

  • Profitability Increasing .
  • Return on Equity Improving, Led by Larger Banks .
  • Fewer Banks Report Losses
  • Noninterest Income Improving for Large and Small Banks.
  • Trading Revenues Return to Pre-Crisis Levels
  • Counterparty Credit Exposure on Derivatives Continues to Decline ………….
  • Low Market Volatility May Understate Risk
  • Net Interest Margin Compression Continues..

B. Loan Growth Challenges

  • Total Loan Growth: C&I Driven at Large Banks; Regionally Uneven for Small Banks….
  • Commercial Loan Growth Led by Finance and Insurance, Real Estate, and Energy …
  • Residential Mortgage Runoff Continues, Offsetting Rising Demand for Auto and Student Loans………….

C. Credit Quality: Continued Improvement, Although Residential Real Estate Lags

  • Charge-Off Rates for Most Loan Types Drop Below Long-Term Averages
  • Shared National Credit Review: Adversely Rated Credits Still Above Average Levels .
  • Significant Leveraged Loan Issuance Accompanied by Weaker Underwriting.
  • New Issuance Covenant-Lite Leveraged Loan Volume Surges .
  • Commercial Loan Underwriting Standards Easing .
  • Mortgage Delinquencies Declining, but Remain Elevated.
  • Auto Lending Terms Extending ..

Part III: Funding, Liquidity, and Interest Rate Risk

  • Retention Rate of Post-Crisis Core Deposit Growth Remains Uncertain
  • Small Banks’ Investment Portfolios Concentrated in Mortgage Securities
  • Commercial Banks Increasing Economic Value of Equity Risk

Part IV: Elevated Risk Metrics

  • VIX Index Signals Low Volatility…
  • Bond Volatility Rising but Near Long-Term Average
  • Financials’ Share of the S&P 500 Rising but Remains Below Average
  • Home Prices Rising .
  • Commercial Loan Delinquencies and Losses Decline to Near or Below Average ..
  • Credit Card Delinquencies and Losses Near Cyclical Lows .

Part V: Regulatory Actions

  • Banks Rated 4 or 5 Continue to Decline
  • Matters Requiring Attention Gradually Decline
  • Enforcement Actions Against Banks Slow in 2013

For those who need a broader perspective, the IMF regularly publishes a report called World Economic Output.  That report is much longer but more specifically focused on the general level of economic activity.  Here are the main chapter headings:

Chapter 1. Global Prospects and Policies

Chapter 2. Country and Regional Perspectives

Chapter 3. Dancing Together? Spillovers, Common Shocks, and the Role of Financial and Trade Linkages

Chapter 4. The Yin and Yang of Capital Flow Management: Balancing Capital Inflows with Capital outflows

The IMF report also includes forecasts, such as the following:

IMF

 


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