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CS-19: Risk Tolerances and Limits

CS-19: Risk Tolerances and Limits. Fred Tavan, FSA FCIA Assistant Vice President, Canada Life ERM Symposium, Washington DC July 29, 2003. Introduction. Net Risk Uses of Exposure Limits Application types Determination of Limits. Net Risk. Net Risk = Inherent Risk mitigated by Controls

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CS-19: Risk Tolerances and Limits

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  1. CS-19: Risk Tolerances and Limits Fred Tavan, FSA FCIA Assistant Vice President, Canada Life ERM Symposium, Washington DC July 29, 2003

  2. Introduction • Net Risk • Uses of Exposure Limits • Application types • Determination of Limits

  3. Net Risk • Net Risk = Inherent Risk mitigated by Controls • Inherent Risk = Severity * Probability • Both Severity and Probability are levers • Can put exposure limits on the severity and/or probability

  4. Exposure Limits • RM technique of placing limits on risk exposure metrics to achieve strategic or operational objectives • Used to reduce expected cost of risk • May also be used to reduce variance of cost of risk • Can be applied in many different ways

  5. Application Types • Limit cost of specific event by setting max. acceptable loss • Limit exposure to a specific risk type as a % of total risk • Limit exposure in any specific instance of a risk type • Limit exposure in contractual agreements

  6. Application Types • Limit exposure by placing a cap or floor on a specific risk metric • Limit exposure through pricing by adjusting prices up or down • Limit operational risk

  7. Limiting Specific Event(s) • Example: • Company should not expose itself to any loss on any one risk in an amount exceeding more than 10% of its surplus

  8. Limits that vary by Mgmt. Level • Examples: • Exposure to any one risk exceeding 8% of surplus requires Board approval • Exposure to any one risk exceeding 5% of surplus requires Sr. Mgmt. approval • Exposure of any one risk exceeding 1% of surplus requires approval of Business Line Mgmt.

  9. Limits on specific instance • Examples: • Company shall not acquire more than 3% of its admitted assets in investments of all kinds issued or guaranteed by a single person • $10 million acquisition limit on investment grade and $5million on high yield bonds • Limit is on management actions and not on actual exposure

  10. Contractual Limits • Examples: • Retention limits on life insurance • Cap on disability benefits • Cap on dental benefits • Exclusion clauses

  11. Limits on various Risk Metrics • Examples: • Limit on exposure to interest-rate risk set in terms of duration mismatch • May have separate limits for key rate duration • Limit may involve combination of duration and dollar duration

  12. Limits on Product Exposure • Example: • Co. has a certain planned target risk-based capital ratio • Co.’s plan based on certain amount of capital being allocated to the GIC line • The GIC line has a minimum ROC target • If sales are better than expected then ROC target raised and vice versa

  13. Limits on Operational Risk • Examples: • No more than 24 hour downtime for critical systems used in day-to-day operations • Systems can include cheque writing systems, call center, web site • Turnover of key staff limited to no more than 20% per year • No more than 5 unsigned reinsurance treaties at any one time

  14. Determination of Limits • Depends on a number of factors: • Are there any regulatory limits? • At what level of management will limits apply? • What are the company’s competencies? • What is the company’s tolerance for publicly reporting large losses? • What is the purpose of setting the limit?

  15. Determination of Limits (cont’d) • How bad can things get? • What are the available data and resources? • How do limits impact capital requirements? • What is the impact on operations?

  16. SOA Website • Detailed paper can be found at: • http://www.soa.org/sections/rmtf/exposure_limitations.

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