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Enterprise Risk Management. Enterprise Risk Management at Nationwide. September 18, 2008 Al Schulman, Vice President-Enterprise Risk Management. The Nationwide View. Nationwide Vision. Requirements. Risk classification Identification and assessment Risk appetite / limits.

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Enterprise risk management at nationwide l.jpg

Enterprise Risk Management

Enterprise Risk Management at Nationwide

September 18, 2008 Al Schulman, Vice President-Enterprise Risk Management


The nationwide view l.jpg

The Nationwide View

Nationwide Vision

Requirements

  • Risk classification

  • Identification and assessment

  • Risk appetite / limits

Significant Risks…

  • Metrics

  • Reporting

  • Training and communications

…are clearly understood,…

  • Clear roles and authority

  • Tools

  • Controls / transfer / financing

…proactively managed…

  • Standard language

  • Reporting

  • Independent assurance and oversight

…and consistently monitored by Nationwide….

… in the context of achieving our business objectives and strategy…

  • Link to strategy / planning

  • Risk-adjusted performance metrics


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Nationwide ERM Framework

  • Risk Governance

  • Planning

  • Execution

  • Evaluation

  • Infrastructure, Communication & External Environment


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Nationwide ERM Framework

GOVERNANCE

  • Risk Governance & Culture

  • Risk Policies

  • Roles & Authorities

Framework

Feedback

PLAN

Legal, Regulatory, & Compliance

EVALUATE

Operational

  • Strategic Planning

  • Capital Allocation

  • Risk Capacity, Appetite & Limits

  • Risk Adjusted Performance

  • Capital Adequacy

  • Risk Modeling

Insurance

Strategic

Market

Credit

Identify

Measure

Analyze

Manage

Monitor

EXECUTE

Objectives

Aggregation

Infrastructure

Communication

External Environment

  • ERM Tools

  • Common Language

  • Risk Classification Framework

  • Internal Risk Management Partnerships

  • Training & Communications

  • Rating Agencies & Regulators

  • Competitors & Best Practices

  • Customers

  • Counterparties


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Risk Governance Guiding Principles

  • Business areas retain accountability for managing their own risks

  • Enterprise perspective

  • Proactive rather than reactive

  • Independent assurance (e.g., Independent Audit)

  • Clearly assigned responsible / accountable parties

  • Transparency of accountability, communication, decision making, and information flows

  • Regular re-evaluation to ensure appropriate evolution


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Nationwide ERM Framework

GOVERNANCE

  • Risk Governance & Culture

  • Risk Policies

  • Roles & Authorities

Framework

Feedback

PLAN

Legal, Regulatory, & Compliance

EVALUATE

Operational

  • Strategic Planning

  • Capital Allocation

  • Risk Capacity, Appetite & Limits

  • Risk Adjusted Performance

  • Capital Adequacy

  • Risk Modeling

Insurance

Strategic

Market

Credit

Identify

Measure

Analyze

Manage

Monitor

EXECUTE

Objectives

Aggregation

Infrastructure

Communication

External Environment

  • ERM Tools

  • Common Language

  • Risk Classification Framework

  • Internal Risk Management Partnerships

  • Training & Communications

  • Rating Agencies & Regulators

  • Competitors & Best Practices

  • Customers

  • Counterparties


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Core Framework Components

The three components of the framework are Risk Capacity, Appetite, and Limits, all of which are logically aligned to achieve a common long-term goal: maximization of economic value subject to risk tolerances.

Capacity

  • Capacity represents the maximum amount of risk that can be supported by the company, expressed as an aggregate capital dollar amount

  • Risk Capacity is determined considering the following:

    • Available capital

    • Ability to raise capital (access to capital markets)

    • Earnings strength and stability, including planned growth in capital over time

Appetite

  • Amount of risk that management and the Board are willing to take, given available risk capacity, our risk preferences, and our strategic business objectives

  • Risk Appetite serves as an overall guide to resource and capital allocation

  • Business strategy should be aligned with risk appetite

Limits

  • Allocation of Appetite to individual risk types, business units, and additional dimensionality (or combinations thereof) based upon capital requirements relative to potential returns and risk concentrations

  • Serve to effectively control our significant risks within the context of our overall risk appetite

  • Should be expressed in specific metrics appropriate for a given risk

  • Should reflect enterprise Risk Preferences and align to support strategic plans and capital allocation

  • Should be set at a level which may be periodically tested (i.e., limits should be established at levels that may be exceeded at times)


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Risk Capacity, Appetite, and Limits Framework: Conceptual Model

  • Nationwide’s risk Capacity, Appetite, and Limits framework expresses tolerance for losses:

    • for three different loss magnitudes (severity)

    • considering likelihood over both a one and three year horizon (probability)

    • reflecting both rating agency and economic measures of risk and capital

Capital Volatility

Severe Downgrade

Insolvency

“Gradually leaking hull”

“Hole in the side of the ship”

“Ship sinks”

What is the acceptable probability of…

…having capital adequacy decline over three years?

…dropping below a minimum acceptable rating level in a single year?

…becoming insolvent in a single year?

Examples of risk events:

  • High inflation environment (multi-year)

  • High trade combined ratio + high growth environment

  • Large catastrophe

  • Severe equity market decline

  • Large catastrophe

  • Severe operational / continuity event

Severity

Severity

Severity

- Loss Magnitude +


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Risk Capacity, Appetite, and Limits Framework: Appetite Quantification and Dashboard

A dashboard is utilized to reflect a chosen risk appetite and exposure levels relative to the chosen appetite. The example below is illustrative.

Capital Volatility

Severe Downgrade

Insolvency

Model

Economic

Rating Agency

Rating Agency

Economic

Rating Agency

Horizon

Multi-year

Multi-year

Single year

Single year

Static

Loss Severity

Required loss severity ($) periodically calculated for each dimension considering capital and risk profile.

Capital Required for Ratings Targets

Tolerance

X%

<X%

X-Y%

>Y%

<X%

X-Y%

>Y%

Modeled Probability

AA-

AA3

A+

Z%

Z%

Z%

≤X%

Within Tolerance

Warning Level

Appetite Violation


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Risk Capacity, Appetite, and Limits Framework: CAL Risk Modeling Tools

Nationwide’s CAL framework calculations use two principal risk modeling tools:

Enterprise Required Economic Capital (REC) model

Dynamic Financial Analysis (DFA) model

  • Tool for measuring economic capital adequacy

  • 1 year view of risk

  • “Extreme Tail” focused

  • REC used in determining Risk Adjusted Return on Capital (RAROC)

  • Statutory, GAAP, and economic views

  • Multi-year view of risk

  • More centrally focused

  • Robust stochastic economic simulation capabilities

  • Enables more “complete” view of risk (central vs. tail, 1 year vs. 4, Economic vs. Statutory vs. GAAP, etc.)

  • Periodic calibration exercises to test models, assumptions, sensitivity, etc.


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Nationwide ERM Framework

GOVERNANCE

  • Risk Governance & Culture

  • Risk Policies

  • Roles & Authorities

Framework

Feedback

PLAN

Legal, Regulatory, & Compliance

EVALUATE

Operational

  • Strategic Planning

  • Capital Allocation

  • Risk Capacity, Appetite & Limits

  • Risk Adjusted Performance

  • Capital Adequacy

  • Risk Modeling

Insurance

Strategic

Market

Credit

Identify

Measure

Analyze

Manage

Monitor

EXECUTE

Objectives

Aggregation

Infrastructure

Communication

External Environment

  • ERM Tools

  • Common Language

  • Risk Classification Framework

  • Internal Risk Management Partnerships

  • Training & Communications

  • Rating Agencies & Regulators

  • Competitors & Best Practices

  • Customers

  • Counterparties


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Nationwide Risk Management Cycle

Identify

Measure

Analyze

Manage

Monitor

There are five elements of best practice risk management execution

What risks exist?

How much is at risk?

What do we want to do with the risk?

Do something about it

Did the management strategy work?

  • Identify potential risk events

  • Investigate emerging risks

  • Classify risk events

  • Gather actual loss data

  • Document Contributing Factors, Controls and Key Risk Indicators

  • Consider possible impacts

  • Uncover possible gaps

  • Etc.

  • Measure direct exposure

  • Consult experts

  • Benchmark industry performance

  • Run potential loss models

  • Measure actual impact

  • Perform scenario analysis

  • Gather anecdotal facts regarding risk exposure

  • Etc.

  • Compare to risk preferences

  • Look at aggregate measures

  • Prioritize against other risks

  • Create strategies and recommendations for risk management actions (terminate, treat, tolerate, transfer)

  • Get feedback and appropriate approvals from risk owners and oversight committees

  • Etc.

  • Implement recommended actions

  • Execute projects

  • Improve / add internal controls

  • Change policies and procedures

  • Make investments

  • Sell assets

  • Acquire hedges

  • Acquire reinsurance

  • Do nothing

  • Etc.

  • Ensure actions took place

  • Compare current results with previous results

  • Compare current results with expected results

  • Generate and distribute reports

  • Etc.

Data

Information

Action


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Nationwide ERM Framework

GOVERNANCE

  • Risk Governance & Culture

  • Risk Policies

  • Roles & Authorities

Framework

Feedback

PLAN

Legal, Regulatory, & Compliance

EVALUATE

Operational

  • Strategic Planning

  • Capital Allocation

  • Risk Capacity, Appetite & Limits

  • Risk Adjusted Performance

  • Capital Adequacy

  • Risk Modeling

Insurance

Strategic

Market

Credit

Identify

Measure

Analyze

Manage

Monitor

EXECUTE

Objectives

Aggregation

Infrastructure

Communication

External Environment

  • ERM Tools

  • Common Language

  • Risk Classification Framework

  • Internal Risk Management Partnerships

  • Training & Communications

  • Rating Agencies & Regulators

  • Competitors & Best Practices

  • Customers

  • Counterparties


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Risk Diversification

SolvencyStandard

EL

Economic Capital

Credit

Market

Product

Strategic

Legal & Reg.

Operational

1.Characterize the risk distributions

Correlations, Dependencies

2.Combine distributions

3.Measure required capital

4.Attribute capital to products and business units


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RAROC Overview

Total Return Required Economic Capital (REC)

RAROC=

How much capital is needed to protect us to a given solvency standard (AA)?

How much are we earning on the capital that we have committed to our businesses?

CAPITAL PRODUCTIVITY

CAPITAL ADEQUACY

Compare RAROC with Hurdle Rate (Cost of Capital)

Compare Required Economic Capital with Available Economic Capital

  • Risk Adjusted Return on Capital - Economic view of capital adequacy and risk adjusted returns


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Enterprise Capital and RAROC Applications

  • Applications

    • Capital adequacy

      • Including future Rating Agency capital adequacy determination

    • Performance measurement & Incentive compensation

    • Strategic planning & Capital allocation

    • Product Structure & Pricing

    • Risk Transfer

    • Expense Allocation


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Nationwide ERM Framework

GOVERNANCE

  • Risk Governance & Culture

  • Risk Policies

  • Roles & Authorities

Framework

Feedback

PLAN

Legal, Regulatory, & Compliance

EVALUATE

Operational

  • Strategic Planning

  • Capital Allocation

  • Risk Capacity, Appetite & Limits

  • Risk Adjusted Performance

  • Capital Adequacy

  • Risk Modeling

Insurance

Strategic

Market

Credit

Identify

Measure

Analyze

Manage

Monitor

EXECUTE

Objectives

Aggregation

Infrastructure

Communication

External Environment

  • ERM Tools

  • Common Language

  • Risk Classification Framework

  • Internal Risk Management Partnerships

  • Training & Communications

  • Rating Agencies & Regulators

  • Competitors & Best Practices

  • Customers

  • Counterparties


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ERM Tool – Ops Risk Information Architecture

ERM

Common Information Architecture

  • Common Dimensional Hierarchies (Classification and Aggregation)

  • Common Metrics Definitions

  • Common Reporting

  • Common Workflow

  • Shared Risk and Control Data

  • Shared Mitigation Activity Data

  • Shared Internal and External Loss Data

Compliance

HR

Privacy

Internal Audits

IT Security / Continuity Management


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Nationwide ERM Framework

GOVERNANCE

  • Risk Governance & Culture

  • Risk Policies

  • Roles & Authorities

Framework

Feedback

PLAN

Legal, Regulatory, & Compliance

EVALUATE

Operational

  • Strategic Planning

  • Capital Allocation

  • Risk Capacity, Appetite & Limits

  • Risk Adjusted Performance

  • Capital Adequacy

  • Risk Modeling

Insurance

Strategic

Market

Credit

Identify

Measure

Analyze

Manage

Monitor

EXECUTE

Objectives

Aggregation

Infrastructure

Communication

External Environment

  • ERM Tools

  • Common Language

  • Risk Classification Framework

  • Internal Risk Management Partnerships

  • Training & Communications

  • Rating Agencies & Regulators

  • Competitors & Best Practices

  • Customers

  • Counterparties


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Strategic Asset Allocation Process


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Total P&C Efficient Frontier


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Total P&C Efficient Frontier


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Asset/Liability Interaction

  • Think of liabilities as negative assets

    • Expected duration based on historical payout patterns

    • Actual duration includes systematic and idiosyncratic volatility

      • Inflation sensitivity

      • Residual volatility

        • Claims practices

        • Mix of coverages/perils

        • Litigation practices

  • Impact on efficient frontier driven by several characteristics

    • Inflation sensitivity and responsiveness

    • Payout pattern (expected duration)

    • Volatility of duration


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Inflation and Economic Value

Avail. Econ. Capital (end year 4)

Average inflation (years 1-4)

In low inflation environments erosion of AEC is driven by catastrophe risk

Nationwide is able to increase premia to keep up with inflation changes

Nationwide not able to reset premia significantly enough to protect AEC in high inflation or inflation changing regimes


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Asset/Liability Management – Inflation Modeling

  • Investment portfolio optimization requires a defined view of inflation sensitivity and responsiveness with respect to reserves and new business

  • Generally, losses have a low correlation with inflation, but a high sensitivity to inflation

  • Key questions:

    • Inflation Modeling

      • What is expected inflation over the model horizon?

      • What is inflation volatility over the model horizon?

    • Liability modeling

      • How sensitive are your reserves to inflation? New losses? If less than fully sensitive, why?

      • How does expected inflation change when actual inflation occurs?

      • How quickly does pricing react to a change in expected inflation?


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US Inflation History

US CPI and CORE CPI inflation

2


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Enterprise Risk Management – Role of Actuaries

  • ERM provides actuaries with an opportunity to use their understanding of the business and its risks to increase their strategic role within the organization

    • Data provider

      • Limited – Reserves, ultimate losses

      • Expanded – Payout patterns, volatility assumptions, correlations

    • Subject matter expert

    • Risk model developer/owner

    • Risk management partner

  • If the actuarial profession doesn’t step up to the challenge of ERM, others will. Who understands the business better than you?


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