22.1 Introduction

Key considerations before creation of internal risk model

  • These are decisions at the beginning of the process

  • How the input parameters should be determined

  • How to overcome political hurdles

  • How to integrate model into the company’s business planning

Things firm often underestimate when implementing an IRM (this is on a similar scale as implementing a new ledger or reserve review process)

  • Resource commitment:
    Hiring staff, purchasing systems, software, consultants

  • Timelines:
    Can take years to implement

  • Organizational impact:
    Can have large impact on how the company is run, how decisions are made

If done properly, IRM can be a hub for:

  • Risk decision making

  • Planning

  • Pricing

  • Reinsurance purchasing

  • Capacity allocation

  • Rating agency interaction

Possible components of a risk model:

  • Freq/sev distribution for each LoBs

  • Premium and LR projections for the forecast year

  • Correlations across LoBs

  • Model for distributions of the unpaid by LoB

  • Correlations of the unpaid

  • ESG that simulates economic conditions, which can be used as an input to some of the other model components

  • Asset / market risk model that model asset prices

Potential use of the risk model:

  • Model u/w losses for the next year

  • Reserve movements

Potential outputs of the risk model:

  • \(\sigma\) of LR for the current AY for each LoB

  • \(VaR\) and \(TVaR\) for the same LoB at various percentiles

  • \(\sigma\), \(VaR\), \(TVaR\) of loss reserves

  • Allocation of various capital metrics (e.g. \(5 \times VaR_{90\%}\)) to each LoB