Describe role of the credit agencies in the evaluation of RM functions, including the RM grading criteria used and discuss the relevance of these criteria
New focus on the proprietary risk framework that is used by an organization for a specific purpose e.g. credit rating
Module will explain how credit rating agencies (e.g. S&P) view insurance companies’ RM systems when considering an appropriate rating for the company’s debt or equity
Background of the general role of credit rating agencies in providing information to investors and their approaches to analysis of risk
Credit Ratings
Issued by a credit rating agency as an indication of creditworthiness
Ratings can be assigned to both the issuer and the particular issue itself
Not supposed to predictive of default probabilities but provide broad rankings of default risk
S&P, Moody’s and Fitch
Specialize focus on the provision of high quality, objective credit analysis
Access both hard accounting data and soft assessments (e.g. management quality)
Each has its own classification of ratings
Goal of having a good rating rating is to borrow as cheaply as possible
Shortcomings of credit ratings
Rating agencies are paid by the debt issuer
\(\hookrightarrow\) Pressure to assign good ratings
Conflict of interest is somewhat offset by the need to maintain credibility with users
Benefits of a robust EMR framework:
Allows a prospective view of the company’s capital needs
Can be highly tailored to suit each individual company
Benefits of diversification (of business, products, locations, etc) can be recognized
…of S&P’s rating framework
Sovereign risk analysis
e.g. tax, currency control
Business risk analysis
e.g. industry prospects, lack of diversification, dis-economies of scale, competitive strength, operations risks, management quality and structure
Financial risk analysis
e.g. profit level, cashflow, capital structure and flexibility
The assessment process is still in its infancy; Will develop as ERM practices develop
Programs that have been tested or operated in adverse situations will be judged more favorably
Two features that determine the significance of the categorization of ERM capability within its overall credit rating
Complexity of the risks that the insurer accepts
Complex risk: one that can change significantly in a short period
e.g. long term contracts that cover multiple contingencies
Amount of available capital and ease of access to it
i.e. capability to absorb risk
Five areas that S&P measure to access ERM capability
Risk Management Culture
Indicators of positive risk management culture
Communication of risk through all levels of the company
Documenting and analysis of past errors
Consistency of risk management across all pars of the business
Incentivizing of good RM practices within the firm
Other areas of evaluation
Risk tolerance statements
Capabilities of individual risk managers
Risk Control
Rating considerations:
How well the risk identification procedures are carried out
How well risks are monitored on an ongoing basis
How the risk retention limits will be adhered to and the consequences for non compliance
Execution of the RM process
Extreme Event Management
Low frequency high severity events
Company must prove that it considers various possible events
(e.g. Terrorism, natural disaster, reputational incidents etc)
Adopts an appropriate course to measure the potential impact and prepare for the events
Should have early warning indicator reporting and CAT insurance as mitigators
Risk Models and Capital Models
Models that determine how much (risk) capital a company should have to withstand a certain level of shock
Rating considerations:
The models used, inputs and assumptions and the modeling formulae
Good model should be consistent across all business areas and regions
Modification of standard formula to better suit the particular LoB the company operates in
Strategic Risk Management
Assess the focus that the organization puts on the risks to its key corporate goals
6 positive features in strategic risk management
Clear decision making w.r.t. the retained risks
Whether the company should refocus to avoid or diversify the risks
Clear strategy for assets investment
Focusing on the allocation across broad categories (e.g. equities vs bonds) and across countries
Pricing strategy that reflects risk/return trade off
Clear standards set of acceptable risk/return profiles
Appropriate capital allocation between the different BUs based on the capital model
Appropriate dividend policy
Influenced by the level of risk-adjusted return on retained capital
Should be able to discuss how the dividend decision was made
Good risk-adjusted returns should be rewarded within the company