Description: In this essay, we focus on the “Prospective Solvency Assessment” aspect of the NAIC’s ORSA. This places a spotlight on an insurer’s strategic decision making from a risk and capital management perspective. It requires those in senior management to describe actions they would take to address possible adverse changes in their risk and solvency position, i.e., what they would do to reduce risk, increase capital, and/or adjust the business strategy. We contend that by applying a slightly broader scope than the specific requirements of the NAIC’s ORSA, insurers can develop this into a valuable process to support risk-based decision making. In this essay, we initially consider how to determine which metrics to include in such a process and then discuss some important business requirements and practical challenges for implementing a calculation approach to support it. Part of the essay collection "Risk Metrics for Decision Making and ORSA"

Description: A central problem for regulators and risk managers concerns the risk assessment of an aggregate portfolio defined as the sum of d individual dependent risks Xi. This problem is mainly a numerical issue once the joint distribution of (X1,X2, . . . ,Xd) is fully specified. Unfortunately, while the marginal distributions of the risks Xi are often known, their interaction (dependence) is usually either unknown or only partially known, implying that any computed risk measure of the portfolio is subject to model uncertainty. Previous academic research has focused on the maximum and minimum possible values of a given risk measure of the portfolio, in the case in which only the marginal distributions are known. This approach leads to wide bounds, as all information on the dependence is ignored. In this paper, we integrate in a natural way available information on the multivariate dependence and provide easy-to-compute bounds for the risk measure at hand. We observe that incorporating the information of a well-fitted multivariate model may, or may not, lead to much tighter bounds, a feature that also depends on the risk measure used. We illustrate this point by showing that the Value-at-Risk at a very high confidence level (as used in Basel II) is typically prone to very high model risk, even if one knows the multivariate distribution almost completely. Our results make it possible to determine which risk measures can benefit from adding dependence information (i.e., leading to narrower bounds when used to assess portfolio risk), and, hence, to identify those models for which it would be meaningful to develop accurate multivariate models.

Description: 2011 SOA Enterprise Risk Management Symposium, Chicago. In this paper, a multivariate quasi-negative binomial distribution is proposed to model frequency dependence among different risk types. The operational risk diversification effect is illustrated through frequency dependency modeled by the bivariate quasi-negative binomial distribution under a framework of Monte Carlo simulation.

Description: This paper evaluates the current practice of operational risk management in the insurance sector. Operational risk is nothing new in insurance, but, because of regulatory requirements, companies have initiated computation of risk capital for their operational losses. The current effort to manage operational risk is not a naturally evolving phenomenon, and operational risk, in the Basel Committee on Banking Supervision’s Basel II definition, is unlikely to be a significant cause of insurers’ failure. In addition, the current Basel II definition of operational risk is not suitable for the insurance sector. Consequently, the invention of models and tools based on the definition is incomplete and illusionary. My findings are based on the analysis of dozens of interviews with insurance industry professionals. I demonstrate the way operational risk is quantified in practice, show that the result obtained from this computation is of littl e use in managerial decision making and propose a set of policy recommendations illustrating the characteristics of operational risk in insurance. This study can be used as a platform for launching dialogues to initiate fresh thinking about operational risk in insurance beyond the current artificial and narrow boundaries.