ERM-117-14: AAA Practice Note: Insurance Enterprise Risk Management Practices

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#1

Reading Source: https://www.actuary.org/files/ERM_practice_note_030713_exposure.pdf

Topics Covered in this Reading:

  • Purpose/Introduction
  • Role of the Actuary in ERM
  • Concepts relevant to the practice and review of ERM
    • Risk culture, risk organization, and risk governance
    • Policies and procedures
  • Identifying and evaluating risks, setting strategy, and monitoring results
    • Risk identification and categorization
    • Risk evaluation
    • Risk Treatment
    • Strategic Treatment of Risk
    • Risk Monitoring
    • External Impacts and Influences
  • Future Developments in ERM

ERM-117-14: AAA Practice Note: Insurance Enterprise Risk Management Practices
#6

Hi there!

What exactly is the difference between Risk Treatment and Strategic Treatment of Risk?


#7

Good question!

Risk treatment is how the firm is going to manage the risks that they current have

  • It involves using tools such as risk appetite, risk tolerance, and risk limits to better manage these risks

Strategic treatment of risk involves assessing how the firm can use its risks to achieve financial goals

  • The focus here is on the risk/reward trade off - Ex/ Should our strategy involve taking on this specific risk in order to achieve specific financial returns?
  • We aren’t just limiting risks, but assessing them in a decision making context

Please let me know if this makes sense


#8

This section describes two types of risk adjusted performance metrics, RAROC and RORAC.

RAROC is Risk-Adjusted Net Income / Allocated Risk Capital
RORAC is Net Income / Allocated Risk Capital

For RAROC, it says Risk-Adjusted Net Income is used to reflect risks that aren’t captured in accounting-based net income, and that the methods vary widely. Does anyone have any experience in producing Risk-Adjusted Net Income, or does anyone have any ideas how this could be done? I imagine there are many ways, so any ideas are welcome!


#9

I don’t have any experience calculating risk-adjusted net income, but I think a reasonable approach might be to deduct the cost of allocated risk capital from net income, and maybe also adjust for any risk diversification benefits the LOB provides at the aggregated level. This metric is used to evaluate how well the LOB is performing relative to the level of risk involved. An example might be if I’m a bank robber, and my friend is an accountant, we might calculate a similar RORAC, but my RAROC would look much worse than my friend because my business is much riskier.


#10

Good thinking! I like considering both diversification and allocated risk capital for RAROC


#11

May I ask what is the difference between Economic Capital and Risk-based Capital? Thanks.


#12

I think Economic Capital is the amount of capital you actually need to protect yourself from adverse situations (what you believe your true capital requirement is). And risk based capital is the amount that the regulator tells you that you need to hold. It could be less, more, or equal to economic capital.