Using Standard Formula and Internal Models: Embedding in business - - PowerPoint PPT Presentation

Using Standard Formula and Internal Models: Embedding in business decision making and aligning to Regulators’ expectations

Paul Barrett – Head of Risk Framework, AIG Europe Limited 29 November 2016

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Agenda

Embedding Models in business decision making and aligning to Regulators’ expectations

• 1. The role of the Model in Risk Management
• 2. Uses of the Model in the Business
• 3. Governance, Oversight and Validation

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• 1. The role of the Model in Risk Management

Components of a Typical Risk Management Framework

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• 1. The role of the Model in Risk Management

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Risk Appetite Framework – 3 Levels

AIG Europe – Risk Appetite Framework

Level 2: RCC Level – Risk Specific Tolerances and Limits (1:7 & 1:200)

Adverse Stress Scenario Ratings Target Entity Level Aggregate Risk (1:7 & 1:200)

Level 1: Board Level – Risk Appetite Level 3: RCC Level – Risk Metrics

AIG PC – Risk Appetite Statement

MARKET RISK CREDIT RISK OPERATIONAL RISK INSURANCE RISK Prem Risk Reserve Risk MM Cat Risk NAT Cat Risk Prem Risk Metrics Res Risk Metrics 5 Most Material Perils AEP & OEP Terrorism Concentration Zones IR Risk FX Risk Equity Risk Spread Risk etc Credit Risk Aggregations Top 3 Op Risk Scenarios

1) Reins Prog Failure 2) Breach of U/W Authorities 3) Failure of IT Systems

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Risk Review of the Business Plan: Drawing it all together for the Business

Business Plan Risk Review

Business Plan Risk Review: ERM-led assessment of AEL’s Business Plan, This activity incorporates:

• Retrospective Review of Prior Year Budgets against Actual Results
• Assessment of AEL’s Capital Adequacy over the Business Plan Horizon
• Modelled Profitability Analysis, applying AEL’s Internal Model
• Stress and Scenario Testing
• Sensitivity Testing of Product Tower Budgets
• Qualitative Deep Dive Reviews across each of AEL’s Key Risk Areas

The outputs of this review are submitted to the AEL Board alongside the AEL Business Plan and form AEL’s forward looking assessment in its ORSA Report. Risk hotspots identified from this assessment are recorded, graded and subject to ongoing monitoring and reporting to the AEL Risk and Capital Committee and Board.

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• 2. Uses of the Model in the Business

1 in 200 isn’t everything

• Firms should be as (if not more) interested in the shape of their risk

profile closer to the mean as points in the tail of the distribution

• By using an Internal Model for more than setting Regulatory Capital,

firms benefit from reviewing the full distribution and not just focused

• n a single point
• Hence The “Use Test” requirement does not stand in isolation.

Model Use is a powerful tool for the purposes of Model Validation… …“Validation through use”

Probability PROFIT LOSS CAPITAL $0 A B C

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• 2. Uses of the Model in the Business

AIG Europe’s Five Main uses of the Model:

• 1. Capital Management
• 2. Risk Management
• 3. Underwriting Strategy
• 4. Reinsurance Strategy
• 5. Investment Strategy

Level 1 Framework Directive Article 120 – Use Test “Undertakings shall demonstrate that the internal model is widely used in and plays an important role in their system of governance”

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Tips for Embedding Model Use

• Business Facing Capital Modellers – The modelling teams job is

not done with the completion of each model build or run. Members of the modelling team should be tasked with producing tactical and strategic tools to aid the business’ use of model

• utput
• Regular and Direct engagement between the modelling

team and the business also aids validation and the second aspect of the use test – “Ongoing appropriateness of the Model”

• Wish list – Ask the business what tools they would find useful to

interrogate and use model output. A model developed and run in a silo is no good to anyone

• The model is there to support the business not the other

way around

• Validation & Ownership – engage the business through 1st Line
• f Defence ownership of aspects of model validation and

reviewing of results, as well as presence on Model committees

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• 3. Governance, Oversight and Validation
• Risk Governance Structure
• Model Oversight Responsibilities of Risk Committees
• Approach to Validation
• Top-down Board-driven Validation
• Bottom-up granular Validation

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AIG Europe: Governance structure

Board of Directors Executive Committee Reserves Committee Board Risk Committee Audit Committee

Zone ExCo / Management Committee Risk & Capital Committee Internal Model Decision Authority European Capital Modelling Data Governance Council Credit Risk Committee Market Risk Committee Insurance Risk Committee Op Risk Committee Pricing Risk Committee Reinsurance Risk Committee Risk Aggregation Sub-Group Country Risk Forums

Conduct Committee

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Model Oversight Responsibilities of Risk Committees

Across an annual cycle each main Risk Committee will:

• Receive and review output from each Model Run
• Review and Validate the Model’s calibration of their risks
• Review the overall performance of the Model
• Propose future developments for the Model

Risk Committee Propose change ERM Modellers Create technical proposal ERM Modellers Revise Plan Risk Committee Approve Plan RCC Review and Approve Plan IMDA* Review Technical requirements / plan Board Approve Plan.

AIG Europe Annual Model Improvement Process

*IMDA – Internal Model Decision Authority

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• 3. Governance, Oversight and Validation

Top Down Board-driven Validation

• A review initiated by the Board
• Supported by an External Expert
• Review driven by 35 Questions

agreed upon by the Board across 8 themes:

• Model Methodology
• External Models
• Expert Judgements
• Model Sensitivities
• Diversification and

Dependencies

• Reasonableness of Results
• Quality of Validation Testing
• Model Operation & data

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• 3. Governance, Oversight and Validation

Bottom-Up Granular Validation

• Detailed Framework of Testing
• Spread across 20 Internal Model

areas such as:

• Premium Risk
• Reserve Risk
• Dependencies
• Market Risk
• Man Made CAT
• Model Documentation
• Model Use
• Model Governance
• Covers not only the design and

calibration of the model, but also the control and operating environment

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Conclusions

“Validation through Internal Use of the Model”

• The Model is an integral component of the Risk Management Framework
• It enhances the understanding of risk across the business and supports many

decision-making processes

• But the model also gains strength and refinement by drawing upon data and technical

expertise across the business, to improve its design, calibration and the quality of data inputs

• This is complemented by robust internal governance and independent validation of the

Model to give assurance around the appropriateness of methodology, the credibility of Expert Judgements and the reliability of the outputs.

• Together, this gives confidence to the Board when using the Model and to regulators

when approving the Model

“Validation through Independent review and benchmarking of design, methodology, calibration and outputs of the Model”

16 American International Group, Inc. (AIG) is a leading international insurance organization serving customers in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional, and individual customers through one of the most extensive worldwide property-casualty networks of any insurer. In addition, AIG companies are leading providers of life insurance and retirement services in the United States. AIG common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange. AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. Products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Not all products and services are available in every jurisdiction, and insurance coverage is governed by actual policy

• language. Certain products and services may be provided by independent third parties. Insurance products may be distributed through affiliated or unaffiliated entities. Certain property-casualty

coverages may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds.