IAIS guidance paper on investment risk management

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IAIS guidance paper on
investment risk management







Insurance Training Seminar IAIS
-

ASSAL

Buenos Aires
,
Argentina
,
1
-
4 November

2005

M
akoto Okubo


Member of the Secretariat

International Association of Insurance Supervisors (IAIS)




IAIS
Guidance
paper on
investment
risk
management

2

November
2005

Makoto Okubo


Insurance Core Principles (in particular ICP9, 10, 11,
18, 21, 22, 23)
Oct 03



Framework paper and Cornerstones paper
Oct 05



Supervisory standard on asset management by
insurance companies
Dec 99



Supervisory standard on derivatives
Oct 98


IAIS standards relevant to investment risk
management




Stress testing by insurers guidance paper
Oct 04



Supervisory standard on disclosures concerning
investment performance for life and non
-
life insurers
Oct 05



Principles on capital adequacy and solvency
Jan 02



Investment risk management guidance paper

Oct 05




IAIS
Guidance
paper on
investment
risk
management

3

November
2005

Makoto Okubo

Contents

1.
Investment management

2.
Investment risk management
framework

3.
Market risk / Credit risk / Liquidity risk

4.
Supervisory considerations

5.
Information from the insurer to
supervisor



IAIS
Guidance
paper on
investment
risk
management

4

November
2005

Makoto Okubo

1.
Investment management by insurers

Manage its assets in a sound and prudent

manner
, taking account of
:


Profile of its liabilities


Solvency position


Complete risk
-
return profile


Product and underwriting policies


Reinsurance policies


Asset liability management policies


Solvency level policies


Investment management policies



IAIS
Guidance
paper on
investment
risk
management

5

November
2005

Makoto Okubo

Investment policies would be expected to
address:


A
sset and liability considerations


Financial market environment


Eligible asset classes


Amount of delegated limits by management level


Strategic asset allocation


Conditions under which the insurer can pledge or lend
assets


Maximum allowed deviation from strategic asset
allocation


Capital considerations


Solvency and liquidity considerations


Concentration risk


Risk parameters

Investment management by insurers



IAIS
Guidance
paper on
investment
risk
management

6

November
2005

Makoto Okubo

Investment risk management framework
should adhere to any regulatory
requirements in relation to:


Investment policies


A
sset
mix


Valuation


Diversification


Asset liability matching


Risk management

2.
Investment
risk
management
framework

ST Index



IAIS
Guidance
paper on
investment
risk
management

7

November
2005

Makoto Okubo

Investment risk management framework
should
include
:


A description and criteria for measuring
each of the investment risks to be
monitored


Market risk / credit risk / liquidity risk /
operational risk


Compliance policies


Reputation risk management policies


Control procedures, including risk
tolerances


Reporting format and frequency

Investment
risk
management
framework



IAIS
Guidance
paper on
investment
risk
management

8

November
2005

Makoto Okubo

Investment
risk
management
framework


Role of the board of directors


Investment risk management function


Internal audit


Compliance


Control procedure


Reporting



IAIS
Guidance
paper on
investment
risk
management

9

November
2005

Makoto Okubo

3.1 Market risk

Market
r
isk
: The risk to an insurer’s financial
condition arising from adverse movements
in the level or volatility of market prices

Market risk includes:



interest rate risk


equity and real estate risks


currency risk



IAIS
Guidance
paper on
investment
risk
management

10

November
2005

Makoto Okubo

Market risk

M
easurement and management


Measure its market risk across risk factors and
across the entire portfolio


Document the following:


Appropriate products to be used


Items that can qualify to be hedged


Assessment of effectiveness


Individuals responsible for monitoring


Set appropriate limit structure to control its
market risk exposure



IAIS
Guidance
paper on
investment
risk
management

11

November
2005

Makoto Okubo

Market risk

M
easurement and management
(cont.)


Determine
whether the market risk measures
for different products should be added,
compounded, have offsetting characteristics,
or be combined in a more complex way


Use stress testing to determine the potential
effects of economic shifts, market events,
changes in interest rates, changes in foreign
exchange and changes in liquidity conditions


Sufficient records should be retained to
enable the insurer to perform back testing of
methods and assumptions used for stress and
scenario testing and for back testing of market
risk models as Value at Risk (VaR)



IAIS
Guidance
paper on
investment
risk
management

12

November
2005

Makoto Okubo

3.2 Credit risk

Credit r
isk
: The risk
of financial loss resulting
from default or movement in the credit
quality of issuers of securities, debtors, or
counterparties and intermediaries, to whom
the company has an exposure

Credit risk includes:



Default risk


Downgrade and migration risk


Indirect credit or spread risk


Concentration risk



IAIS
Guidance
paper on
investment
risk
management

13

November
2005

Makoto Okubo

Credit risk

M
easurement and management


Credit exposure limits


Rules for the aggregation of individual
exposures within a common risk classification


Measurement tools to determine the insurer’s
credit risk exposure:


Internal rating


External rating


Results of stress testing


Concentration aggregations


Concentrations with the insurer’s group of
affiliated companies



IAIS
Guidance
paper on
investment
risk
management

14

November
2005

Makoto Okubo

Credit risk

M
easurement and management
(cont.)


Policies may impose a credit limit to:


A single issuer, industry, geographic region,
or some other risk classification


Certain levels of credit ratings


More sophisticated measures
(cf. maximum VaR)


System to track portfolio diversification
characteristics


Credit risk management function


Potential changes in financial and economic
conditions


Measure and monitor its risk at both the
transaction and portfolio level to the
appropriate time horizon



IAIS
Guidance
paper on
investment
risk
management

15

November
2005

Makoto Okubo

3.3 Liquidity risk

Liquidity r
isk
: The risk
that an insurer,
though solvent, has insufficient liquid
assets to meet its obligations when they
fall due


Liquidity profile of an insurer is a
function of both its assets and liabilities

Liquidity risk includes:



Liquidation value risk


Affiliated investment risk


Capital funding risk



IAIS
Guidance
paper on
investment
risk
management

16

November
2005

Makoto Okubo

Liquidity risk

M
easurement and management


Cash flow modeling


Assess the magnitude of deficits, surpluses
and the ability of contingent funding to meet
the needs of the insurer



Liquidity ratios


Address the need for liquidity by establishing
a normal expected amount of liquidity


Emergency liquidity funding in the event of
catastrophe by drawing cash early under
reinsurance policies or by other means


Liquidity contingency plan



IAIS
Guidance
paper on
investment
risk
management

17

November
2005

Makoto Okubo

4 Supervisory considerations

Supervisor should review the insurer’s:


Investment risk management framework


Identification of risks


Measurement of risks


Control procedures


Reporting procedures


Investment policies


Execution thereof



IAIS
Guidance
paper on
investment
risk
management

18

November
2005

Makoto Okubo

Supervisory considerations

The insurer’s investment policies:


Compliance with regulatory requirements


Protection of policyholders rights


Operational risks


Appropriate emphasis on risk
management and demonstration of asset
liability management


Use and management of third parties


Use of derivatives and structured products


Risk
-
return profile



IAIS
Guidance
paper on
investment
risk
management

19

November
2005

Makoto Okubo

Supervisory considerations

The insurer’s overall investment risk
management policies:


Insurer’s risk tolerance


Investment risk management function


Investment guidelines and procedures


Adequate staff who understand the risks
involved and clearly defined
responsibilities


Approval and regular review by the board
of directors



IAIS
Guidance
paper on
investment
risk
management

20

November
2005

Makoto Okubo

Supervisory considerations

Supervisor:


Should satisfy itself that investment risk
management functions are independent
of the investment function


Should assess whether insurer:


Is aware of the range of risks


Has procedures in place to identify, monitor
and measure there risks


Take steps to manage and mitigate them
effectively


Should conduct regular evaluations of an
insurer’s policies, procedures and practices


May apply its own tests


Should assess compliance in a group context



IAIS
Guidance
paper on
investment
risk
management

21

November
2005

Makoto Okubo

Supervisory considerations

Means to assess the insurer’s
investment risk management framework:


Regulatory reporting


External validation and/or use of experts
(ex auditors ,actuaries, risk managers)


Review of the insurer’s systems and controls


On
-
site inspections


Off
-
site surveys and surveillance


Internal audit report


Review of the insurer’s product control


Publicly disclosed reporting


Documentation describing risk management
and investment committee framework



IAIS
Guidance
paper on
investment
risk
management

22

November
2005

Makoto Okubo

5
Information the supervisor may request
from the insurer

Documents relating to management of
investment risk


Investment risk management policies


Asset liability management procedures


Investment policies


Procedures for the approval of counterparties


Embedded options


Procedures for seeking approval to use new
investment instruments and for monitoring
the risks associated with these instruments


Description of the board of directors’ overall
approach and policies



IAIS
Guidance
paper on
investment
risk
management

23

November
2005

Makoto Okubo

Information the supervisor may request
from the insurer

Sample reports


Investment risk management reports


Internal and external audit and risk
assessment functions


Investment risk measurement report


Investment activities


Positions by asset type


Concentration analysis of credit exposures
by counterparty


Regulator or internal limits breached in the
period and subsequent actions taken,
when appropriate


Planned future investment activities



IAIS
Guidance
paper on
investment
risk
management

24

November
2005

Makoto Okubo

Information the supervisor may request
from the insurer

Sample reports

(cont.)


Market risk reports


Market risk types (interest rate risk, equity
and real estate risk, commodity risk, and
currency risk)


Expected change in the economic value
change of assets and liabilities for
changes in interest rate


Significance of economic value of
derivatives and structured products


Returns made on the investment portfolio



IAIS
Guidance
paper on
investment
risk
management

25

November
2005

Makoto Okubo

Information the supervisor may request
from the insurer

Sample reports

(cont.)


Credit risk reports


Credit exposures


Credit decisions


Information relevant to
assessing current credit quality


Liquidity risk reports


Prospective cash flows


Level of liquid assets held and the terms
and condition of existing credit lines



IAIS
Guidance
paper on
investment
risk
management

26

November
2005

Makoto Okubo

Information the supervisor may request
from the insurer

Regular reporting to the supervisor


Establish reporting mechanisms, directly with
insurers, including internal audit, and third party
reports, depending on the regulatory framework


Consideration should be given to the frequency
of the data requests


Ad hoc requests


A
n overall business plan


Details on the insurer’s stress testing for
economic trends in investment markets


Internal management information on asset
portfolios etc.



IAIS
Guidance
paper on
investment
risk
management

27

November
2005

Makoto Okubo

IAIS Guidance paper on investment risk
management
(Recap)

1.
Investment management

2.
Investment risk management
framework

3.
Market risk / Credit risk / Liquidity
risk

4.
Supervisory considerations

5.
Information from the insurer to
supervisor



IAIS
Guidance
paper on
investment
risk
management

28

November
2005

Makoto Okubo

www.iaisweb.org

International Association of Insurance
Supervisors (IAIS)

Questions and Answers
















makoto.okubo@bis.org


or visit www.insurance
-
finance.com