Integrated Risk Management in Life Insurance Companies

1
Integrated Risk Management in Life Insurance
Companies

• Dr. Etti G. Baranoff
• Virginia Commonwealth University
• Dr. Thomas W. Sager
• The University of Texas at Austin

International Insurance Society
Seminar Chicago July 19, 2006
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Overview

• In this paper we use accounting data to map the
  spectrum of enterprise risks and enterprise risk
  management (ERM) tools of U.S. life insurers.
• To our knowledge, these are the first risk and
  tool maps to be based on statistical analysis of
  objective data, rather than on surveys of ex ante
  best practice desiderata and ex post practices.

International Insurance Society
Seminar Chicago July 19, 2006
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Outline

• We use a two-step methodology to analyze risk
  space
• (1) cluster analysis of about 150 risk-related
  variables to group associated risks together
• (2) factor analysis to uncover hidden themes of
  each cluster.
• The same methodology is applied to ERM tool space
  variables.
• Then we lay the two maps side by side for
  comparison.

International Insurance Society
Seminar Chicago July 19, 2006
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Expectations Risk Space

• Theoretical conventional wisdom expects that risk
  space should be organized into the following risk
  categories
• Asset
• Product
• Operational
• with significant cross-category overlap generated
  by financial risk (Capital structure) and the
  risk of asset/liability matching (ALM).

International Insurance Society
Seminar Chicago July 19, 2006
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Figure 1. The Conventional View of Risk and ERM
Tools
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Seminar Chicago July 19, 2006
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• The RISK categories correspond to the three major
  activities of life insurers
• Investing
• Underwriting
• Operations
• major category-straddling activities of
  structuring capital and ALM.

International Insurance Society
Seminar Chicago July 19, 2006
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Figure 1. The Conventional View of Risk and ERM
Tools
International Insurance Society
Seminar Chicago July 19, 2006
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Expectations ERM Space

• The organization of tool space is expected to
  mirror the hypothetical organization of risk
  space, since insurers deploy the tools to
  mitigate the risks.
• ERM_Geneva Papers2006_Baranoff_Sager.doc

International Insurance Society
Seminar Chicago July 19, 2006
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Figure 1. The Conventional View of Risk and ERM
Tools
International Insurance Society
Seminar Chicago July 19, 2006
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Overall Results/Contribution

• We find three risk clusters that represent asset,
  product, and operational risks.
• We also find five other risk clusters some
  including aspects of financial and ALM risks.
• The structure of ERM space does not clearly match
  that of risk space.
• Tool space seems to be thematically clustered
  more by tool than by the risk to be mitigated.
• Within each space, we find complex relationships.
• Some clusters are thematically relatively pure,
  whereas others are mixed, and there is a fair
  degree of overlap.

International Insurance Society
Seminar Chicago July 19, 2006
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Emerging Risk Space Themes

• See Figure 4, Risk side ERM_Geneva
  Papers2006_Baranoff_Sager.doc

International Insurance Society
Seminar Chicago July 19, 2006
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Emerging ERM Space Themes

• See Figure 4, ERM side ERM_Geneva
  Papers2006_Baranoff_Sager.doc

International Insurance Society
Seminar Chicago July 19, 2006
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High Level Results Risk Space

• The empirical analysis finds three clusters that
  can be identified primarily with asset, product,
  and operational risks.
• In addition, five other clusters emerge, with
  distinct themes, including liquidity, financial,
  and reinsurance risk.

International Insurance Society
Seminar Chicago July 19, 2006
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High Level Results Risk (Cont.)

• A number of variables that might conventionally
  be thought of as product or operational risks are
  more closely aligned with other clusters.

International Insurance Society
Seminar Chicago July 19, 2006
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High Level Results Risk (Cont.)

• Some clusters, like cluster 6 (operational) are
  thematically relatively pure but others, like
  cluster 1, involve a complex mix of themes.

International Insurance Society
Seminar Chicago July 19, 2006
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High Level Results ERM Space

• A conventional view of ERM tool space might
  expect risk mitigation tools to be organized into
  asset, product, and organizational clusters to
  mirror corresponding risk clusters. Summary ERM
  (Cont.)
• But the only leg of the hypothetical triad for
  which we find a clear parallel is the operational
  leg (ERM cluster 8 with Risk cluster 6).

International Insurance Society
Seminar Chicago July 19, 2006
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High Level Results Risk and ERM Spaces Compared

• We tend to see ERM tools organized by type of
  tool to be used, rather than by type of risk to
  be mitigated.
• The ERM tool space shares many of the structural
  characteristics of risk space
• a similar number of clusters, some thematically
  pure clusters, some mixed, with some overlap.

International Insurance Society
Seminar Chicago July 19, 2006