November 26th, 2009

Capital Modeling in the Age of Systemic Risk, Part IV

Posted at 1:00 AM ET

mango_smallDonald Mango, Chief Actuary

Even in the early stages of ERM and economic capital modeling, progress continues. Investments are being made in better risk identification methods and more resilient ERM structures. Capital modeling technology is advancing as well, including better coverage of asset-side risks. With property-catastrophe modeling fairly well established, attention is now turning to casualty catastrophes — a far tougher modeling challenge, as the dimensions of correlation are broader and more complex. Economic bubbles expand and burst with greater frequency and severity. Government intervention policies and practices could be reducing the relevance of the past for forecasting the future. Global interdependency, trading relationships and economic shifts are colliding with property catastrophes, which may be showing the effects of climate change.

Industry leadership will be defined by the ability to stay ahead of the pack. The innovators will develop solutions first, gaining experience and expertise by the time competitors realize they too must change. To stay in front, companies will have to become committed to finding and solving the most vexing problems the industry faces, even when these challenges are in their infancy.

Guy Carpenter has seen this dynamic at work and continues to refine MetaRisk®, our proprietary risk and capital model, to meet these modeling demands. MetaRisk brings true systemic risk modeling capability, including asset-liability correlation, with a powerful underlying timeline foundation that gives integrated stress testing and transparency. With MetaRisk, (re)insurers can move confidently and take charge of their risk,

Today, however, we’re looking back - not far — on a financial catastrophe that has fundamentally changed how (re)insurers view risk. Systemic and concealed exposures must be addressed comprehensively, especially now that the “excess capital” cushion of 2007 and early 2008 are gone. Balance sheets are thinner, but the financial targets remain. A smaller capital base has to be deployed in a manner that creates as much value as possible for every dollar put at risk. This can be done, but it requires a change in thinking. Every decision takes on new magnitude, as risk managers need to consider the implications of more than just a particular portfolio — they have to gauge the effect on the company as a whole.

The rewards for this change in approach are substantial. Beyond improving capital productivity directly, (re)insurers can use capital modeling and management techniques to turn rating agency assessments and regulatory compliance into competitive advantages, with the results improving the security of the company and possibly freeing capital for investment elsewhere. Every interaction, informed by rigorous study, is focused on creating value — from writing profitable business to minimizing downside risk to bolstering market capitalization.

Taking a leading position requires commitment, though. Up front, that means implementing an ERM framework and managing capital to achieve stated financial objectives. Over the long-term, it requires a dedication to innovation. In a rapidly changing world, the path from differentiating new idea to commodity product is shrinking. Staying at the top only happens by remaining on the lookout for the next industry-changing solution to a dynamic array of threats.

Read Part I in this series >>

Read Part II in this series >>

Read Part III in this series >>

Click here to have the rest of this series delivered to you by e-mail >>

Click here to order a free copy of Enterprise Risk Analysis, Guy Carpenter’s ERM book >>

This article was originally published in Contingencies.


This article is intended for general information only. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. Statements concerning accounting, legal, regulatory or tax matters should be understood to be general observations based solely on the author’s experience in the reinsurance industry, and may not be relied upon as accounting, legal, regulatory or tax advice which he is not authorized to provide. All such matters should be reviewed with your own qualified advisors in these areas.

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