Picturing + Risk

The financial crisis has increased demands - both internally and from regulators and raters - on insurers' risk managers to deliver reliable, accurate and up-to-date views of risk exposure, real and potential.


To say the recent financial crisis was a crisis of risk management is undeniable: Bad bets were made on multiple levels, and their potential consequences were not foreseen until it was too late. Also undeniable is that the senior executives of many financial services enterprises, including insurance companies, now must rethink how they manage risk and, in particular, how they use predictive modeling to justify the risks that they take.

But risk models are merely tools that can be used or abused, and their failure to predict the crisis largely is attributable to the assumptions, rationalizations and just plain denial on the part of those using them. It's not as if the math suddenly ceased to work. Rather, the credit/financial crisis has shown not only that insurers must better manage the interaction of the art and science of risk management, but that risk modeling - and the increasingly sophisticated technology that supports it - is more important than ever.

As the economy slowly emerges from the crisis, insurers realize that they need a clearer, more current view of their risk exposures, including access to both accurate source information and more comprehensive risk modeling. And while insurers feel the need for these capabilities internally, regulators and rating agencies also are increasingly demanding more granular reporting. One result is that many insurers are playing catch-up and depending on external sources of risk management capabilities.

"With the current demand for risk management globally across industries, we decided to separate risk management as a service line," says Edward Grau, a New York-based senior executive in Accenture's financial services risk management practice, which was launched in February 2010. While the Accenture unit serves many industries, Grau says, insurers are among the companies with an increased seriousness about risk expertise and technology. "We've been involved in several engagements [with insurance companies] over the last six months," he reports.

Though insurers are risk managers by nature, their performance during the crisis exposed a need to improve in that regard, Grau adds. "In the recent credit crisis we've seen insurance company asset portfolios fall by as much as a third," he notes. "This has caused a lot of new thinking in the insurance space."

Even before the crisis, according to Grau, many insurers were challenged by changing regulatory demands driven by a shift to economic capital accounting and the implications of emerging global reporting standards, such as IFRS and Solvency II, as well as by the potential of technology itself. "Regulators are starting to require demonstrated control of position, of valuation, of asset and liability coverage, and capital adequacy," he says.

Answering Regulatory Demands

Regulatory demands were among the reasons that Chicago-based The Warranty Group, an underwriter and administrator of service contracts and related benefits, sought a robust platform for accounting and monitoring risk exposure in the first half of 2008, according to Jim Krygier, the firm's assistant VP and de facto CIO. "We were looking for technology that we could implement for daily transparency on our portfolio, which is multi-asset, multi-currency and global," he reports. "From an insurance point of view, we have many regulatory constraints and multiple reporting bases, including U.S. GAAP, U.K. GAAP, statutory, tax and, because our parent company is a Canadian entity, we'll be rolling out IFRS this year." The Warranty Group is a subsidiary of Toronto-based Onex Corp.

It was in the second half of 2008, when the credit crisis developed, that The Warranty Group ($4.9 billion in assets) realized that it lacked the transparency it needed, Krygier recalls. "As the days drew on during the crisis, our board was asking about our concentration of exposure, but we didn't have the robustness to say, 'This is last night's price,'" he relates. "By the time we established our prior portfolio price, it had already changed. We were constantly playing catch-up."

Before the end of that year, The Warranty Group had met with Boise, Idaho-based Clearwater Analytics to address the insurer's need for daily transparency, improved stress-testing of financial positions, and robust compliance and monitoring of investment managers, Krygier reports. "With the multiple modules they offer, Clearwater gave us what we wanted, and more," he comments.

The Clearwater platform can handle multiple regulatory regimes - for example, from individual states and the National Association of Insurance Commissioners (NAIC) - and can work with The Warranty Group's multi-currency environment. "We have about 35 currencies under our portfolios, and though we don't have foreign exchange exposure owing to our liabilities being denominated in local currency, there were huge currency swings on a quarterly basis during 2009," Krygier notes.

Clearwater also gives The Warranty Group the ability to monitor from a consolidated view credit rating changes on a daily basis. "We can take a holistic view of our portfolio, both dollar and non-dollar denominated, in a single view," Krygier explains. "Clearwater lets you drive down into market sectors and look at every single asset we own, no matter where in the world, and roll it up into one overarching picture. It gives you the ability to view in great detail, but it gives you the ability to look at the holistic picture first."

With the Clearwater solution, The Warranty Group has also been able to move from semi-annual to monthly stress testing. "To keep the car on the road, so to speak, we need to nudge it a little rather than have to get it back in the lane after it swerves hugely," Krygier says. "Without frequent stress testing, the potential is there to swerve."

The Warranty Group also enjoys the Clearwater platform as a secondary compliance check. The insurer's compliance guidelines are hard-coded into both the systems of its asset manager, J.P. Morgan (New York), and Clearwater. The latter provides a kind of post hoc check, according to Krygier. "If there's a [guideline] violation on any of your portfolios, the Clearwater system sends an e-mail alert," he relates. "If something falls through the cracks, we'll know about it immediately and will be able to rectify it."

Reporting for Duty

The net effect of the system has been to provide a far more up-to-date view of The Warranty Group's portfolio, which enables more timely decision support and greater stability, as well as the peace of mind that comes with that, Krygier points out. "With the Clearwater platform, you're able to get a snapshot of your portfolio effectively in real time; you have the previous night's closing price, and in the morning you have a fully reconciled portfolio - you know your position," he says. "I'm at the point now where I can't wait to deliver reports to the board."

The senior risk managers at Minneapolis-based Allianz Life, a division of Munich-based Allianz (US$129 billion in annual revenue), also are facing greater demands for risk transparency from the company's leadership in the wake of the financial crisis, according to Neil McKay, the carrier's SVP and chief actuary. "It's not only about reporting but also telling management what would happen in certain scenarios and being very proactive in how we do that," he says.

"We have an increased demand for precise, timely reporting," McKay adds. "But what was really emphasized by the crisis was the management part of risk management: How are you managing your company? What actions did you take?"

If there's one lesson that can be learned from Allianz Life's experience during the financial crisis, McKay adds, it is that, "You need to have your capabilities built before an event happens so that you can manage through it."

Allianz began building those capabilities nearly a decade ago, when it became clear that the risk management discipline was departing from a traditional paradigm in which actuaries used prescribed formulas to calculate reserves, according to McKay. In today's world of financial simulation, insurers must be able to run an exponentially multiplying number of models and scenarios, he asserts.

McKay adds that Allianz has invested heavily in the hardware, software and people - including physicists in its hedging area to execute sophisticated mathematical operations - to meet the new world's requirements. "Being able to run scenarios at the close of the market and have the information before you go home to support the next day's decisions has become imperative to running our business," he comments.

Remodeling Risk

McKay is not exaggerating when he says modeling demand has increased exponentially. Having already invested heavily in grid technology and blade servers earlier in the decade, Allianz Life added another 600 blades in 2008, doubling their number. The carrier also went live on TIBCO's (Palo Alto, Calif.) GridServer grid technology in 2008. "We spent millions of dollars to get the hardware to give us the capability to run high-end models in a very efficient manner, to deliver results in a very timely fashion," McKay relates. "It used to take three weeks to do one run that we're now running overnight with hundreds of scenarios - what we're doing today is a night-and-day difference over what we were able to do five years ago."

Providing this level of modeling is not just a matter of responding to internal demands that have increased in the wake of the financial crisis, stresses Andreas Graser, Allianz Life's chief risk officer. "We're seeing much greater interest in modeled results from the regulators as opposed to the formulaic approaches that we had in the past; and as a subsidiary of a German company, we are implementing Solvency II here locally, which is a very model-intense exercise," he reports. "You would not believe the increase in requests from both regulators and rating agencies following the financial crisis."

Allianz Life's longer-term move to a model-focused paradigm included the creation of a new department dedicated to sophisticated scenario simulation and processing. "We took the programming out of being a solely actuarial risk management responsibility and coupled it with the best we could get in IT and created a department called Actuarial Solutions," relates McKay. "The department consists primarily of IT people whose role is to make sure my models are efficiently designed and effectively modeled from an IT control standpoint."

He adds, "We've enjoyed many gains from this, owing to the fact that actuaries are typically not very good programmers. You get the answer you want, but the system isn't going to run as efficiently."

Formed at the end of 2006, the Actuarial Solutions department has built a system that incorporates best-of-breed elements, including the firm's existing Towers Watson's (New York) MoSes actuarial software and Microsoft (Redmond, Wash.) SQL databases, according to McKay. The carrier's blade hardware vendors are HP (Palo Alto) and ClearCube (Austin, Texas). McKay notes that Allianz Life's actuaries have left behind spreadsheets and now log directly into the actuarial system's front end.

McKay stresses that Allianz is far from alone in using the modern methodologies and technologies exemplified by its system. But, he says, the carrier's risk management capabilities have put Allianz in a much more favorable position.

"We have a lot more information at our fingertips when we make decisions, and that gives us the confidence that we can manage through events such as the crisis," McKay remarks. "I can't say that it gives us a huge competitive advantage, but it confers much more stability in the company and the risks that we take on."

Graser is willing to go a little further. "In our industry, you see a fair amount of ups and downs and aggressive entering and exiting of markets," the CRO says. "That's not how we want to be; we want to make sure that our products are out there for the long run. We analyze products by multiple methodologies before we bring them out, and that makes us confident that we can continue to sell them. That's a competitive advantage in itself."