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Development of Earnings at Risk - Sun Life Financial

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1. Enterprise Risk Management Case Study 5: Earnings-at-Risk Ron Harasym Sun Life Financial Casualty Actuarial Society / Society of Actuaries Enterprise Risk Management…
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  • 1. Enterprise Risk Management Case Study 5: Earnings-at-Risk Ron Harasym Sun Life Financial Casualty Actuarial Society / Society of Actuaries Enterprise Risk Management Symposium April 14, Chicago Illinois
  • 2. 2 Outline of Presentation • Market Risk Tolerance Limits (MRTLs) • Progression to Earnings-at-Risk (EaR) • Comparison with other tools • Sample Earnings-at-Risk report • ERM moving forward
  • 3. 3 Development of Market Risk Tolerance Limits • Senior management was surveyed as per risk tolerance. • Limits were established on interest, equity, and currency risk at the company and business group level. • Stylized capital market shocks were defined. • An income sensitivity testing standard was developed. • Income sensitivity is now tested against these limits. • Business groups must explain and justify if beyond these limits. • Compliance report is presented to the Executive Risk Committee and the Risk Review Committee of the Board.
  • 4. 4 Progression to Earnings-at-Risk • Quantifies both the frequency and severity of scenarios • Forward looking: • can identify exposures • can act as an early warning system • High information density: • identification of cross-operation risk diversification • identification of intra-operation risk diversification • Complex stochastic modeling required • heavy computational demands • use of representative scenarios helps • Communication challenges
  • 5. 5 Comparison: Business Plan, MRTL, EaR (1) Business Plan: consists of a single projection (2) Market Risk Tolerance Sensitivities: • 4 interest scenarios • 4 equity scenarios -30% -20% -10% 0% 10% 20% 30% -200 bps -100 bps 0 bps 100 bps 200 bps Interest Movement EquityMovement (3) Earnings-at-Risk ,,,,,,Sensitivities: • Additional 16+ ,,joint interest/equity ,,scenarios
  • 6. 6 -40% -20% 0% 20% 40% 60% -300 bp -200 bp -100 bp 0 bp 100 bp 200 bp 300 bp Interest Movement EquityMovement (4) Earnings-at-Risk Simulation • simulation of typically 10,000 economic scenarios via interpolation into the earnings surface Comparison of Approaches (Continued)
  • 7. 7 Comparison With Other Tools Tool Number of Scenarios Projection Period Purpose Business Plan 1 base scenario 1-3 years  detailed (precise) projection of base scenario MRTL 4 interest scenarios 4 equity scenarios 1 year  inderdstanding of stylised shocks Earnings-at- Risk 10,000 fitted scenarios 1 year  probabalistic measure of risk DCAT 5-10 scenarios 5 years  severe deterministic stress testing
  • 8. 8 Sample Earnings-at-Risk Report CTE [95%] Uncorrelated Correlation Risk Originator Interest Equity Currency Total Effect Total EaR Country A $88 $24 $0 $112 ($22) $90 Country B $23 $68 $14 $105 ($18) $87 Country C $44 $42 $17 $103 ($5) $98 Country D $56 $9 $55 $120 ($35) $85 Uncorrelated Total $211 $143 $86 $440 ($80) $360 Correlation Effect ($140) ($51) ($5) ($196) $37 ($159) Total EaR $71 $92 $81 $244 ($43) $200 Risk Category
  • 9. 9 Sample Earnings-at-Risk Chart Interest Rate Equity Currency Country A Country B Country C Country D $0 $10 $20 $30 $40 $50 $60 $70 $80 $90
  • 10. 10 ERM Moving Forward • MRTL & EaR are decisions support tools, directed at supporting risk based decision making by senior management • It will take a number of years to: • to include other risk factors such as mortality/morbidity, credit risk,.... • to fully embed in the organization with • greater drill down • greater linkage between decisions made in front/operational lines and resultant impact on risk exposure • Finally, the process is still evolving.
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