Zero Problems Risk Management

More and more we actuaries and risk managers become aware that our risk models can't just be based on numbers and statistics exclusively.

Some examples:

Systemic risk

The recent financial crisis made it clear that a 'mono risk approach' on a sole risk-object (mortgage, fund-investment) is insufficient.

Investments and loans are embedded in a worldwide sea of connected financial instruments and reinvestments. Systemic risk has to be included in our models.

Main challenge here is that systematic risk essentially depends on macroeconomic and (mostly) irrational factors. Further, systemic risk is related to the structure and dynamics of the market. More than numbers.....

Supervisory Herding Risk

In their effort to control and support financial institutions like banks, pension funds and insurance companies, country supervisors, regulators and 'accounting standards boards', defined a meticulously set of guidance rules (Basel I/II/II, Solvency I/II, Qis-I-V, IFRS, FAS, AIFMD, FTK, FIRM, etc.,etc.)

Financial institutions not only confirmed and adopted to those new rules, but - in their rush and driven by cost and time pressure - also implicitly (and often unintentionally) declared those same imposed rules and rationales as their own business 'Risk Appetite'. This way, most financial Institutions became so called: 'Supervisory Compliant'.

Instead of  expliciting their specific company-targets and successively developing their own correspondent risk appetite and risk framework, they incorporated the supervisor's risk philosophy. 

Without a sound own (board) risk vision that would undoubtedly have included some extra safety on 'company specific risk issues', financial institutions became - like a herd - all in the same way extremely vulnerable to (less defined) external risks.

Summarized:

Overregulation increases Herding Risk

Financial institutions all measure and respond to regulated risks in the same way. Supervisory Herding Risk is born.....

Too Much Focus Risk

As a consequence of pre-subscribed risk categories and ruling by law or (accounting) standards, there's the risk of 'too much focus' on specific risks while forgetting, denying or neglecting other important risks. Remember, the devil is in the (correlating) details....

Here's a useful, but not exhaustive, checklist to keep track on your risk models...

Average Premium Risk	Diversification Risk	Matching Risk
Commodity risk	Employer Continuity Risk	Operational risk
Compliance Risk	Environmental Risk	Outsourcing Risk
Compliance Risk	Equity Risk	Oversight Risk
Concentration Risk	Herding Risk	Price Inflation Risk
Counterparty Risk	Interest rate risk	Property Derivatives Risk
Coverage Ratio Risk	IT Risk	Reinsurance Risk
Credit Risk	Legal risk	Reinvestment risk
Culture Risk	Legislative Risk	Reputation risk
Currency Risk	Liability Risk	Sex Calculation risk
Default Risk	Liquidity risk	Strategic risk
Deflation risk	Longevity Risk	System Risk
Disaster Risk	Market Risk	Systemic Risk
Discount Risk	Matching Risk	Wage Cost Inflation Risk

ALM Simplifying Risk

Univariate models are killing and even multivariate models have proven to be too vulnerable and too limited in the recent crisis. It's not just about correlation and covariance matrices. What we need is an self-explaining model. A model  that predicts or generates expected values in an economic context, depending on exogenous economic variables like inflation rate, GDP-Level, etc. and that is based on the same structured historical economic data-set.

We need 'Asset Liability Modeling New Style' and not only Stress Testing or
advanced and excellent Crash Modelling as well explained by EMB.

Geopolitical Risk

With Europe and Japan as recent examples, it's clear that risks come from everywhere around the world.

The consequence of earthquakes (Japan, Australia), a possible  country default (Ireland, Greece, Portugal, ..), political instability (Libya, Ivory Coast, ..), war threat (Vietnam,Iraq, ..), financial easing (US, Europe,...), on our economic system, prices and financial institutions seems substantial and - moreover- predictable.

More than just trying to catch and capitalize these kind of risks in our risk models, we need to develop (financial) mechanisms and products that can cope as best as possible with these kind of risks.

The Riskmap 2011, Managing Risk | Maximising Opportunity, offers a good description of the actual risks that influence our lives and risk models.

A nice example is the recent (unexpected) leading role that France took in action against Libya.  'Riskmap 2011' mentions the 'Arabic Poll 2010' that clearly shows (despite the lack of sympathy for president Sarkozy) the trust and sympathy for France. France clearly outperforms the US and president Obama  unfortunately has lost the trust of the Arabic world... Take a look at the next slide summary (or the original complete pdf):  

Arab Public Opinion Poll 2010 Summary

Arab Public Opinion Poll 20... by Jos Berkemeijer

The Arabic poll shows that the prime minister of Turkey, Erdogan, has clearly gained  the confidence and trust of the  Arabic countries. With Ergodan, Turkey - at the cross road between East and West - takes a leading role in the 'World Risk Management Process'.  Ergodan's Risk Philosophy, invented  by the Turkish Foreign Minister Ahmet Davutoglu,   is 'Zero Problems'.....

Perhaps that should be the philosophy of actuaries too...

Zero Problems

Conclusion

From now on 'Modeling Risk' is more than just a financial exercise.
It's building scenario's, mechanisms and products that can cope with this risky world.  Success as actuary or risk manager!

Related Links:

- Committee (behaviour) assessment tool
- Control Risks:Riskmap 2011
- Arabic Poll 2010
- Supervisory Compliant
- Maplecroft Risk Maps 
- EMB: How to Model a Crash (REVO)