Using Standard Formula and Internal Models: Embedding in business - PowerPoint PPT Presentation

Using Standard Formula and Internal Models: Embedding in business decision making and aligning to Regulators’ expectations Paul Barrett – Head of Risk Framework, AIG Europe Limited 29 November 2016

Agenda Embedding Models in business decision making and aligning to Regulators’ expectations 1. The role of the Model in Risk Management 2. Uses of the Model in the Business 3. Governance, Oversight and Validation 2

1. The role of the Model in Risk Management Components of a Typical Risk Management Framework 3

1. The role of the Model in Risk Management 4

Risk Appetite Framework – 3 Levels AIG Europe – Risk Appetite Framework AIG PC – Risk Appetite Statement Level 1: Board Level – Risk Appetite Entity Level Aggregate Risk Adverse Ratings (1:7 & 1:200) Stress Target Scenario OPERATIONAL INSURANCE Level 2: RCC Level – MARKET CREDIT RISK RISK RISK RISK Risk Specific Tolerances Reserve NAT Cat MM Cat Prem Risk Risk Risk Risk and Limits (1:7 & 1:200) Perils AEP & OEP Res Risk Metrics 1) Reins Prog Failure 5 Most Material Spread Risk etc Concentration Top 3 Op Risk 2) Breach of U/W Aggregations Credit Risk 3) Failure of IT Equity Risk Terrorism Scenarios Prem Risk Authorities Level 3: RCC FX Risk IR Risk Systems Zones Metrics Level – Risk Metrics 5

Risk Review of the Business Plan: Drawing it all together for the Business Business Plan Risk Review Business Plan Risk Review: ERM- led assessment of AEL’s Business Plan, This activity incorporates: • Retrospective Review of Prior Year Budgets against Actual Results • Assessment of AEL’s Capital Adequacy over the Business Plan Horizon • Modelled Profitability Analysis, applying AEL’s Internal Model • Stress and Scenario Testing • Sensitivity Testing of Product Tower Budgets • Qualitative Deep Dive Reviews across each of AEL’s Key Risk Areas The outputs of this review are submitted to the AEL Board alongside the AEL Business Plan and form AEL’s forward looking assessment in its ORSA Report. Risk hotspots identified from this assessment are recorded, graded and subject to ongoing monitoring and reporting to the AEL Risk and Capital Committee and Board. 6

2. Uses of the Model in the Business 1 in 200 isn’t everything • Firms should be as (if not more) interested in the shape of their risk profile closer to the mean as points in the tail of the distribution • By using an Internal Model for more than setting Regulatory Capital, firms benefit from reviewing the full distribution and not just focused on a single point • Hence The “Use Test” requirement does not stand in isolation. Model Use is a powerful tool for the purposes of Model Validation … Probability …“ Validation through use ” A B C $0 LOSS PROFIT CAPITAL 7

2. Uses of the Model in the Business AIG Europe’s Five Main uses of the Model: 1. Capital Management 2. Risk Management 3. Underwriting Strategy 4. Reinsurance Strategy 5. Investment Strategy Level 1 Framework Directive Article 120 – Use Test “ Undertakings shall demonstrate that the internal model is widely used in and plays an important role in their system of governance ” 8

Tips for Embedding Model Use • Business Facing Capital Modellers – The modelling teams job is not done with the completion of each model build or run. Members of the modelling team should be tasked with producing tactical and strategic tools to aid the business’ use of model output  Regular and Direct engagement between the modelling team and the business also aids validation and the second aspect of the use test – “ Ongoing appropriateness of the Model ” • Wish list – Ask the business what tools they would find useful to interrogate and use model output. A model developed and run in a silo is no good to anyone  The model is there to support the business not the other way around • Validation & Ownership – engage the business through 1 st Line of Defence ownership of aspects of model validation and reviewing of results, as well as presence on Model committees 9

3. Governance, Oversight and Validation • Risk Governance Structure • Model Oversight Responsibilities of Risk Committees • Approach to Validation • Top-down Board-driven Validation • Bottom-up granular Validation 10

AIG Europe: Governance structure Board of Directors Executive Conduct Reserves Board Risk Audit Committee Committee Committee Committee Committee Internal Model Risk & Capital Decision Committee Authority European Zone ExCo / Capital Op Risk Insurance Risk Market Risk Credit Risk Management Modelling Data Committee Committee Committee Committee Committee Governance Council Country Risk Forums Pricing Risk Committee Reinsurance Risk Committee Risk Aggregation Sub-Group 11

Model Oversight Responsibilities of Risk Committees Across an annual cycle each main Risk Committee will: • Receive and review output from each Model Run • Review and Validate the Model’s calibration of their risks • Review the overall performance of the Model • Propose future developments for the Model AIG Europe Annual Model Improvement Process RCC ERM IMDA* ERM Risk Review Board Modellers Review Risk Committee Committee Modellers and Create Approve Technical Propose Approve Revise Approve technical Plan. requirements change Plan Plan Plan proposal / plan *IMDA – Internal Model Decision Authority 12

3. Governance, Oversight and Validation Top Down Board-driven Validation • A review initiated by the Board • Supported by an External Expert • Review driven by 35 Questions agreed upon by the Board across 8 themes: • Model Methodology • External Models • Expert Judgements • Model Sensitivities • Diversification and Dependencies • Reasonableness of Results • Quality of Validation Testing • Model Operation & data 13

3. Governance, Oversight and Validation Bottom-Up Granular Validation • Detailed Framework of Testing • Spread across 20 Internal Model areas such as: • Premium Risk • Reserve Risk • Dependencies • Market Risk • Man Made CAT • Model Documentation • Model Use • Model Governance • Covers not only the design and calibration of the model, but also the control and operating environment 14

Conclusions “ Validation through Internal Use of the Model ” • The Model is an integral component of the Risk Management Framework • It enhances the understanding of risk across the business and supports many decision-making processes • But the model also gains strength and refinement by drawing upon data and technical expertise across the business, to improve its design, calibration and the quality of data inputs • This is complemented by robust internal governance and independent validation of the Model to give assurance around the appropriateness of methodology, the credibility of Expert Judgements and the reliability of the outputs. • Together, this gives confidence to the Board when using the Model and to regulators when approving the Model “ Validation through Independent review and benchmarking of design, methodology, calibration and outputs of the Model ” 15

American International Group, Inc. (AIG) is a leading international insurance organization serving customers in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional, and individual customers through one of the most extensive worldwide property-casualty networks of any insurer. In addition, AIG companies are leading providers of life insurance and retirement services in the United States. AIG common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange. AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. Products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Not all products and services are available in every jurisdiction, and insurance coverage is governed by actual policy language. Certain products and services may be provided by independent third parties. Insurance products may be distributed through affiliated or unaffiliated entities. Certain property-casualty coverages may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds and insureds are therefore not protected by such funds. 16