Risk Management Methods Iryna Nyenno, Doctor of Economics, Odessa I.I. Mechnikov National University

In accordance with this standard it is necessary: 1. Establishing a risk context; 2. Identification of risk factors and risks; 3. Risk assessment; 4. The choice of risk management methods; 5. Risk-based strategy selection. 6. Monitoring risk management 7. Risk financing (calculation of economic efficiency or risk management effect) Structure of the RM program: (см. AS/NZS Risk Management Standard 4360:

The first step in developing a program is to establish a risk context, which includes defining the strategic, operational goals of the company and the principles of risk management. It is on the basis of the company's strategy (its mission, specific goals and principles) that the Program should be developed. For example, the mission can be defined as: to favor the social and economic well-being of customers by providing them with high-quality services and thereby obtaining a profit that meets the expectations of shareholders and is sufficient for the development of the company and its staff. The strategic goal is to achieve a reduction in the company's loss ratio by 10% until Tactical goal - to achieve a reduction in unprofitability for CASCO insurance - up to 30% in 2020 Stage 1. Establishing the context of risk: determining the strategic and tactical positions of the company.

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Loss ratio of auto CASCO by year,%

The share of contracts in the portfolio with the franchise "0" by risk of "damage" Year 1 Year 2 Year 3 Year 4 Year 5

Development of measures to reduce losses to 30% Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Loss ratio of auto CASCO by year,%

One of the most authoritative methods of risk management is the approach proposed by PricewaterhouseCoopers, which worked on the instructions of the International Federation of Accountants (IFAC). We take it as a basis. Identification of risk factors is the most important step, and as shown below, there are a lot of potential sources of risk (see Table 1): Table 1. Identification of risk factors Risk sourcesDescription CompetitionThreats of absorption and merger GlobalizationNew markets, complex logistics, scattering of suppliers and consumers, special requirements of local markets. Regulation of the economyTrade unions, monopolies, tax reforms Financial instabilityInternational capital flows, currency and interest rate fluctuations, complex hedging instruments Political changeUnpredictable government action Scientific and technological revolution New products, short life cycle life, the need for continuous investment in R & D Other… Stage 2. Identification of risk factors and risks

Detection methods: The main methods are based on statistical, financial, management and other reporting documents or require direct inspection of hazards. There are quantitative and qualitative. The main ones include: standardized questionnaire; conducting stress testing; consideration and analysis of the primary documents of management and financial reporting; compilation and analysis of the organizational structure of the enterprise; inspection departments; evaluation of investment areas; risk field analysis; SWOT analysis, etc. Stage 2. Identification of risk factors and risks

Risk fields common to insurers: 1.loss or depreciation of cash deposits in banks and other assets; 2.fuzzy, often far from optimal decisions of the legislative bodies and the government; 3.vague decisions and actions of shareholders; 4.extreme imbalances between capitalization (expected income and expenses) and liability (insurer's obligations); 5.irrational decisions (including statements) of company management; 6.loss of insured confidence and (often underestimated factor) reinsurers. Stage 2. Identification of risk factors and risks

Using the example of Royal Bank Financial Group (RBFG), we can propose a model for determining and analyzing risk factors, which is represented in the form of a pyramid divided from the apex into levels 1 - the macro level, 2 - the micro level, 3 - intra-organizational risks. At the first level, there are systematic (systemic) risks that the organization practically has no control over. They belong to the elements of the environment in which companies operate. These are political, legal, macroeconomic risks, etc. At the second level are the risk factors that the organization can not control, but can influence them. This is competition, reputation and regulation. At the third level are the risks that the company can manage - credit, liquidity, technology, production. Stage 2. Identification of risk factors and risks

Risks of insurance companies: 1.Underwriting risk (risk of insufficiency of premiums and reserves, catastrophic risk; risk of increased mortality, risk of increased life expectancy, risk of disability and damage to health, risk of increased business costs, risk of changes in the size of annuities, risk of cancellation of contracts, catastrophic risk, risk changes in expenses incurred in connection with servicing health insurance contracts, fluctuations in the frequency and severity of insured events, inaccurate estimates and projections regarding crumpets epidemics. 2.Market risk (equity investment risk; interest rate risk; currency risk; spread risk; property risk; market concentration risk; counterparty default risk). 3.Operational risk. 4.Technical, non-technical, investment risks. 5.Asset risk, insurance risk, operational risk (model of economic capital). Stage 2. Identification of risk factors and risks

Emerging risks and risk mitigation measures for insurance company business processes Methods of control and risk management in business processes: identification of risk fields that may lead to a deterioration in the company's financial position recognition of risks and their analysis risk communication determination of the responsibility of accountable persons establishment of an internal control system, verification of internal audit principles documenting actions taken Stage 2. Identification of risk factors and risks

Sales risks Consulting errors The level of competence of intermediaries Commission risks Risks of cooperation in the implementation Asset and liability management risks Computer risks Data loss Business Continuity Risk Software bugs Physical risks Human Resource Risks Quality - Qualification, Education Quantity - fluctuations lack of motivation Accounting risks Fast close procedures Stage 2. Identification of risk factors and risks Risks of insurance companies:

Personnel: wage fund growth; the difficulty of recruiting qualified personnel; staff turnover; non-fulfillment of the planned tasks in terms of the deadlines; Financial: liquidity reduction; reduced financial sustainability; increase unprofitability; decrease in efficiency (turnover); decrease in profitability risk of bankruptcy. Political risks: changes in the legal framework; social unrest, causing damage to the property interests of the enterprise; tax laws that would prevent further investment or profitable business management; Stage 2. Identification of risk factors and risks Risks of insurance companies:

What happens during the ascent?Risks / odds for insurance companies Tasks of the insurance company risk management system Availability of relatively cheap capital. Significant amounts of capital imports. Debt growth. Increase in equity through the use of cheaper risk capital. The increase in the size of capital, or, after the crisis, the recapitalization or attraction of new capital. Pay attention to guarantees for investors, etc. Fast inflow and high share of foreign currency funds Factors impeding the development of our own financial institutions Setting clear assignments and controlling capital raising. Mergers and AcquisitionsAbsorption riskRegulation of the sale of shares The rapid growth of investment in insurance companies and companies serving the insurance sector Accumulation of financial and insurance risks accompanying the process of investing in insurance companies Investments in insurance companies. Structuring groups and achieving real synergies in capital structure. The rapid growth in demand for insurance products. The emergence of new directions of insurance and insurance products. Growth in the volume of insurance products that combine risk taking with capital raising. Rapid growth, accompanied by: - stretching responsibility; - the acquisition of risks not measurable in medium term; - acquisition unwanted risks; - too wide participation in too wide spectrum various risks; - hazards associated with risk accumulation. Monitoring the company's business policy. Control of the structure in the formation of a portfolio of risks. Determination of acceptable risk parameters. Analysis of the effect of the "long tail" (long- tail-effect). Competitive advantages due to transparency of pricing. Obtaining "optimal" risk capital (risk reinsurance). Optimal allocation of capital. Increment reserve. A growing offer of insurance and other services. Excessive staff growth, growing bureaucracy. Control over expenses and combined ratio Growing demand for capital in the private and public sector The acquisition of insufficiently reliable and profitable securities and banking products and investments in them. Restructuring of investments. Control of guarantees against the risks of investment. Boom period

Crisis period What happens during a crisis?Risks / odds of insurance companies Tasks of the insurance company risk management system Shortage of funds: rapid outflow or loss of capital. Credit crisis due to cessation of loans or high interest rates on loans. The fall in real income. Reducing the volume of bank deposits. Reducing insurance with new customers. Loss of previous clientele. Reduced profitability of insurance contracts. Reduced investment. High credit risks. There is the possibility of obtaining high returns from capital. Redistribution in part of the risks assumed, change in the parameters of acceptable risk. Capital transfer to stable or growing sectors. The pressure of competition. Dumping. Declining tariffs with increasing risks and losses Establishing a technical minimum for making a decision on withdrawal or expansion of activities, the adoption of counter-cyclical measures. The number of claims for claims settlement is growing. Increased incidence of fraud. Rising costs for damages. Disproportion between rising costs and declining premiums. Take measures to assess and limit the scope of potential losses. Immediately bring the underwriting process in line with the situation. Banking crisis. Crisis in securities trading. Loss of assetsContinuous monitoring. Rapid investment restructuring. Crisis among competitorsReducing the number of requirements imposed by other insurers. Mutual reinsurance of insurers is especially dangerous. Mergers and acquisitions of companies are possible (this also applies to your own company) In case of reinsurance of risks, limit the parameters of acceptable risks (propensity to take risks). Identify and exploit the potential of the crisis. Structuring groups and achieving real synergies in capital structure.

Crisis period (continued) Reinsurance companies under pressure. Loss of capacity by reinsurers. Reinsurers are not able to pay in case of loss. The inability to use reinsurance as a source of replenishment of reserves. Rise in cost of "reinsurance capital". Mobilize your own reserves. Regrouping of optional reinsurance contracts. National currency under pressure. The remaining currencies are depreciated. Currency losses of up to 100% are possible.Analyze the consequences of willingness to take risks and take them into account in the underwriting process. Country rating is downThe insurer's rating decreasesAnalyze the effects of rising capital raised. The crisis of the financial system of the state. Budget deficit. Providing state assistance only when certain requirements are met. Where the state retreats, the emergence of new insurance products is possible. Tax pressure is growing. Anticipate and manage the transition period. Analyze the risk load applied to these products and set limits. The propensity of politicians and policyholders to make radical and irrational decisions The financial burden on insurers. The collapse of the tariff system. Assess the impact on the risk situation of the insurance company.

Assessment of the ratio of profitability and risk when placing reserves and available funds. Identify key risks. Scale risks of IC Not subject to management Macroeconomic risks Counterparty risk Currency risk Market risks Operational risks Price risk Staff risk

Assessment of the ratio of profitability and risk when placing reserves and available funds. Management of risks Low liquidity Additional operating costs _________________ The presence of a tangible asset Avoiding counterparty risk The property Low capitalization of banks Low risk management of financial institutions _________________ The possibility of expanding sales, subject to participation in banking insurance programs High liquidity Banking Investments Failure or late fulfillment of obligations by counterparties "Closed" information to assess the actual financial condition ________________ Risk sharing The possibility of increasing incoming cash flows Rights of claim

1. Technical insurance purposes risk sharing Increase underwriting Services and advice from a professional reinsurer 2. Technical management objectives Increase safety planning / budget process 3. Financial technical objectives Adhere to the criteria of solvency Manage internal cash flows FPG Stage 3-4. Risk assessment and choice of risk management methods Objectives of reinsurance as a method of RM

1.Proportional Quota 2. Disproportionate Exceed loss (XL) Stop loss Stage 3-4. Risk assessment and choice of risk management methods Forms of reinsurance as a method of RM IC

Establish the role of executive risk managers (CROs) and merge existing risk management operations in the central group Create a risk committee (s) to facilitate decision making and risk management dialogue Stimulate the development of a common risk culture through training and communication Control & Processes Create a framework for strategic risk management (definition of the term risk appetite based on the top-down principle, in accordance with the selected criteria) with reference to the Strategic Business Plan. Get tangible risk limits from strategic risk appetite Risk strategy Create market valuation methods (especially liabilities) Strengthen opportunities for stochastic risk modeling based on market valuation of assets and liabilities Improve the quality of design of risk models and controllability of data flows Risk models Create a framework for intra-company controls to link top-level risk management tools with everyday processes Periodically improve internal controls Intrafirm controls Create coherent internal risk reporting that would satisfy the needs of various stakeholders from one comprehensive source of information. Improve the transparency of external risks based on the structure of reporting on internal risks. Risk transparency There is no universal ERM program - measures depend on the structure, complexity and size of the business Optimal ERM measures for small and medium-sized insurance companies

Stage 5. Risk selection strategy Strategies N1, p= N2, p= N3, p= S1 S2

Stage 5. Risk selection strategy For each strategy, we calculate the net profit discounted using a discount rate adjusted for risk. Then we calculate the estimated cost, standard deviation and coefficient of variation for each strategy. Table. Expected net profit, estimated cost, standard deviation and coefficient of variation for each strategy Стратегии N1, p= N2, p= N3, p= Е(S)σC S1 S2

Stage 5. Risk selection strategy Define recommended strategies by Wald and Hurwitz criteria N1, p=0 N2, p=0 N3, p=0 WaldD S1 S2

Stage 5. Risk selection strategy We compose a loss matrix, and in accordance with the Savage criterion choose a strategy that is accompanied by the lowest maximum losses. Solution MatrixLoss matrix max losses N1, p= N2, p= N3, p= N1, p= N2, p= N3, p= S1 S2 We define the recommended strategy according to the criterion of Laplace- Bayes

Stage 6. Risk Management Monitoring The distribution of risks between functional units: authority in risk management (by job, division... who?) Tracking benchmarks (what?) Unity of the information base Setting principles for assessing and diagnosing risks when setting priority strategies and objectives Establish procedures for ensuring accountability, self-assessment and performance measurement in accordance with risk management principles (how?)

Stage 6. Risk Management Monitoring The distribution of risks between functional units Responsible Risk groups Accounting department Insurance department Human Resources and Intermediary Interaction Department Settlement department Reinsurance department Legal department Underwriting + ++ Market + + Operating + + HR+ + + Investment + + …

Stage 6. Risk Management Monitoring 1.Early warning systems constant comparison of plans and facts list of indicators to be checked network check 2.Compliance with corporate governance principles 3.An effective internal control department - to monitor procedures and monitor performance Principles

Stage 6. Risk Management Monitoring 1. Calculating bonuses Documentation Compliance with the criteria for being insured Does the actuary check calculations? Compliance with the solvency criteria Decision making structure and procedures Permanent bonuses and performance monitoring throughout the life of the product? Underwriting guidelines (do they exist, do they control the procedures?) Checklist for managing technical risk insurance

Stage 6. Risk Management Monitoring 2. Claims Management Is there proper claim statistics? Is there a control system? Has the risk of cumulative claims been verified? There is a control for fraud? Are reserves monitored regularly? Are there verified benchmarks? Checklist for managing technical risk insurance

Stage 6. Risk Management Monitoring Personnel: staff incompetence; untimely performance of work; errors in the reports; poorly established "direct" and "feedback" links. Financial: liquidity indicators financial sustainability indicators profitability indicators, etc.; Political: tax law changes; change of government. Benchmark Tracking

Stage 7. Risk financing The concept of risk financing means finding and mobilizing financial resources for using selected risk management methods. Risk financing involves three steps: Contingent; Expenses for compensation of losses for assumed risks (post event); Administrative risk management costs. Evaluation of the effect or effectiveness involves cost accounting and the three stages of financing risk management in the final financial result of the enterprise.

Stage 7. Risk financing Formation of self-insurance fund Outsourcing Premium Payments... Conducting research to identify risk factors Salary to the risk manager (employees of the risk management department) of the insurance company Total: The net effect of introducing risk management = net planned profit is the cost of risk management.

Stage 7. Risk financing Sale of a portfolio of regressions; Sale of part of the insurance portfolio; The choice of insurance niche; Expansion of the product line through the agency scheme. Methods of risk sharing by insurance companies Co-insurance (open and hidden) Insurance pool Reinsurance (obligatory or optional). IC risk financing opportunities

Stage 7. Risk financing Sale of regressions: price factors, portfolio requirements. Stages of the transaction. In most cases, insurance companies create a subsidiary structure, which assigns recourse rights for recourses and this structure independently collects debts. Disadvantages: - type of insurance product (auto hull, GO, financial risks, property); - extended in time cash flows; - low collection efficiency; - not a transparent transaction structure. IC risk financing opportunities

Stage 7. Risk financing Sale of regressions: price factors, portfolio requirements. Stages of the transaction. Factors determining the price of a portfolio: debt growth (the period from the date of occurrence of the insured event / payment of insurance compensation to the date of the sale of the portfolio); completeness of the package of documents in the insurance business (sore spots: the presence of payment orders for the payment of insurance claims, the presence of an extended certificate of the State Traffic Police (F-2), the presence of a court decision on the administrative case); history of work with the portfolio (who worked, for how long); regional portfolio structure (by region of occurrence of insurance events); circumstances of the sale (the IC is eliminated in connection with the sale of the portfolio, the planned sale of the portfolio in order to optimize the work with regressions). IC risk financing opportunities

Stage 7. Risk financing Sale of regressions: stages of the transaction. Signing a confidentiality agreement. Providing insurer information on the portfolio as requested. Assessment of the proposed portfolio based on a statistical model. Sample test of completeness of insurance cases. Approval of the price offer and other conditions of the factoring agreement. Signing factoring agreement. Transfer of insurance by the Insurer to the Factor. Payment Factor purchase price. IC risk financing opportunities

General recommendations and conclusion: The risk management program must conceptually correspond to the structure: risk-content risk management-the effect of risk management and strategically determine the greatest threats in the company's development, clarify ways to reduce them and justify quantitatively the choice of a strategy for future development, taking risk into account.

General conclusions on the work: 1.In this paper, we analyzed the activities of the insurance company, using stress testing, analysis of the insurer's risk fields. 2.Identified risk factors. 3.Identified risks (underwriting, commercial, financial, personnel, political...) and placed them on the risk map. 4.Determined the methods of managing the above-mentioned risks (in particular, reserving, diversification, limiting...) 5.Distributed responsibility for risk management between the organizational departments of the insurer. 6.Calculated the effect of the introduction of risk management system, which amounted to ______. 7. Developed 2 variants of the company's development strategies: reorganization of the sales network; expanding the range of services. 8.Determined the feasibility of implementing these strategies according to the method of calculating the estimated cost, standard deviation, coefficient of variation, and by the criteria of Hurwitz, Savage, Laplace-Bayes, Wald. After that, they concluded that the best development option for the company is the reorganization of the distribution network.