‘Independent’ risk management needed

The importance of ‘pre-emptive’ and ‘independent’ risk management is one factor that regulators and (re)insurers should bear in mind when considering lessons from the global financial crisis, according to a new paper by the CRO Forum.

The CRO Forum, a group of chief risk officers from Europe’s biggest (re)insurers, published the report in anticipation of governments reviewing their regulatory regimes to help avert future crises.

Preventing another crisis will require international cooperation and coordination as well as group-level supervision and efficient capital management for global (re)insurance groups, noted the report.

‘Any new regulation will need to take account of the insurance industry’s distinct business model; it should avoid creating market distortions and offer clear incentives for sound risk and capital management,’ said the report.

Raj Singh, Swiss Re’s chief risk officer and member of the CRO Forum, commented: ‘The financial crisis has demonstrated the need for an integrated approach to risk management and one that encourages risk managers to think in terms of scenarios. The crisis also reinforced the case for Solvency II as a principle-based, economic, risk-sensitive and prudential approach.’

The paper summarised the CRO Forum’s views on the key elements of effective risk management. It considered five responses to the crisis, these are summarised below:

Integrated risk governance

• The risk management function needs to be pre-emptive, independent and empowered. This will foster a genuinely risk-aware culture in each organisation, by clearly articulating and monitoring the company’s risk tolerance.

• Compensation should be based on risk-adjusted performance.

Risk models

• These are indispensable tools for developing business, designing and managing products, valuing portfolios, gauging capital adequacy and regulatory purposes.

&#8220Rating agencies played an important role in the financial crisis. They should be brought under supervision.

The CRO Forum

• But they can never be a substitute for common sense as they do have significant inherent limitations.

• Risk models require regular improvement to be effective.

Liquidity risk management

• Liquidity risk is distinct from risk to capital adequacy.

• Liquidity risk of insurers is fundamentally different from that of banks.

Valuation and risk disclosure

• Market-consistent valuation of both assets and liabilities should become the principle that underpins financial information and prudential oversight in insurance.

• Rating agencies played an important role in the financial crisis. They should be brought under supervision, however the use of ratings in financial regulation should be curtailed.

Group supervision

• The financial crisis emphasises the need for international cooperation among regulators to develop group-level supervision.

• The CRO Forum supports a principle and economic risk-based approach for the supervision of groups.