Considering Risk Appetite Using Quantitative Risk Analysis

33 Pages·2012·0.51 MB·English

Considering Risk Appetite Using Quantitative Risk
Analysis
29 May 2012
Sydney
Andrew Kight
Why undertake risk analytics?
Median TCOIR Per $1,000 of Revenue ($)
Organisations that: 2009/10 2010/11
Use risk analytics 5.52 6.44
Do not use risk analytics 7.59 7.63
Difference -27.3% -15.6%
Source:Aon’s Australasian Risk Management Benchmarking Survey
(cid:131) Median TCOIR per $1,000 Revenue over the last two years is 21.4% less
for organisations that use risk analytics
Aon Risk Solutions | Global Risk Consulting 1
Outline
(cid:131) Risk Appetite Theory
(cid:131) Case Study – Insurable Risk
(cid:131) Further Considerations
Aon Risk Solutions | Global Risk Consulting 2
Definitions
(cid:131) There are various definitions of risk tolerance and risk appetite, however, we
define them as follows:
– Risk Tolerance: an organisation’s financial ability to retain additional risk. On a
strict interpretation of the definition it would describe the ability to absorb an
unbudgeted loss whilst continuing as a going concern.
– Risk Appetite: an organisation’s desire to retain risk and will depend on the
views of the Board and management (conservative or aggressive), as well as
being influenced by other stakeholders (banks, governments and shareholders /
owners).
(cid:131) Tolerance should be bigger than Appetite?!
Aon Risk Solutions | Global Risk Consulting 3
How to express Risk Appetite
(cid:131) This is not easy!
(cid:131) Car Insurance Example
Option 1 Option 2 Option 3 Option 4
Excess ($) 500 1,000 5,000 No insurance
Premium ($) 1,000 800 400 0
(cid:131) What is driving your decision?
– Risk vs Reward?
– Risk Appetite?
– Both?
(cid:131) How would you express your risk appetite?
(cid:131) Is it qualitative or quantitative?
Aon Risk Solutions | Global Risk Consulting 4
Aon’s Global ERM Survey
(cid:131) 43% of organisations new to ERM (Initial /
Lacking & Basic) still evaluate risk appetite
based on ‘gut feel’
(cid:131) 0% of Advanced ERM organisations
evaluate risk appetite on ‘gut feel’
(cid:131) 26% of survey participants do not have a
formalised risk appetite evaluation
methodology
(cid:131) 23% of survey respondents have had
success quantifying risk appetite / tolerance
“Origin Energy now takes a very quantitative approach to risks and expresses them in terms of the volatility they
introduce to key financial measures reflecting profitability, liquidity and our equity position.”
John Rodda, Origin Energy
Aon Risk Solutions | Global Risk Consulting 5
Aon’s Global ERM Survey
(cid:131) Organisations with mature ERM programs use
more sophisticated quantification techniques to
leverage risk-based information to support decision
making
(cid:131) 43% of Advanced ERM organisations utilise
stochastic / Monte Carlo simulation to understand
risk and measure the value of ERM
(cid:131) While most respondents with mature ERM
programs utilise qualitative tools to assess risk, the
use of sophisticated quantification tools including
value at risk, actuarial analysis and stochastic
modelling drop significantly
Aon Risk Solutions | Global Risk Consulting 6
How to express Risk Appetite
Risk Appetite Statements
(cid:131) Can be qualitative and quantitative
– Financial measures (ie. profit, banking covenants etc.)
– Based on likelihood and impact grid
– Qualitative statements
– Key indicators – risk, control and performance
– Impact on credit ratings
(cid:131) Our job (and our challenge):
– Qualitative statements into quantitative amounts
– Translate technical / quantitative models for decision-makers
Aon Risk Solutions | Global Risk Consulting 7
Sensitivity Analysis
g
Sensitivity Analysis - Earnings Before Interest & Tax (EBIT)
$500m
$446.2m EBIT cannot dropmore 
$450m $436.2m
$421.2m than 25% below budget
$396.2m
$400m
x
a $346.2m
T $350m
&

t
s
e $300m
r
e
t
n
e I $250m $246.2m
r
o
f
e
B
$200m
s
g
n $146.2m
ni $150m
r
a
E
$100m
$50m
$0m
2011 $10m $25m $50m $100m $200m $300m
Unbudgeted Loss Scenario
Aon Risk Solutions | Global Risk Consulting 8
Risk Categories
(cid:131) The entire risk portfolio must
be taken into consideration
when making decisions on risk
appetite
(cid:131) How is the aggregate risk
appetite spread across
different risk categories?
(cid:131) Insurable risk: deemed to be
between 30% to 40% of a risk
portfolio
Aon Risk Solutions | Global Risk Consulting 9