“The key is how well the risk is understood. We must understand the whole business that we’re underwriting: the various loss scenarios, the interdependencies, and the underlying risk. If you don’t understand it, you can’t price it and you can’t manage it.”
“We are fully aware there are events and circumstances we cannot foresee or model appropriately. Only risk limits and accumulation management can protect against an unknowable downside risk and prevent the over-leveraging of our capital base.”
A sound technical framework
PartnerRe’s integrated risk management framework provides a common basis for identifying, evaluating and managing our assumed risks across different risk categories and business units. This promotes consistent decision-making and execution on both the reinsurance and capital markets sides of our business, and at all levels of the Company, which in turn leads to stability.
We apply a common unifying principle to every risk. We use capital to measure risk and apply a consistent capital charge methodology to every risk we assume. This allows us to measure risk consistently across the Group and enables us to evaluate whether risks – both reinsurance and capital markets – are adequately priced. It also allows us to identify and manage interrelationships between the various categories of risk, manage the portfolio dynamically and leverage the benefits of diversification.
We employ state of the art tools to model all of our reinsurance and capital markets risks and quantify their financial consequences to PartnerRe. We combine these measurements in our Capital at Risk model, a financial modeling tool that provides a holistic view of the capital we put at risk at PartnerRe in any year. This allows us to optimize return relative to risk by allocating more capital to those lines that promise greater return for a risk level consistent with our risk appetite. The model is continually being expanded, with capital markets business coming fully on line in early 2009.
The Capital at Risk model also allows us to have a very clear idea of how much capital we should hold, not just to meet our anticipated obligations, but to ensure we can ride out unforeseen losses. Our starting point for capital adequacy is to hold enough economic capital to weather an extreme event or aggregation of events. In addition, we hold capital to weather “model error” – and on top of that, we hold capital to account for the “unknown unknowns”. That total capital is known as our minimum desired economic capital and is monitored at the Board level.
As we know that models are never 100% foolproof, we take one step further. We impose absolute limits to those areas of risk – catastrophe, casualty and equity investment – that have the greatest potential for shock losses. No matter how attractive a return may appear, or how “safe” the models suggest a risk to be, we will not exceed our established limits for those risks. Our limits are clearly communicated to and understood by every underwriter and asset manager.
Ultimately this framework should allow us to consistently make good risk decisions and protect against the model error that has hurt many financial institutions in the recent crisis. Next >