The Big Rethink
In wake of the economic crisis, financial risk managers will need to rely on process and technology innovation, as well as a dose of introspection.
Insurance Networking News, 06/01/2010
The economic crisis that began in the fall of 2008 was many things: an affirmation of the interconnectedness of the financial markets, a wake-up call for legislators and regulators, a validation of risk management, but also a reminder of its inherent limitations.
The crisis was especially momentous for financial managers within insurance companies, who were called upon to make sense of markets where stock prices and credit ratings swung wildly, and formerly clear distinctions became subject to interpretation.
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During a time when "toxic asset" became a part of the lexicon, portfolio managers were suddenly subject to an entirely new level of scrutiny, chief investment officers and chief financial officers were required to demonstrate increased transparency into the assets they managed and their exposure to counter-parties.
Accordingly, many of the decisions made during the height of the crisis were tactical-unloading a higher-risk asset regardless of a short-term loss. "Many companies de-risked by selling at bottom," says Cliff Gallant, an equity analyst at Keefe, Bruyette & Woods, a New York-based investment bank.
In addition to the urgent need to detoxify, some traditional capital management options, such as accessing public debt markets, vanished for a period of time. Other formerly routine tasks, such as hedging and setting surplus and reserves, suddenly took on a new sense of urgency.
"The fourth quarter of 2008 was a watershed event," says Kevin Kelley, CEO of Bermuda-based Ironshore Inc. "It changed the landscape of the financial services business as well as the P&C industry."
One of the primary changes to the landscape is how insurers view their investments. "By and large, most of the industry is managing their asset portfolios on a much more conservative basis-shorter durations and a much greater eye to safety of principal and liquidity," Kelley says.
Another traditional means of hedging risk-buying reinsurance-also has changed, as carriers look to spread their risk around to a greater number of players in the secondary market. "Customers and intermediaries no longer want to have concentrations of counterparty exposures," Kelley says.
RISK & REWARD
Because no company came through the crisis entirely unscathed, it helped to widely illuminate the state of risk management across the breadth of the insurance industry.
"2008 and 2009 were great test years for the insurance industry, and with one major exception, they performed remarkably well," Gallant says. "It was a time when good behavior was rewarded."
The companies that fused financial management with solid risk management practices fared better than those that divorced risk-taking from core corporate objectives, Gallant adds.
"The fundamentals of good risk management haven't changed, but there have been failures within other financial institutions of the proper application of sound risk management principles," says Gideon Pell, SVP and chief risk officer for New York-based New York Life Insurance Co.
According to Pell, one of the keys to managing risk is remaining true to a company's corporate mission. Freed from quarterly expectations, mutual companies may have an advantage in that they don't have to make short-term decisions. In the case of New York Life, the company's risk management practices are inseparable from its vision of providing long-term policyholder value, Pell says. "As a mutual, we're not about chasing large short-term returns that involve outsized risks. Stable growth in a controlled manner is much more important to us than looking to chase returns."
Pell says a successful financial risk management strategy should seek to dampen volatility- both on the upside and downside. "It's all about prudent risk-taking-understanding the risks that we are taking, knowing what risks we are comfortable taking, and those which we are not advantaged to take," he says. "You have to be financially disciplined to do that, especially when times are good and there is the appearance of gains to be had seemingly with 'little or no risk.' If it seems too good to be true, it probably is."
A similar commitment to a disciplined investment philosophy also helped Minneapolis-based Allianz Life Insurance Company of North America weather the storm, says Ross Bowen, the company's VP of profitability management. "From the beginning, Allianz was fairly conservative, which helped us come through the crisis well," he says.
Much of Bowen's bailiwick revolves around determining the company's exposures-and thinking ahead: Is the stock market or bond market the greatest source of risk? Is the economy expanding or contracting?
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