Raj Singh | MultaQa Qatar 2010 | 8 March 2010
Risk Management –Setting a New CourseRaj Singh, Chief Risk Officer, Swiss ReEuropean Commission, DG MARKT, 12 November 2010
EC, DG MARKT meeting | 12 November 2010 2
Agenda
(Re)insurance fulfils important economic functions
(Re)insurers weathered the crisis well
(Re)insurers are faced with challenging regulatory reforms
Crisis reinforces the call for strong ERM – Swiss Re's approach
Closing remarks
EC, DG MARKT meeting | 12 November 2010 3
(Re)insurance fulfilsimportant economicfunctions
3EC, DG MARKT meeting | 12 November 2010
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(Re)insurance enablesentrepreneurial risk-taking
«This has only been made possible by the insurers.They are the ones who really built this city. With no insurance,there would be no sky-scrapers.No investor would finance buildings that one cigarette butt couldburn to the ground.»
Source: Swiss Re, Introduction to Reinsurance ed. 1995/2000
Henry Ford,referring to New York City in the early 20th century:
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(Re)insurance is a catalyst foreconomic growth
What (re)insurers do Benefit to society Pre-requisites
Risk transferfunction
Diversify risks on anational or globalbasis
Make insurance morebroadly available andless expensive
Mobility of premiumsand capital
Capital marketfunction
Invest premiumincome accordingto expected pay-out
Provide long-termcapital to the economyon a continuous basis
Ability to invest in realeconomy (equity,corporate bonds, etc)
Informationfunction
Put a price tag onrisks
Set incentives for riskadequate behaviour
Market and risk-basedpricing
(Re)insurers absorb shocks, provide capital for the real economy andsupport risk prevention
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(Re)insurers manage the coverage oflarge and complex eventsInsured catastrophe losses 1970–2009
0
20
40
60
80
100
120
1970 1975 1980 1985 1990 1995 2000 2005Earthquake/tsunami Weather-related Nat Cats Man-made disasters
USD bn, at 2009 prices
Source: Swiss Re, sigma No 1/2010, Figure 3
2005:Hurricanes
Katrina, Rita,Wilma
2008:Hurricanes Ike,
Gustav
2001:Attackon WTC
1999:Winter storm
Lothar
1992: HurricaneAndrew 1994:
NorthridgeEQ
2004:Hurricanes Ivan,Charley, Frances
Ocean Drive, FL, 2000
Ocean Drive, FL, 1926
increased insurancepenetrationmore valuesmore values in high-risk areashigher vulnerability
climate change (storm,flood)
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Diversification is necessary tocover large losses such as terrorism
International(re)insurers paid 64%of 9/11 related claimsof USD 26.8 bn
By Company headquarters USD million
U.S. Reinsurers 4 109
U.S. Primary Insurers 5 659
Europe Reinsurers 5 506
Europe Primary Insurers 3 865
Bermuda Companies 2 479
Lloyd's 2 844
Japan Companies 2 338
Total announced 26 799
Source: Dowling & Partners
World Trade Center Losses
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Same benefits of global diversificationapply to coverage of hurricanes
Source: J. David Cummins, “The Bermuda Insurance Market: An Economic Analysis”, 6 May 2008.
Regional distribution of 2005 hurricane payments: Wilma, Rita and Katrina
0%
100%
80%
60%
40%
20%
Wilma Rita Katrina
OtherUS ReinsuranceUS InsuranceLloyd’sEuropeBermuda
Foreign (re)insurersmade more than 60%of Wilma, Rita andKatrina total losspayments of USD 59 bn
Open markets for (re)insurance are a pre-requisite to efficientlyabsorb large risks
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Demographics indicatelife and health insurance growth will continue
Source: Swiss Re, Economic Research and Consulting
Ageing population in the developed world
Continuous improvement of average global standard of living
Responding to increasing demand for insurance and wealth protection solutions
36 3118
2618 15
27 21 17
6064
6566
6858
6566
61
618
8 1528
8 1222
4
0%
20%
40%
60%
80%
100%
1950 2000 2050 1950 2000 2050 1950 2000 2050
0-14 (in %) 15-64 (in %) 65 or over (in %)
Asia Europe North America
Age:
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In managing risks, insurers become theworld’s largest institutional investors
Assets under management, USD trillion
Source: McKinsey Global Institute, The new power brokers, 2009
25.0
18.8
16.2
5.0
4.8
1.4
0.9
0 10 20 30
Pension funds
Mutual funds
Insurance companies
Petrodollar foreignassetsAsian sovereigninvestorsHedge funds
Private equity
Insurers’ world-wideinvestments totalledUSD 16.2 trillion(= 22.5% ofinstitutional investors’assets at end of 2008)
Insurers and pensionfunds together accountfor 57% of institutionalinvestors’ assets undermanagement
The real economy needs the financing from (re)insurers and pension funds
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Insurers provide long-term capitalto the economy
Asset allocations of nonlife and life insurers
Source: Swiss Re Economic Research & Consulting *US, Japan, UK, France, Germany ** Germany and France
0%
20%
40%
60%
80%
100%
Non-life Life
Cash
Other
Real estate
Loans
Equities
Bonds
Overly conservative investment rules would mean lower returns forpolicyholders and less capital for the real economy
Bonds61%
Shares5%
Investments inaffil.
undertakings4%
Cash anddeposits
1%
Land andbuildings
2%Mortgages
1%
Participation ininvestment
pools12%
Investmentsfor linked life
insurance15%
Based on five largest insurance markets* Example European life insurers**
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(Re)insurersweathered the crisis well
12EC, DG MARKT meeting | 12 November 2010
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Crisis hit insurers less than banks,resulting in lower recapitalisation need
Cumulative credit losses since 2007
Source: Geneva Association Systemic Risk Report 2010 based on Marsh EMEA Insurance Reports 2007, 2008 and 2009, Bloomberg (as at 10 February 2010), DataStream, Oliver Wyman analysis
x 6
USD 271bn
USD 1715bn
0
500
1 000
1 500
2 000
Insurers Banks
Lower credit losses for insurers meant stable prices and capacity for customers
Total capital raised globallyCumulative since 2007
x 9
USD 170bn
USD 1468bn
0
500
1 000
1 500
2 000
Insurers Banks
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Overall, (re)insurance weatheredthe crisis relatively well Reinsurers’ losses were mainly related to investments due to the
asset meltdown in financial markets
Reinsurers remained solvent and no diversified reinsurer failedduring the crisis
Cover was always provided both in insurance and reinsurance, andclaims were paid as usual throughout the crisis. Prices remainedstable
Problems arose from monoline insurers involved in financialguarantee business and insurers with important quasi-bankingbusinesses
Crisis revealed critical accounting issues and flaws in supervisorysystems
Core (re)insurance was conducted in a “business as usual” manner
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0
10
20
30
40
50
60
70
80
90
100
110
Dec 06 Jun 07 Dec 07 Jun 08 Dec 08 Jun 09 Sep 09E
Capital situation of large(re)insurers recovered after a dip
Shareholders’ equityIndex Jun 2007=100, USD*
*) Sample: ACE, AEGON, AIG, Allianz, Aviva, AXA, AXIS, Fortis, Generali, Hartford,HSBC, IAG, ING, Liberty Mutual, Lincoln Financial Group, Manulife Financial,Mass Mutual, MetLife, MSIG, Prudential, PLC, QBE, RSA, Talanx, Travelers, Vienna,XL Capital, Tokyo Marine, Zurich, Chubb, Prudential Financial
Shareholders’ equity by countryIndex Q4 2007=100, USD
Sources: Company reports, Bloomberg, Swiss Re Economic Research & Consulting
Top 30 companies* = approx. 25% market share
0%
20%
40%
60%
80%
100%
120%
2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3
Sample average (21 companies) 3 Canadian companies
7 US companies 6 European globals
5 UK companies**UK companies are reporing semiannually Source: Company reports, Bloomberg
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Different business models ofbanks and (re)insurers demanddifferent regulatory treatment
Issue Insurers Banks
Contract Insurance only pays when there is a realinsured event (financial loss asconditionality).
Capital market contracts pay whetheror not the counterparty has a loss(sight / term contracts).
Liquidity risk Insurance business is pre-funded throughpremium payments. There is no liquidityrisk in property & casualty, however, lifesavings products can be redeemed, butusually only at a high cost.
Many of the liabilities of banks –deposits, savings accounts andcommercial paper – are short term.Therefore, significant liquidity risksexist.
Contagion There is little risk of contagion betweeninsurers. And gradual cash flows allow totake corrective actions.
The inter-bank markets and othershort term funding make banksvulnerable to contagion (bank run).
Unwinding of globalgroups
Due to the long duration of liabilities,insurance books of business can bewound-up by regulatory authorities in anorderly manner.
Due to the risk of a bank run,regulatory authorities must act veryquickly to avoid further disruptions.And the crisis revealed that therewas a need for bankruptcy laws forlarge investment banks.
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Deferred acq.costs; 2%
Intangibles; 3%
Other assets; 11%
Reinsurancerecoverables; 11%
Total investments;73%
Shareholders'equity ; 20%
Hybrid debt; 3%Debt; 4%
Other liabilities;18%
Technical Reserves,gross 56%
Assets Liabilities
Source: Swiss Re, Economic Research & Consulting
Low levelof short-term debt
Insurance ispre-fundedby premiumsAssets
matched toliabilities,often held tomaturity
* Based on asample of 27leadingreinsurancecompanies,excl. BerkshireHathaway
Reinsurance industry*, 9 months 2009
Assets Liabilities
(Re)insurers’ balance sheet:built-in resilience to shocks
Payment istriggered byreal event
No systematic liquidity risk in (re)insurers’ balance sheet
Accounting mismatch between assets and liabilities as key issue
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79% 72%
40%
10%23%
7% 13%
4%8%
36%
30%
41%
43% 25%
17%
19%
45%37%
7% 9%6%
28%
5%
10% 11% 18%32%
11% 8% 7%1%
3% 2%
0%
20%
40%
60%
80%
100%
CommercialBanking
Retail Banking Sales & Trading AssetManagement
Life Insurance P&C Insurance Reinsurance
Credit Market Life Insurance P&C Insurance Business Operational Other
Risk profile of insurers is morediversified than that of banks
Source: Geneva Association Systemic Risk Report 2010 based on 2006 ECAP Survey, – IFRI CRO Summary, prepared by Oliver Wyman – Companies’ Annual Reports
Financial risks Insurance risks Other risks
Breakdown of economic capital for European banks and insurers
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(Re)insurers are facedwith challengingregulatory reforms
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The crisis accelerated existing regulatoryinitiatives and triggered new ones
United StatesFederal Insurance OfficeSystemic regulatorNAIC solvency modernizationFinancial tax initiativesCDS regulationCompensation regulationRating agencies reform…
EuropeSolvency II implementationNew supervisory architectureCrisis managementCompensation regulationInsurance guarantee schemesRating agencies regulationPension reformRevisiting securitisation… International
IAIS ComFrameFinancial Stability BoardIMF leviesIASB & FASB projectBasel IIIG 20 agenda…
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Insurance industry faces significantregulatory challenges
Regulatory developments
New macro-supervisory regimes
Conservative regulatory reactions
Spill-over risks from banking requirements
Influence of central banks
Protectionism and fragmentation of regimes
Market distortions and competition issues
Supervisors and governments under political pressure to implementchanges without full assessment and appreciation of economic impact
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Promote sound risk and capital management
• Principles of approved Framework Directive are economic and risk-based
• Implementation to properly reflect these principles
Introduce effective group supervision
• Regulation must keep pace with globalisation of business
• Large institutions to be supervised in their entirety
• Revisit group support regime after 2015
Increase regulatory convergence through equivalence
• Opportunity to accelerate cooperation and recognition among regulators
• Switzerland well positioned for equivalence: Swiss Solvency Test (SST)complemented by Swiss Quality Assurance (SQA)
Crisis reinforces the case for Solvency II –Principle-based, economic and risksensitive approach
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Industry raises concerns on Solvency IIimplementing measures
Treatment of own funds
Calibration of capital requirements
Internal model approval process
Reporting and public disclosure
Key objective for (re)insurers is to avoid detrimental effects of the new EUsolvency regime on the European insurance industry
Recognition of (non-prop.) reinsurance
Calibration of cat risks (primary non-life)
Segmentation for technical provisions
Diversification effects at group level
Industry welcomes Solvency II as new risk sensitive solvency regime
However, on-going regulatory concerns due to conservative proposals from thesupervisors through CEIOPS
QIS5 is a critical test; first finding demonstrates that the standard formula is notappropriate for large (re)insurance groups
Reinsurance specific issuesIndustry general concerns
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Systemic risk debate is shifting to(re)insurers, while they were not thesource of the crisis Both supervisors and the insurance industry have concluded that core
insurance activities do not pose systemic risk
– Geneva Association report (March 2010) and IAIS position paper (June2010)
However insurance supervisors remain under pressure and insurance is partof macro-prudential regulation
Financial Stability Board (FSB) has focused on systemically important banks,as they are at the centre of the financial crisis
– FSB paper on moral hazard associated with SIFIs
Focus is shifting to other financial institutions, including (re)insurers
Critical to strike the right balance between (re)insurance and systemic riskregulation
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Size: a typical large insurer is much more diversified than a bank; the size of specific activitiesshould be assessed rather than the whole institutions
Interconnectedness: insurers and reinsurers far less inter-connected than banks in their risktransfer and funding activities
Substitutability: insurance capacity is highly substituable as demonstrated after naturalcatastrophes
Timing (IAIS criteria): insurers are not exposed to sudden liquidity crunches and timing ofinsurance claims settlements reduced the risk of contagion
Source: FSB, IAIS
Review of FSB/IMF systemic risk definition and criteria
The impact of the definition and criteria of systemic risk varies depending onthe range of activities carried out by financial institutions
Regulatory focus needs to be on riskactivities and not on institutions The insurance industry provided policymakers and the public with its view on
systemic risk in insurance through the special report of the Geneva Association(March 2010)
The report indentifies potential systemic risk drivers and puts forward somerecommendations on how to deal with them
EC, DG MARKT meeting | 12 November 2010 26
Implement comprehensive, integrated and principles-based supervision ofinsurance groups
1
Establish macro-prudential monitoring with appropriate insurance representation4
Strengthen liquidity risk management2
Enhanced regulation of Financial Guarantee Insurance3
Strengthen risk management practices and build on lessons learned5
Mitigating measures to reinforce regulatory regimes and strengthen industry practice
The industry put forward fiverecommendations to strengthen its resilience
To tackle the issue of systemic risk, supervisors and policymakers need toidentify systemically risky activities
Potentially systemically relevant activities should be dealt with through aresponsive regulatory framework
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Cross-sectorial implications of regulatoryreforms need to be better understood
Banking and capital markets reforms
Basel III and liquidity reforms
Contingent capital and new forms of "loss absorbency for banks"
Resolution and "living wills"
Derivatives regulation and securitisations
Insurance industry concerns
Regulatory reforms must take into account the linkages/repercussions betweenregulatory changes in different sectors
Regulatory changes threaten to move insurers away from optimum pattern of assetand liability holdings
Limitations of insurers' willingness/appetite to supply (CoCos) finance to banks
Insurers cannot not be the solution to problems that regulators are trying to fix inthe banking sector
EC, DG MARKT meeting | 12 November 2010
Insurers and bank wind-ups are notcomparable as they are driven by differentbusiness models
Insurers are required to hold reserves against claims as well as incurred but not yet reported claims
Supervisors’ early intervention allow appropriate work out (reinforced under Solvency II)
Low lapse rates in life insurance during run-off (as compared to banks)
Insurance failures extend over many years, as liabilities mature over an extended period
Insurers lack two-way trading portfolios as they have one set of liability holders and one set of assets
(Re)insurer failures should not be prevented at any cost – (re)insurers are not "toobig to fail"
Insurance company wind-ups traditionally conducted in an orderly manner
■ Strict regulation on reserves covering liabilities■ Policy-holders’ claims generally receive privileged treatment in insurers’ insolvencies■ Supervisors have far reaching powers ahead of actual insolvency■ Supervisors can act as liquidators or order deconsolidation during insolvency proceedings■ International legal challenges remain in the case of cross-border resolutions
Regulatory frameworks provide further stability to insurers wind-ups
EC, DG MARKT meeting | 12 November 2010 29
Global (re)insurers actively participatein the global regulatory debate
Underline (re)insurancespecificities
Acknowledge differences in business models of (re)insuranceand banks - and therefore a differentiated regulatory approach
Promote sound risk andcapital management
Maintain market accessand level playing field
Promote global regulatorystandards
Implement economic and risk-based regulatory frameworkunder comprehensive group supervision
Support IAIS effort to establish global standards and achieve greatertransparency and recognition among supervisory regimes
Secure commitments to open markets and avoid marketdistortions
Respond to remainingresolvability concerns
Address international legal challenges and engage into opendialogue with (group) supervisors and colleges
Key objectives for the industry
Enforce market-consistent valuation and avoid pro-cyclicalityunder harmonised accounting standards
Achieve accountingconvergence
EC, DG MARKT meeting | 12 November 2010
Swiss Re takes an active part inindustry discussions on the newregulatory regimesSwiss Re’s activities Active contribution to consultation papers
Discussions with regulators and supervisors' experts groups
Active participation in various industry bodies
Pan €EuropeanInsurance Forum
European Financial Services Roundtable Institute of International Finance
Geneva Association
Reinsurance American AssociationPan European Insurance Forum
Comité Européen des Assurances
CRO Forum
CFO Forum
American Council of Life Insurance
EC, DG MARKT meeting | 12 November 2010 31
Crisis reinforces thecall for strong ERM –Swiss Re's approach
31EC, DG MARKT meeting | 12 November 2010
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Operationalrisks and theirmanagement
1990s Today
Enterprise Risk Management (ERM)
Integrated perspective, i.e.comprehensive analysis andquantification
Capital allocation and riskadjusted returns
Financial marketrisks and theirmanagement
1970/80s
Mitigation ofinsurancehazards
1960s
Swiss Re has been driving keydevelopments in the evolution of riskmanagement in the industry
Integratedmodelling
IndependentCRO functionat ExecutiveBoard level
Nat Cataccumulationcontrol
Financialmarket riskmodelling
Technical focuson life riskmanagement
Industry
Swiss Re
EC, DG MARKT meeting | 12 November 2010 33
Independent and centralized risk functionremained critical during the crisis
The economic crisis highlighted the importance of a centralized riskfunction
Realizing the full benefit of an independent function requires that
Risk function is well embedded in the strategic steering of thecompany
CRO has an equal seat at the decision table
Risk has the courage to raise its voice
Risk provides an independent and transparent view of obstaclesahead
EC, DG MARKT meeting | 12 November 2010 34
Capital and liquidity risk managementwere key focus during the crisis
Four key control requirements of insurers …
Capital– Sufficient capital to absorb unexpected
losses?
Capital adequacy framework
Liquidity– Sufficient spot liquidity and liquidity
generation capabilities under stressedconditions?
Liquidity stress testing framework consistentwith capital view
… give rise to two key questions
Insurer balance sheet
Liabilities
Economicequity
Assets
Pool large number ofsufficientlyindependent risks, tomake aggregateclaims morepredictable
Use risk capital to ab-sorb unexpectedlosses
Control ALM risk
ALM
Hold enoughliquid assets tomeet expectedand un-expectedliquidityrequirements
Control diversification
Ensure assetliquidity
Investing premiums and capital to matchmarket risk of liabilities
Ensure capitaladequacy
EC, DG MARKT meeting | 12 November 2010 35
Capitalallocation
Strategy
TargetsettingDecision-
making
Portfolio-and
performancemeasurement
Group risk policy andtolerance
Capital costallocation(projected)
Large transactionapproval
Risk model input intooptimisation
Testing of risktolerance criteria
Derivation of limitframework
Capital costallocation(factual)
Reporting ofimpact on capitaladequacy
Limit monitoring
Accumulationcontrol
Part of all decision takingbodies concerned with risktaking
Risk management further embeddedacross the full performance cycle
EC, DG MARKT meeting | 12 November 2010 36
Do we hold enough capital (survival)?
Regulatorycapital
Ratingcapital
Internalcapital
Liquidity stress test
“Extreme loss event”:100 year annual aggregate Group loss
Capital adequacy requirements Related liquidity risk
Swiss Re risk tolerance:“To be able to continue to operate following an extreme loss event.”
Can we meet all our obligations as they falldue (operation)?
Definition of risk tolerancereinforced as the basis for risksteering and limit setting
Strategy
EC, DG MARKT meeting | 12 November 2010 37
Leading-edge internal modelcontinuously enhanced andchallenged to reflect changingrisk environment
Over 15 years experience in integrated riskmodelling
Over 10 years experience in economic valuemanagement (EVM)
Basis for reporting to Swiss supervisor (SSTon Tail Var risk measurement)
Consideration of entity relationships andintra-group transactions
Time-tested expertise
Targetsetting
P&C risks Creditrisks
L&Hrisks
Financialrisks
EC, DG MARKT meeting | 12 November 2010 38
Quantitative limit frameworktranslates risk tolerance intodefined risk appetite
Group risk tolerance
Available capital
Annual Group Plan
Group Tail VaR of Plan
L&H risk Financial risk
Nat Cat
TC NA
WS EU
EQ California
EQ Japan
Mortality
Longevity
Equity
Hedge Funds
Interest Rate
Real Estate
Credit (spread &default)B
usin
ess
capa
city
mea
sure
Bus
ines
s ca
paci
ty m
easu
re
Risk appetite derived byoptimisation procedures
Risk tolerance criteria ofthe Board
Actual situation from allcapital perspectives
Group Risk Model as basisfor limit setting
Targetsetting
Bus
ines
s ca
paci
ty m
easu
re
P&C risk
EC, DG MARKT meeting | 12 November 2010 39
Importance of group-wideliquidity risk managementincreased during the crisis
Liquidity is fundamentally different from capital and requires separatemeasurement – but fully integrated into Swiss Re’s ERM
Swiss Re’s core policy is to hold sufficient unencumbered highly liquid assets inthe individual regulated entities to meet potential liquidity stress event
Swiss Re has proactively responded to the market crisis by
– reviewing and strengthening our liquidity stress tests assumptions
– suspending our share buyback programme
– selectively raising additional liquidity
– increasing the amount of readily available liquidity held centrally
Swiss Re’s exposure to liquidity risk (mainly through its legacy activities andregulatory constraints) is managed and monitored centrally
Capitalallocation
EC, DG MARKT meeting | 12 November 2010 40
Chief Risk Officer (CRO)participates in all Groupcommittees concerned withrisk taking
Decisionmaking
Finance and RiskCommittee
Board ofDirectors
CompensationCommittee
AuditCommittee
InvestmentCommittee
Risk and CapitalCommittee
Asset-LiabilityCommittee
Products andLimits Committee
RegulatoryCommittee
Executive Committee
EC, DG MARKT meeting | 12 November 2010 41
Independent risk reporting toprovides transparent and timelyrisk information for internal andexternal stakeholders
Annual reports
Executive Committee / Finance and RiskCommittee Risk Updates
Reports to Regulators (eg SSTReport) and Rating Agencies
Capital Adequacy Dashboard
Liquidity RiskReport
Financial Risk Report
P&C, L&H and ORMdashboards
Measurement
External Internal
Investorpresentations
Clientdiscussions
EC, DG MARKT meeting | 12 November 2010 42
Closing remarks
42EC, DG MARKT meeting | 12 November 2010
EC, DG MARKT meeting | 12 November 2010 43
Key findings
(Re)insurance enables the risk taking that is essential to economic growth andentrepreneurship
Risk diversification is an essential value proposition of (re)insurers
(Re)insurers are long-term investors; assets are managed against liability-drivenbenchmark
(Re)insurers and banks are driven by different business models, which explainswhy (re)insurers weathered the crisis well
The insurance industry faces significant regulatory challenges due to the crisis asinsurance gets bundled into the banking debate
(Re)insurers are not "too big to fail" and core insurance activities are not sourcesof systemic risk
Solvency II is the appropriate response to the crisis for the insurance industry, butprinciple-based and economic-based approaches need to be preserved
Crisis reinforced the need for an independent, integrated and empowered riskmanagement function
Raj Singh | MultaQa Qatar 2010 | 8 March 2010
Thank you…
Questions ?
EC, DG MARKT meeting | 12 November 2010 45
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