What Gets Measured Gets Managed: Best Practices in Risk Management
January 05, 2023
By Matt Reilly, Managing Director, Yazeed Abu-Sa'a, Director, and Jeremy Lachtrupp, Director, Institutional Solutions
With the ever-present risk of market volatility, it is critical insurers understand the risks that exist across their business and within their investment portfolios. There are many ways to measure and manage risks in a portfolio, Conning has a range of methods to help insurers measure investment risk in isolation, view investment risk in the context of overall enterprise risk, and consider specific “objective” risks that get at the core of an insurer’s operations and goals.
Analytics such as duration, convexity, and credit ratings provide a well-understood assessment of specific types of risks on a security or across a portfolio. However, they lack depth as they are point-in-time and focus on specific risks. They lack insight into risks that might not be priced in the current market and thus fall short in their ability to assess prospective future economic states and associated risk. For investors worried about risks looming in their portfolio, there are tools that can help measure those risks and provide insight on how to consider positioning the portfolio for a variety of other economic environments.
Conning utilizes its GEMS® economic scenario generator to create a set of 1,000 stochastic economic scenarios and accompanying investment returns to better understand the range of prospective portfolio outcomes. Figure 1 has a histogram and accompanying table of prospective returns for a portfolio over a one-year period. With this in hand, an insurer can understand estimates for average return over the time period across a range of scenarios along with the accompanying volatility. Other risk measures can be added, such as VaR or T-VaR, to better understand drawdown risk, or Sharpe ratio to better understand prospective returns on a risk-adjusted basis. This work can be extended across varying time frames to compare a variety of investment strategies.
Deterministic shocks are another tool to help investors understand how the portfolio could react across a range of scenarios. Figure 2 is a table of projected returns for a sample portfolio across a range of interest rate and credit spread shocks. With this type of tool insurers can understand what happens to their portfolios if spreads widen or tighten, if rates fall or increase, or any combination thereof to varying magnitudes.
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