Risk Management: The Current Financial Crisis and Lessons Learned

Lessons Learned

What you would attempt to do if you knew you could not fail?

Risk Management LL
The Current Financial Crisis, Lessons Learned and Future Implications

The current financial crisis presents a case study of a “financial tsunami” (as former Federal
Reserve chairman Alan Greenspan recently called it) on what can go wrong. Its ramifications are
far-reaching and the lessons learned will be embedded in risk management practices for years to
come. As one of the premier enterprise risk professions in practice today, the actuarial profession
is sharing its substantial insight into what went wrong and the implications for the future.

On behalf of the society of Actuaries, the casualty Actuarial society and the Canadian institute of
Actuaries, we are pleased to provide a series of essays on Risk Management: The Current
Financial Crisis, Lessons Learned and Future Implications. This e-book is the result of a
call for essays on the subject coordinated by the following groups:

•        The Joint Risk Management Section of the Society of Actuaries, Casualty Actuarial Society
and Canadian institute of Actuaries
•        The Investment Section of the Society of Actuaries
•        International Network of Actuarial Risk Managers
•        Enterprise Risk Management Institute International

Included in this are the opinions of a number of authors written in response to our call for essays.
An essay is, essentially, a short non-fiction form of writing expressing the often subjective opinion
of the author.

The thoughts and insights shared herein are not necessarily those of the society of Actuaries, the
casualty Actuarial society, the Canadian institute of Actuaries, or the authors’ employers.

We hope these essays will provide thought-provoking discussion and commentary in the months
and years to come.

The Essays

EXPLANATIONS, CAUSES AND CURES

These essays address the philosophies and origins of how the crisis began, with anecdotes about
what has happened and insight into encouraging thought leadership going forward.

The Causes and Cures of the financial Crisis by Ira Robbin
The Upside of a Downturn by Krzysztof Ostaszewski
Bubbles, Cycles and Insurers’ ERM – what Just Happened? by Paul Kneuer
Our Titanic Crisis: An Economic Rescue plan by Bertram Horowitz
It is Time to Decide what kind of Crises We Want to Have in the Future by Ioannis
Chatzivasiloglou and Charalampos Fytros
The Financial Crises: A Ripple Effect of Incentivised Disorder by Paul Conlin

PRUDENT ENTERPRISE RISK MANAGEMENT STRATEGIES

Some discussion of the crisis has reflected on the perceived failure of enterprise risk
management. The consensus of these authors is that the crisis is not a result of a failure of the
enterprise risk management process, per se, but rather a failure to implement enterprise risk
management processes at all. These authors point out that the key to prudent enterprise risk
management is in the enactment of a corporate culture that aligns desired performance with
incentives and the matching of the authority to make decisions with accountability for the decisions
made. Currently, most incentive compensation rewards returns, but without reflecting the risk
undertaken to achieve the returns.

Culture

Your Mother Should Know by David Ingram
Mixed Risk Management Strategies – Diversification That you Can Count on by Wendy Yu
Derivatives, AIG and the future of Enterprise Risk Management by Michael G. Wacek
The Democratization of Risk Management by Michael C. Schmitz and Susan J. Forray
Should you Have a Chief Skeptical officer? by Max Rudolph
Lessons from the financial Crisis for Directors and CEos of Insurance Companies© by Jean-
Pierre Berliet
Against the Grain: The Wisdom of Counter-cyclical Capital by Anson J. Glacy, Jr.

Aligning Incentives

Reaffirming your Company’s Commitment to ERM in light of the financial Crisis by Prakash
Shimpi
A Tale of Improperly placed Incentives by Sam Gutterman
Risk Management: The Current financial Crisis, lessons learned and future Implications by
Neil Bodoff

Managing/Matching Authority and Accountability

Recent Crisis: Roots and lessons by Stephen Mitchell and John F. McGarry
There Is No free lunch by Daniel C.F. Hui
Risk Management – Buyer Beware! by Dennis Barry
Risk Management and the financial Crisis: why weren’t we protected? by Mike Batty

Managing Liquidity
Modeling and Managing liquidity Risk by Gary G. Venter

Societal Themes

These essays center on the behavior of society and provide interesting and thought-provoking
commentary on the inter-connectivity of individuals’ behavior with the resultant behavior and roles
of the markets, regulation and the inherent responsibilities to society. Given the existing limited
liability laws, the role of regulation, and imperfect (and at times) “wild” interconnected and
correlated markets, how and where does society put the costs and responsibilities of such a crisis?

Limited Liability Laws

An Ideal Crisis by Shane Whelan
Markets: Regulation Of, Efficiency Of, Interconnectivity Of Transparency and Liability
Valuation by Philip E. Heckman
Creating an Exchange for Insurance Contracts by Oakley E. (Lee ) Van Slyke
The Game of ‘Pass the Risk’: Then and Now by Joy A. Schwartzman
From Liquidity Crisis to Correlation Crisis, and the Need for ‘Quanls’ in ERM by Stéphane
Loisel

Behavioral/Personal Economics

Essay on the Financial Crisis by Andrew Winkler
The Human Touch Underlying the Current Financial Crisis by Vivek Gupta
If It Looks Too Good to Be True by Steve Malerich

Effective Risk Modeling

These essays cover the reliance and over reliance on models. Models that tend to break down
under ‘crisis mode’ and society’s reactions are discussed. Efficient models must reflect correlation
and the domino effect that can occur when bad things happen.

Credit Crisis Lessons for Modelers by Parr Schoolman
What Is a Robust Level of Risk Capital? by Larry Rubin and Xiaokai (Victor) Shi

Insights from the Insurance Industry

The actuarial profession has served as the enterprise risk management backbone of the insurance
industry over the centuries. The authors of these essays share their insight on what has worked
and what has not in the insurance industry and suggest how these learnings could be applied to
other industry sectors in terms of analytical tools, regulation, contractual obligations and prudent
risk trading schemes.

Seven Simple Lessons from Two Actuaries on the Mortgage Crisis by Randy Roth and John
Pierce
An Industry in Question, a Profession with Answers by James Ramenda
The Financial Crisis: An Actuary’s View by Louise Francis
Actuaries Would Have Made a Difference by W. James MacGinnitie