Liquidity risk: A wolf in sheep’s clothing?

Liquidity risk is one of those risks we often don’t pause to think that much about, but it’s one that can wreak havoc on a business if not kept constantly in check. It is also a risk that has become heightened in recent times, because of a combination of regulatory and macroeconomic developments. Companies can often grow complacent about liquidity risk, especially if they have tended to generate cash on a consistent basis through ongoing operating performance. However, certain activities, such as mergers and acquisitions (M&A), a new product launch, or perhaps regulatory development, can give rise to new exposures. It’s worth reminding ourselves of some of the key drivers of exposure to liquidity risk, and what we can do to manage and mitigate this risk.

In Europe, the ability to recognise negative best estimate liabilities on the solvency balance sheet, effectively capitalising estimated future profits on books of in-force business, and considering these profits to be immediately available to absorb losses in the business, requires companies to be extra vigilant. In reality, such assets may be far from liquid, unless they can be repackaged through value-in-force (VIF) monetisation, or used to secure reinsurance financing of some sort. The same may be said of the likes of deferred tax assets, except that these assets may be even less liquid unless they can be sold on to other entities within a group structure.

Other aspects of the liability side of the balance sheet can also pose liquidity challenges. Take, for example, a company with a range of unit-linked funds operating on a t+1 basis (i.e. settlement occurs one day after the transaction date), with a further range of funds operating on a t+2 basis. Policyholder fund switches out of the t+2 funds and into the t+1 funds can leave companies needing to provide liquidity for transaction settlements upon purchase of the t+1 assets, before payment is received from the sale of the t+2 assets. Depending on the volume of transactions, which could be significant, firms may struggle to provide such financing on an ongoing basis. More severe examples of firms struggling to cope with fund switch activity have included suspension of redemptions from property funds, albeit more because of the underlying lack of liquidity of the assets than the nature of the pricing basis, though ultimately leading to similar problems. Funds that permit a mix of both individual and corporate investors may be particularly susceptible, as the latter potentially have the ability to move vast sums of money very quickly, and before redemptions are suspended, precipitating the lack of liquidity for individuals.

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Milliman consultant makes Captive Review Power 50 list

Milliman’s Mike Meehan was named to the 2016 Captive Review Power 50 (subscription required). The Power 50 is a ranked list recognizing the 50 most influential professionals in the global captive insurance industry.

“I am honored and humbled to have my name included among this group, which contains so many individuals for whom I have the utmost respect,” he said about the distinction.

A.M Best recently interviewed Mike from the 2016 Cayman Captives Forum about the domicile’s captive market. He’ll be a speaker at the upcoming CICA Conference in San Diego from March 12-14. For more information, click here.

Big data challenging how insurers think about business

The insurance industry has a long history of using data to make decisions around risk. However, as more and more data on risk becomes available insurers will encounter numerous business challenges. In the Milliman Impact article “Harnessing the transformative power of big data,” consultants Neil Cantle, James Dodge, and Derek Newton offer perspective on big data and its implications for insurers’ business models, data governance, and skills moving forward.

Board oversight of emerging and long-distance risks—and how ERM can help

holly-gregoryFounded in 2011, the Milliman Risk Institute provides scientific-based thought leadership on all facets of enterprise risk management (ERM). Composed of senior risk executives, actuaries, and university professors, the Milliman Risk Institute Advisory Board meets semiannually to discuss ERM trends, research, and key topics.

Risk-taking lies at the heart of all entrepreneurial activity, and monitoring management’s efforts to identify, monitor, and manage risk is a key responsibility of the board of directors that is closely linked to the board’s role in overseeing corporate strategy and performance. The board has a vital role to play in assisting management to:

• Focus on the risks associated with corporate strategies and the ever-changing business and geopolitical environment,
• Determine the company’s risk appetite
• Devote appropriate resources to risk identification and management activities.

Prudent risk-taking requires reliable information about the trade-offs in risk and reward and a fundamental understanding of risks associated with the drivers of corporate performance. Management is responsible for capturing this information with the assistance of the enterprise risk management (ERM) system it puts in place to help identify risks and their possible impacts.

Identifying and understanding both emerging and long-term risks can be difficult, and boards should press management to continually scan the environment and think about both the immediate future and the longer-term outlook. The challenge is to escape overreliance on data that by its nature is focused on the past.

The good news is that both boards and managements have become more savvy over recent years with respect to risk oversight, particularly since the global financial crisis. Many boards are currently focused on geopolitical risks relating to Brexit and the recent U.S. presidential election, and are grappling with what uncertainties may lie ahead and what the company can do to prepare. Boards are also beginning to pay more attention to risks relating to the Internet of Things—in addition to cybersecurity, which has been top of mind for many companies for some time now. Some boards have also added directors with specialized competencies to help navigate risks of particular concern to individual companies. For example, technology and/or cybersecurity expertise are on the “wish list” of new director backgrounds for many companies (per the Spencer Stuart Board Index 2016).

ERM professionals can help boards “look around corners” with respect to emerging risks and provide support to boards that are determining what to do next. They can also help boards understand the time horizons involved with respect to risks such as those relating to climate change and water rights that require longer-term thinking, and they can assist the boards in prioritizing discussions on longer-term issues. Boards should ensure that there is sufficient time on the agenda to discuss emerging and long-distance risks, in addition to more typical risks, and pay attention even when something might not seem mission-critical. The world is constantly changing at an ever-increasing pace and risk managers help boards stay in front.

Holly Gregory is a member of the Milliman Risk Institute Advisory Board. She is co-leader of Sidley Austin LLP’s Corporate Governance and Executive Compensation practice. As part of this blog series, we asked Holly to share her views on trending topics in ERM.

A harmonised Recovery and Resolution Framework – EIOPA discussion paper

king-eoinOn 2 December, the European Insurance and Occupational Pensions Authority (EIOPA) issued a discussion paper on ‘Potential Harmonisation of Recovery and Resolution Frameworks for Insurers.’ The paper sets out a number of considerations for the development of a harmonised European framework in the recovery and resolution planning space. It is open to comments from stakeholders until 28 February 2017.

Recovery and resolution planning is a very topical subject at present and there are numerous examples of requirements for financial services companies and regulatory authorities to develop recovery and resolution plans and frameworks. For example, larger financial institutions that are classified as globally systemically important financial institutions (G-SIFIs) and globally systemically important insurers (G-SIIs) are required to undertake recovery and resolution planning under the Financial Stability Board’s ‘Key Attributes of Effective Resolution Regimes for Financial Institutions’ and similar requirements adopted by the International Association of Insurance Supervisors. This is also an area of focus for European regulators. In Ireland, for example, Sylvia Cronin, Director of Insurance Supervision at the Central Bank, noted at the European Insurance Forum in March that recovery and resolution for insurers is an area of particular interest for the Central Bank.

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The Cayman captives landscape

A.M. Best TV recently interviewed Milliman’s Mike Meehan during the 2016 Cayman Captive Forum. In this video, Mike discusses why the Cayman captives market seems “poised to have another really strong year.” He also talks about an increase in interest from companies seeking to use captives as a possible solution to insuring their cyber risks.