Gaining support for a decentralized approach to risk management

The IBM Algorithmics Economic Capital and Solvency II solution offers insurance firms a comprehensive and integrated risk management platform, enabling automated and detailed risk measurement and reporting processes with controls and audit trails that are consistent for both standard formula and internal model approaches under Solvency II.

Leveraging two decades of experience working with some of the world’s leading financial institutions, IBM’s award-winning solution employs innovative risk methodologies such as replicating portfolios, curve fitting and risk aggregation techniques, as well as capital aggregation and attribution on its advanced architecture, which allows companies to evaluate their overall solvency picture.

The solution provides decision-makers with a unified and consistent overview of a firm’s material risk across the enterprise, or at any business, geographical or unit level, with a framework that is both easy to use and able to support an insurer’s specific requirements. This enables the embedding of risk management in their planning to meet current challenges and support future growth.

About Allianz Group
The Allianz Group is one of the leading integrated financial services providers worldwide.

With approximately 142,000 employees worldwide, the Allianz Group serves to approximately 78 million customers in more than 70 countries. On the insurance side, Allianz is the market leader in the German market and has a strong international presence.

In fiscal 2011 the Allianz Group achieved total revenues of over 103.6 billion euros. Allianz is also one of the world’s largest asset managers, with third-party assets of 1,281 billion euros under management at year end 2011.

In 2006 Allianz SE, the parent company, became the first company in the EURO STOXX 50 Index to adopt the legal form of a Societas Europaea, which is a new European legal form for stock corporations. Allianz SE is headquartered in Munich, Germany.

Beyond the quality of its financial performance, a number of other activities and factors are important for the sustainable growth of Allianz's competitive strength and company value. These include, but are not limited to, the company's global diversification, its reduction of complexity, its value-based management approach, and its crucially important employees.

Hampered by manual data aggregation
Prior to implementing the IBM Risk Analytics solution, Allianz had relied on an internal model that made it difficult to effectively apply its strategy to risk management. Calculations for economic capital figures were predominantly handled in spreadsheets and disparate, local actuarial systems. Group Risk, which is based in Munich,would then populate spreadsheets centrally with market data and entity information, but continuously struggled with risk aggregation.

“Aggregation of numbers was cumbersome and required an extensive communication loop with all operating entities and redistribution of spreadsheets and assumptions to come up with calculations.This was time consuming, and a very manual process,” explains Marco Hauck, Head of Middle Office at Allianz Group.

As a workaround, Allianz took a streamlined approach to aggregation, focused on a restricted number of simplified scenarios. Even then, it took the firm an average of five to six weeks to calculate its risk capital number. Moreover, results and insights from a business perspective were quite limited. With a goal of transitioning to adopt the new European regulatory regime under Solvency II, Allianz needed to make a change in order to satisfy these new requirements. Hauck notes that, “Under our prior internal model framework, it would have been challenging to seek approval under the future regulatory framework.”

Going with IBM’s solution
In early 2008, Thomas Wilson, former Chief Risk Officer at ING Insurance, joined as Chief Risk Officer for Allianz SE. Having already implemented the IBM Algorithmics Economic Capital and Solvency II solution at ING, Wilson encouraged the adoption of this proven risk platform.

Hauck gives the background behind Allianz’s rationale: “As an organization, we follow the basic principle of leveraging best practice solutions wherever possible. In the case of market risk calculation and risk aggregation, we would have had to implement the required functionality separately if we had not adopted the IBM Algorithmics Economic Capital and Solvency II solution, where this comes as standard. Clearly we had to allocate resources and time to customize the solution, but the scale of this undertaking is not comparable to starting from scratch and building everything bottom-up, especially in the area of replicating portfolio analysis. Plus, as a global insurer, we need to keep up with rapid changes in the market, which is much easier to do with the IBM Risk Analytics solution.”

Streamlining implementation of a new risk architecture
The robust functionality underpinning the Economic Capital and Solvency II solution helped streamline the implementation process. “This was a complex project, involving a number of different work streams and incorporation of tens of thousands of instruments, risk capital scenarios, and unique positions across hundreds of portfolios. Yet we were able to adopt the solution in a short time frame by integrating the standard solution into our workflow and configuring it quickly, as needed,” says Hauck.

The firm set up a risk architecture based on the IBM Risk Analytics solution, including a web-based user interface developed by SecondFloor that allows Allianz to transfer information from its feeder systems in a controlled manner. Only authorized risk users have access to the risk system and associated data. A centralized source of data also means that Allianz can ensure quality and audit control. Hauck believes, “Now we can easily ensure that the data is complete, and that everyone signed off as required.”

Addressing risk and reducing capital requirements
Allianz’s basic principle is to handle modeling locally to address unique regional or country-specific needs where they exist. Advanced aggregation techniques enable market risk and other risk types, including credit and other non-market risks to be consolidated at a group level.

As a result, the company can apply a centrally developed model while supporting local processes and local process ownership. “By applying appropriate approaches which are designed specifically for our unique business footprint the IBM Algorithmics Economic Capital and Solvency II solution empowers us to relax from the conservative assumptions that have to be applied with the standard model. This should lead to a significant reduction in our capital requirement,” explains Hauck.

Reporting of economic capital figures
With the new risk platform in place, Allianz is in a position to conduct analysis and report economic capital figures on a more frequent basis. In addition, the newly adopted IBM Risk Analytics solution reduces the operational constraints inherent in the previous system, allowing Allianz to produce a full set of up-to-date risk and capital reports based on new market data within just a couple of days.

This is possible because the life operating entities that are live on the IBM Risk Analytics platform make use of replicating portfolios which can be dealt with quite flexibly. They upload scenario-dependent cash flows through the user interface, and then use the power of the optimizer in the risk analytics engine to find replicating portfolios via a limited number of pre defined constraints.

Empirical loss distributions representing the non-market risks are also loaded into the system by each operating entity. This representation allows Group Risk, in charge of aggregating risks, to effectively revalue all financial assets and liabilities. This includes replicating portfolios and non-market risks for all portfolios across the reporting hierarchy, using a set of 30,000 real world scenarios, calibrated to a one year holding period. Due to the availability of full portfolio value distributions in the IBM Risk Analytics solution, Allianz has the ability to identify the risk capital (VaR) per individual portfolio for any confidence interval. Furthermore, it is possible to identify the corresponding market conditions and risk contributions driving these results. Analysis of different risk measures, such as Tail VaR, is also possible.

Gaining new insights into risk and capital
With the IBM Algorithmics Economic Capital and Solvency II solution, Allianz gains more insight into overall risk by having access to capabilities that previously did not exist. The replicating portfolios provide Allianz with a way to investigate specific risk scenarios, thus achieving better understanding of the nature of market risk. Plus, Allianz can analyze the interaction of market risk with credit risk, operational risk, and various insurance risks at both the group and operating entity level. Different scenarios are easily incorporated, which allows Allianz to flexibly recalculate capital and study the impact for intended actions. Users can also take advantage of the solution’s ability to analyze market movements and produce comprehensive P&L explanation reports.

According to Hauck “On the group level, we are able to re-evaluate our overall portfolio quite quickly, whereas it would take weeks or months prior to adopting the IBM Risk Analytics solution. We can also run more alternative scenarios, and we get a good sense of how to manage market risk in terms of potential hedging strategies.”

Moreover, because Allianz aggregates all risk types, users can easily find all required risk related information in the system. The solution provides users with the ability to view data at the individual position level using drill-down capabilities, allowing them to interactively conduct what-if analysis, both for market and non-market risks, and to grasp a better feeling for sensitivities of each portfolio. “Economic Capital and Solvency II gives us improved early warning signals and a better feel for our ratios. We know more about how changing market conditions will impact our capitalization ratios, and actively use this understanding to derive limits and steer the business,” continues Hauck.

A platform for risk management, economic capital and Solvency II
Allianz is in the midst of presenting its internal model to an international group of regulators for Solvency II. Hauck states that, “The insurance regulators are getting a feel for the power and possibilities of the Economic Capital and Solvency II solution.” Going forward, Allianz intends to roll out the Economic Capital and Solvency II solution to its remaining operating entities. What’s more, the firm is continuously working to improve replicating portfolios so that they can be used more actively for investment management in addition to the risk application. “With IBM Risk Analytics, we get both a capital benefit and a jumping-off point to leave the arena of risk controlling and enter the arena of risk management,” concludes Hauck.

About IBM Business Analytics
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