Stephen Friend Dana Farber Cancer Institute 2011-10-24
A New Approach to Predict Emerging Risks Using Risk DNA Model
1. A New Approach to Predict Emerging
Risks Using Risk DNA Model
Motoharu Dei, FIAJ, Consultant
Milliman Inc.
IAJ, Open Discussion Forum ERM Section
December 7th, 2012
3. Reference Material for Today’s Presentation
Management Board of the UK Actuarial
Profession invited proposals for a
funded external research, and this
report was awarded.
“A review of the use of complex systems
applied to risk appetite and emerging risks
in ERM practice”
Authors (from Milliman, the Universities of
Bristol and Bath Systems Centre)
N. ALLAN
N. CANTLE
P. GODFREY
Y.YIN http://www.actuaries.org.uk/research-and-
resources/documents/review-use-complex-systems-
applied-risk-appetite-and-emerging-risks
4. System Thinking
The methods discussed in the report are based on “System
Thinking”.
“Concept Mapping”, “Systems Dynamics Modelling”, “Chaos
Theory”, “Fuzzy Theory”, “Neural Networks”, “Genetic
Algorithms”, “Phylogenetic Analysis”, Bayesian Network”,
“Cellular Automata”, “Agent Based Modelling”, ”Network
Theory”
Output
Output Input
Output
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Input
5. System Thinking
The methods discussed in the report are based on “System
Thinking”.
“Concept Mapping”, “Systems Dynamics Modelling”, “Chaos
Theory”, “Fuzzy Theory”, “Neural Networks”, “Genetic
Algorithms”, “Phylogenetic Analysis”, Bayesian Network”,
“Cellular Automata”, “Agent Based Modelling”, ”Network
Theory”
Output
Input
Output
Input
6. System Thinking
The biology, phylogenetics (/faɪlɵdʒɪˈnɛtɪks/) isare study ofon “System
In methods discussed in the report the based
Thinking”. relation among groups of organisms (e.g. species,
evolutionary
populations), which is discovered through molecular
sequencingMapping”, “Systems Dynamics Modelling”, “Chaos
“Concept data and morphological data matrices. (Wikipedia)
Theory”, “Fuzzy Theory”, “Neural Networks”, “Genetic
Algorithms”, “Phylogenetic Analysis”, Bayesian Network”,
“Cellular Automata”, “Agent Based Modelling”, ”Network
Theory”
Output
Input
Output
Input
8. Emerging Risk
We should not guess in advance what we expect to see in
identifying the emerging risk
Many attempts to monitor risk registers throw that away at outset
Need a “model-free” approach to see emergence
Allow people to “mix”
colours
9. Phylogenetic Approach
This approach was also presented in the SOA annual meeting in
this October (Session 99 – Emerging Risk) by Neil Cantle.
The core idea is to adapt the same analysis which researchers
use to analyse the “biological evolution” into the “risk evolution”.
Which risk scenarios are “similar”
How the risk characteristics “evolve”?
Future potential risk “mutation”
11. Illustration for the biology phylogenetics
Large
Characte Rasping
Paired fin Jaws dermal Fin rays Lung
ristics tongue
bones
Lamprey
✓
Shark
✓ ✓ ✓
Salmon
✓ ✓ ✓ ✓
Lizard
✓ ✓ ✓ ✓
12. Illustration for the biology phylogenetics
By application of phylogenetic analysis (parsimony algorithm), the
evolution process can be revealed using the tree-like
“cladogram”:
First, assume that the species evolve from nothing to existence and
one of the two branches shall be occupied by the species with the
least characters, i.e., the lamprey
Second and later, repeat the selection method to find the organism
that owns the least changes to the lamprey and last species.
(a) paired fins, (b) jaws, (c) large dermal
bones, (d) fin rays, (e) lungs, and (f) rasping
tongue
13. Illustration for the biology phylogenetics
Now we can dig into the evolution analysis:
The shape of lamprey is stable and not likely to have changes soon.
Salmon and lizard must share the same ancestor which shark does not
have relations to.
……
We can do the same thing for risk analysis!
(a) paired fins, (b) jaws, (c) large dermal
bones, (d) fin rays, (e) lungs, and (f) rasping
tongue
19. Animals – Risk Scenario (Ireland)
1. Economic Downturn
2. Failure to deliver the required scale and breadth of
improvement plan benefits leading to under delivery of
projected 2011 UW result.
3. Business does not achieve planned growth.
4. ABC integration / alignment.
5. Loss of key intermediary / corporate account through
failure of intermediary or transfer of business to
competitor.
…….
20. Animals – Risk Scenario (UK)
1. Fail to recognize and protect portfolios against the
effects of larges losses and abnormal weather
2. Current review by Lord Chancellor requires reserve
strengthening for Ogden lump sum awards delivery of
projected 2011 UW result.
3. Adverse Bodily Injury trends continue to rise.
4. Insufficient rate within Commercial Property portfolios
to achieve required risk adjusted return
5. Fraud trends continue to rise
…….
21. Data prepared (Ireland)
“Characteristics”
1 Portfolio 2 Portfolio 3 Claims 4 Technical 5 Reinsurance
Risk ID Risk Risk Selection Management Management Reserving Arraignments
IRE1 Economic Downturn. ✓
Failure to deliver the required scale and breadth of improvement
IRE2 ✓
plan benefits leading to under delivery of projected 2011 UW result.
IRE3 Business does not achieve planned growth.
IRE4 ABC integration / alignment.
Loss of key intermediary / corporate account through failure of
IRE5
intermediary or transfer of business to competitor.
“Animals”
IRE6 Non-compliance with regulatory requirements, including subsidiaries.
IRE7 Inadequate Data Privacy procedures.
IRE8 Risk of adverse development of Prior Year claims on X Book.
IRE9 Repeat of catastrophic weather events. ✓ ✓ ✓
IRE10 Implementation of Periodic Payment Orders. ✓ ✓
IRE11 Failure of Software House.
IRE12 Immature capability re direct and on-line channel.
IRE13 XXX Insurance Ireland S&P downgrade.
IRE14 Outcome of test Achats by ECJ – EU gender directive decision.
22. Data prepared (UK)
1 Underwriting Risk
6 Longevity risk
1 Portfolio risk
arrangements
5 Reinsurance
management
Management
4 Technical
2 Portfolio
Reserving
(Pension)
selection
7 Pricing
3 Claims
Risk
ID Risk
Fail to recognise and protect portfolios against the effects of larges losses and abnormal
UK1 ✓ ✓ ✓ ✓
weather
Current review by Lord Chancellor requires reserve strengthening for Ogden lump sum
UK2 ✓
awards
UK3 Adverse Bodily Injury trends continue to rise ✓ ✓ ✓
Insufficient rate within Commercial Property portfolios to achieve required risk adjusted
UK4 ✓
return
UK5 Fraud trends continue to rise ✓
Focus on top line leads to a failure to maintain underwriting, pricing and controls
UK6 ✓ ✓ ✓ ✓
discipline resulting in negative bottom line impact
Inadequate reserves to cover Disease (asbestos, deafness, vibration white finger) and
UK7 ✓ ✓ ✓
Abuse claims
The European Court of Justice rules against gender based risk pricing in insurance
UK8 ✓
contracts (Achats)
UK9 Periodic Payment Orders (PPOs) adversely impact current reserve levels ✓ ✓
Lack of capacity for key initiatives, deals and change programmes resulting in poor
UK10
execution and / or poor integration
Systemic Credit risk event such that default levels on unsecured credit reach 1991 levels
UK11
or default of a major counterparty
UK12 Poor control of Delegated Authority Schemes business results in a loss
UK13 Fail to achieve business case for key initiatives, deals, change programmes
UK14 Inflation drives adverse impact on expense base and claims cost
UK15 Fail to adapt and implement changes to the regulatory architecture, including Solvency II
23. Risk Evolution Cladgram (Ireland)
Lots of evolution from “7 Pricing” and “38 Trans”
1. Economic Downturn
# = Code of Risk 3, 8, 9, 10, 11, 13, 16, 17, 18, 19, 20, 21, 24, 55
characteristics 49 2. Under delivery of projected UW result
Portfolio Mngment
2
9. Repeat of catastrophic weather events
Pricing 4, 56
7 10. Implementation Periodic Payments
1
7
Portfolio Risk Selection
14. Outcome - EU gender directive
45, 54
8. Prior Year claims on X Book
56
52, 53
44, 46, 50
All of these related to Pricing
10, 58
Vendors & Suppliers
43 3. Buss doesn’t achieve planned growth
37
38
4. ABC integration / alignment
57
7. Inadequate Data Privacy procedures
Internal
38
12. Immature capability re on-line channel
Transaction Capture & Maintenance 26, 28, 29, 50, 52
40, 41
All of these relate to Operation
24. Risk Evolution Cladgram (UK)
8, 9, 10, 11
37
38, 40, 41
5. Fraud trends continue to rise
49, 56
27, 28, 29
7. Inadequate reserves to cover Disease and Abuse
Claims Mngment claims
3 9. (PPOs) adversely impact current reserve levels
5, 56
4
Technical Reserving
46, 54, 57
8. The European Court of Justice rules against
54Legal, Public Affairs & Regulatory
(Achats)
2. Review by Lord Chancellor requires reserves rise
Pricing 4. Insufficient rate within Commercial Property
7 portfolios
3. Adverse Bodily Injury trends continue to rise
3, 56
6. Failure to maintain underwriting, pricing and
1
3, 26, 39 controls
Portfolio Risk Selection 2 1. Fail to protect portfolios against larges losses and
Portfolio Mngment
5 abnormal weather
Reins Arrangements
25. Key Observations and Questions
For Ireland and UK, ‘Pricing‘(7) is the most important risk
character since it defines a biggest clade.
The risk ‘Economic Downturn’(IRE1) is quite distinct due to its
large number of characters:
Economic downturn is a complex risk and covers many areas
and this could also be argued that it is too high level and should be
split into more defined areas (like ‘housing crises‘ or ‘euro crises‘).
Branches with the most characters indicate there has been
significant evolution and we are likely to see more cascading
evolution, like a warm jungle is host to more forms of life than
the cold tundra.
If the risk ‘Inadequate Data Privacy Procedures‘(IRE7) (3 branches
and 5 characters) were to combine with ‘Immature Capability on
On-line Channel‘(IRE12), what does the emerging risk look like?
26. Key Observations and Questions
In the UK, there are 3 risks which show no relation to any
others ‘Systematic credit risk event’ (UK11), ‘Inflation derives
adverse impact on expense and claim cost’ (UK14) and ‘Fail to
adapt changes to the regulatory architecture such as SII’
(UK15).
Risks that have not changed significantly are likely to be stable.
Or this should be checked against whether the risks have not been
described in sufficient detail.
We can presume “co-evolution”, which means that characters
or risks have a tendency to evolve in each other‘s presence.
Like a bird that develops a long beak and a flower holding nectar that
continues to extend the long shape.
For example, ‘Media‘(53) only evolves in the presence of ‘Investors/JV
Partners‘(52). So we can investigate risks that have character (52),
but not yet (53) and presume some new risk events occurring.
28. Summary
Modern risk management is complex and ERM requires a
holistic approach to make sense of the layers, interconnections
and non-quantitative measures.
Using the phylogenetic analysis as the means of constructing
model-free evolutionary risk trees and their interpretation
enabled us to reveal the possible emerging risks.
The visualization of the risks and characters in a tree format
enables a lot of fruitful observations to be quickly spotted that
would be difficult and tiresome in a spreadsheet.
It also could be a good news that new and free software
programs and algorithms allow easy access for actuaries to be
able to construct their own risk trees.
29. This presentation has been prepared for illustrative purposes only. The views expressed in this presentation are
those of the speaker and do not necessarily represent the views of Milliman as a firm.
No reliance or inference should be placed on the statements presented herein.
Actual experience and developments may differ than those presented in this presentation.