How Safe Is Safe Enough

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How safe is safe enough?
An introduction to risk management

By Angela Darlington, Simon Grout & John Whitworth

Presented to The Staple Inn Actuarial Society At Staple Inn Hall At 6 p.m. On 12 June 2001

Contents

Section
1 2 3 4 5 6 7 8 9

Page

Introduction.................................................................................................................. 1 Why is risk interesting? ................................................................................................ 2 Types of risk ................................................................................................................ 4 Risk perception .......................................................................................................... 10 Traditional risk management...................................................................................... 14 Risk analysis methods ............................................................................................... 17 Basel Capital Accord ................................................................................................. 24 Enterprise risk management ...................................................................................... 26 How can actuaries add value? ................................................................................... 32

Appendices
A B The FSA and risk management References

How Safe Is Safe Enough? To Risk Management

1

Introduction

"One of the common denominators I have found is that expectations rise above that which is expected." George W Bush, US President 1.1 1.2 As we are sure is the experience of most writers of SIAS papers, we found it very easy to volunteer but extremely difficult to get around to actually writing it. Initially, we planned to write a paper on e-commerce - a hot topic causing great interest and debate at the time that we booked this session. However, by the time we got round to writing the paper, the market for technology stocks had crashed and job losses were piling up. At the same time, Equitable Life was in the middle of the problems created by its unhedged annuity rate guarantees. This lead us to consider that much had changed over the previous year. And so our thoughts turned towards how to avoid the problems which appeared to be plaguing both the e-commerce and financial services industries. And so this paper was born. This paper aims to provide an introduction to some of the key risk management concepts, issues and processes. This paper is not intended to be an all-singing, alldancing description of the risk management industry. Rather, we hope that it provides a summary of the themes and practices that we use in risk management. This may enable actuaries to understand how risk management ideas and processes can add value to their organisation and how they can use these concepts in their work. We have tried to use some practical examples that illustrate the main themes of risk management in an interesting way. However, hindsight is a wonderful thing, and if we had perfect information about the future, risk management would be easy and perhaps unnecessary. In any case, we hope that the examples prove if not useful then at least interesting. The thoughts, words and deeds in this paper are our responsibility and not those of our employer, the Institute of Actuaries or the Faculty of Actuaries. However we would like to thank our colleagues for their invaluable input and, in particular, our enterprise risk management colleagues for lending us many of the diagrams in this paper. Finally, we would like to thank George W Bush for his words of wisdom.

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Page 1 How Safe Is Safe Enough? An Introduction To Risk Management

2

Why is risk interesting?

"When I was coming up, it was a dangerous world, and you knew exactly who they were. It was Us v. Them, and it was clear who 'Them' was. Today, we are not so sure who the 'They' are, but we...
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