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                                                                                                   MEMBERS’ UPDATE




                                                                                                                        May 2005


         PRMTM Candidate of the Year Finalists Announced,                                                       Volume 4 Issue 5

                Winner to be Named Next Week
Finalists from the fourteen nominees for the     • Frank Hayden, Managing Director - Global
PRM Candidate of the Year award have been          Market Risk, Cinergy, Houston, (Regional
chosen by a diverse review committee of            Director, PRMIA Houston)                             Inside this issue:
PRMIA leaders.                                   • Errol D’Souza, Head of Corporate Risk
                                                   Management, Merrill Lynch, Mumbai,
                                                                                                      Risk Measurement of 2
The finalists are:                                 (PRMIA Mumbai)                                     Satellite Investments
                                                 • Paul Glasserman, Jack R. Anderson Profes-
• Rickard Branvall, Nikko Citigroup, Tokyo,        sor of Risk Management, Columbia Univer-           Featured Jobs           3
  Japan                                            sity, New York, (PRMIA Education and
                                                                                                      Ford, GM and Health 4
                                                   Standards Committee)
• Matthias Friese, Cominvest Asset Manage-                                                            Care: Hilary Right?
                                                 • Karina Carrero, Financial Services Consult-
  ment, Frankfurt, Germany                         ant, Accenture, Caracas, (Regional Director,       Recent Top Scoring      4
• Giovanni Gentili, European Investment            PRMIA Venezuela)                                   PRM Candidates
  Bank, Luxembourg                               • Anastasia Marina, , SunGard, Makati City,          ERM Symposium           5
                                                   (PRMIA Philippines)
• Rene Sanda, Banco do Brasil, New York,                                                              Draws 500 to Chi-
                                                                                                      cago: Summaries
  United States of America                       Interviews will be conducted, letters of recom-
• Peter Scheidler, WGZ-Bank, Düsseldorf,         mendation from employers will be reviewed,           China Float: Beware     8
  Germany                                        performance on the exams and the committee           what you ask for
                                                 review of the essays will be considered in
• Stephan von Bismarck, Fidelity Investments     choosing the winner of this year’s award.            PRMIA Names Four        9
  Int’l Ltd., London, UK                                                                              Regional Directors
                                                 Dr. Michel Crouhy, co-author of the book Risk        PRM Award Winners 10
Candidates were nominated based on their per-    Management and Research & Development
formance of the exams of the PRM program,        Director, Ixis Corporate and Investment Bank
and were all awarded their PRM designation in    in Paris, Carol Alexander, Chair of the PRMIA
2004. Each nominee then provided brief essays    Academic Advisory Council, Chair of the Risk
to the review committee, which then selected     Management Department, ISMA Centre, Uni-
the finalists. The review committee members      versity of Reading, co-Editor of the Profes-        Points of Interest
were:                                            sional Risk Managers' Handbook: A Compre-           During the last month,
                                                 hensive Guide to Current Theory and Best            candidates from the fol-
• Oscar McCarthy, Group Treasury, Lloyds         Practices and author of several other books,        lowing countries regis-
  TSB, London, (PRMIA London)                    and David R. Koenig, Chair, PRMIA Board of          tered for the PRM exams:
• Joel Bessis, Head of Risk Analytics, Caisse    Directors will conduct the final review.            Australia, Bahrain, Brazil,
  Epargne, Paris, (PRMIA Paris)                                                                      Canada, China, Croatia/
• Andrzej Kulik, Head of Middle Office, BRE      The winner will be announced next week.             Hrvatska, France, Ger-
  Bank, Warsaw, (PRMIA Vice Chair)                                                                   many, Hong Kong, India,
• Hilary Till, Principal, Premia Capital, Chi-   Our congratulations also go to the winners of       Israel, Italy, Jamaica,
  cago, (PRMIA Chicago)                          the PRM Award of Merit:                             Kenya, Korea (South),
• Francois Bourdon, Quantitative Strategist,                                                         Kuwait, Lithuania, Neth-
  Fiera Capital, Montreal, (2004 PRM Candi-      • Konrad Augustynski, Jagiellonian Univer-          erlands, Poland, Russia,
  date of the Year)                                sity, Krakow, Poland                              Singapore, South Africa,
                                                                                                     Sweden, Trinidad/
• Tan You Leong, Risk Analyst, OCBC Bank,        • Viktoria Baklanova, Moody's Investors Ser-        Tobago, United Kingdom,
  Singapore, (2004 PRM Candidate of the
                                                   vice, New York, USA                               United States of America
  Year)
                                                 • Till Baulig-Brand, DZ Bank AG, Frankfurt,
    Germany                                                            chance to grow faster than the broad market averages.”
• Frank Bensics, Central CT State University, New Britain,
                                                                       In previous articles, we had noted that a number of satellite in-
  CT, USA                                                              vestments require additional risk measurement techniques in
• Tianqi Fang, Bank of America, Charlotte, United States of            order to take into consideration the default, devaluation, and/or
  America                                                              liquidity risks frequently associated with them.
• Keith Ganzer, AXA Financial Inc., New York, USA
                                                                       Here, we discuss several proposed risk metrics that improve
• Michal Goss, SEB Investment Fund Company, Warsaw,                    upon those that are typically used.
  Poland
• Yat-Fai Lam, Hong Kong Monetary Authority, Hong Kong                 Conditional Value-at-Risk

                                                                       Agarwal and Naik (2004) recommend applying the Conditional
Those who received the highest score of all candidates on each         Value-at-Risk (CVaR) framework to satellite asset classes like
exam in 2004 have been awarded the PRM Focus Award of                  hedge funds. They advocate replacing Value-at-Risk (VaR),
Distinction. We congratulate the following winners:                    which has been popular among traditional asset managers. The
                                                                       authors explain that:
Exam I:
                                                                       “[Whereas] VaR measures the maximum loss for a given confi-
•   Dominik Dersch, HypoVereinsbank, München, Germany                  dence interval, … CVaR corresponds to the expected loss condi-
•   Rafal Lerski, Poland                                               tional on the loss being greater than or equal to the VaR.”
•   Kit Yee Ng, Hong Kong
                                                                       By using CVaR, the authors are able to capture the left-tail risk
Exam II:                                                               of those hedge fund strategies that have short put option-like
                                                                       exposures. (Exhibit 1 shows an example of a return distribution
•   Tianqi Fang, Bank of America, Charlotte, USA                       that has noteworthy “left-tail risk.”)

Exam III:

•   Frank Bensics, Central CT State Univ., New Britain, USA
•   Stephan von Bismarck, Fidelity Investments Int’l Ltd.,
    London, UK

Exam IV:

•   Anthony Okuefuna, Abbey National, Glasgow, UK
•   Alexander Wilson, Bank Nederlandse Gemeenten, The
    Hague, Netherlands
•   Chandramohan Ganapathi, Commercial Bank of Kuwait,
    Kuwait

Risk Measurement of Satellite Invest-
ments: Part IV of VI                                                   They additionally show that the application of the mean-
                                                                       variance framework for some hedge fund strategies can underes-
Contributed by Hilary Till                                             timate tail risk by as much as 50%.
Principal, Premia Capital Management, LLC
http://www.premiacap.com                                               The authors conclude that if a fiduciary’s goal is to create port-
PRMIA Member Since February 2002                                       folios for which the magnitude of extreme losses is kept under
(co-authored with Joseph Eagleeye)                                     control, then that fiduciary should consider using CVaR as their
                                                                       risk constraint during portfolio construction.
This article is the fourth in a six-part series that provides a risk
framework for fiduciaries considering using a core-satellite           Modified Value-at-Risk
approach to investing. As defined by Singleton (2005), a
“portfolio managed from a core-satellite perspective allocates         When one cannot assume that an investment’s returns are dis-
some money to core asset classes and uses them to help the             tributed normally (or at least symmetrically distributed), Signer
portfolio keep pace with the broad markets.” Further, “other           and Favre (2002) propose a risk measure that also incorporates
funds are allocated to the satellite ring and give the portfolio a     the third and fourth moments of an investment’s distribution.

Volume 4 Issue 5                                                                                                               Page 2
They describe a statistical method for adjusting VaR to incor-           Not all hedge fund strategies can be characterized as exhibiting
porate skewness and kurtosis; the authors refer to this new              negative skewness. It is mainly the event driven and fixed-
measure as “modified VaR.”                                               income arbitrage strategies that have been characterized as hav-
                                                                         ing disadvantageous skewness and kurtosis properties (for
The authors advocate using modified VaR as the risk constraint           given levels of average returns and variance).
for portfolios that include hedge funds because:
                                                                         One should also add that the cautionary notes on taking into
“nearly all hedge fund strategies show negatively skewed re-             consideration an investment strategy’s skewness and kurtosis
turn distributions with positive excess kurtosis.”                       properties do not only pertain to hedge funds. It also pertains
                                                                         to investments with default risk (like high-yield bonds) and
The authors provide an example that shows how the efficient              investments with potential liquidity problems (like small-
frontier is affected when using modified VaR rather than VaR             capitalization stocks).
as the risk constraint. See Exhibit 2.
                                                                         For example, as noted by Goetzmann et al. (2002):

                                                                         “…. some assets in the U.S. market, primarily small cap stocks,
                                                                         behave as if they are short a[n] [out-of-the-money] put [on the
                                                                         overall stock market.]”

                                                                         A last qualifying remark is that to be more precise, the impor-
                                                                         tant statistical characteristics are co-skewness and co-kurtosis
                                                                         rather than skewness and kurtosis, per se. Co-skewness (co-
                                                                         kurtosis) refers to the component of an asset’s skewness
                                                                         (kurtosis) related to the market portfolio’s skewness (kurtosis.)

                                                                         Co-skewness and co-kurtosis provide an investor with informa-
                                                                         tion on how an investment will perform during times of overall
                                                                         market stress. Negative skewness, as with a hurricane bond,
                                                                         which results from factors unrelated to market stress, is not as
                                                                         undesirable an investment as one that does very poorly during
                                                                         times of equity market stress and so has negative co-skewness.
“shows the degree to which [a] … sample portfolio with a                 This is because it is during times of market stress that one is
hedge fund portion of maximum 10% is represented too posi-               particularly worried about having a portfolio of seemingly di-
tively (in the sense of returns being too favorably risk-adjusted)       versified investments that all perform poorly at the same time.
by not taking account of the skewness and kurtosis of the return
distributions.”                                                          Brooks and Kat (2002) show how this qualification matters in
                                                                         portfolio construction. They note that:
The authors conclude that an evaluation of the benefits of
hedge funds needs to incorporate the higher moments of the               “in most cases where the skewness of the hedge fund index is
investment strategies’ return distributions.                             lower (higher) than that of the portfolio to which it is added …,


Over 450 Jobs Posted On the PRMIA Jobs Board: 200 New This Month
The PRMIA Jobs Board is a free resource to PRMIA members.
                                                                                    U.S. Lawyer—Investment Banking
Over 25,000 job searches take place each month on the board and
this month, over 450 Jobs in 21 countries are listed.                                         Salary: US$Competitive

 Vice President, Capital Markets (Debt) Compliance                                                  Zurich, CH

                      Salary: US$Competitive                            If you’re looking to hire, you can post your openings for free
                                                                        and can even use the search utility to find a certified PRM to
                            London, UK                                  meet your needs.
                                                                                             Marktrisiko-Analyst
Each month we feature some of the latest postings, but be sure to
search the entire database to see what is available. All job listings                         Salary: US$Competitive
can be found by clicking
http://www.prmia.org/jobs/jobs.php.                                                                     DE

Volume 4 Issue 5                                                                                                               Page 3
the skewness of the new portfolio tends to be less (more) at-          F, GM & Health Care: Was Hilary Right?
tractive than that of the original portfolio comprising only
stocks and bonds. The Equity Market Neutral indices are an             Contributed by Christopher Whalen
exception, though. Although the latter do not exhibit much             PRMIA Member Since January 2004
skewness themselves, adding them still causes portfolio skew-          http://institutionalriskanalytics.com/index.html
ness to deteriorate. This strongly suggests that the correlation
between the Equity Market Neutral indices and the S&P 500 is           There is a false notion abroad in the land that the auto industry
higher in down markets than in up markets.”                            no longer matters to the long-term health of the American
                                                                       economy. On this point, we must differ. The credit downgrade
The next article of the series will cover the asset-based style        of GM (NYSE:GM) and Ford (NYSE:F) last week, in the case
factor approach to summarizing investments. The concluding             of the former by a full two ratings notches, signals the begin-
article of the series will discuss the need for understanding the      ning of a difficult and increasingly painful process of aligning
source of returns of an investment strategy, noting that a purely      legal commitments to existing resources that mirrors the larger
quantitative approach to understanding risk is insufficient.           debate in Washington over Social Security and Medicare.
References                                                             Unfortunately, the Texas contingent that controls the White
                                                                       House, despite the President's courage in addressing the public
Agarwal, Vikas and Narayan Naik (2004). Risks and Portfolio            sector financial issues related to the Baby Boomers, has yet to
Decisions Involving Hedge Funds. Review of Financial Stud-             acknowledge how this demographic reality affects the private
ies, 17 (1), pp. 63-98.                                                sector. Fed Chairman Alan Greenspan has painted a clear pic-
                                                                       ture of the mismatch between real assets and the Social Secu-
Brooks, Chris and Harry Kat (2002). The Statistical Properties         rity and Medicare liabilities enshrined in current law, but few
of Hedge Fund Index Returns and Their Implications for Inves-          in Washington are willing to extend this analysis to private
tors. Journal of Alternative Investments, Fall, pp. 26-44.             industry, in part because the already daunting arithmetic of
                                                                       Social Security and Medicare deficits becomes outright awful
Goetzmann, William, Jonathan Ingersoll, Matthew Spiegel, and           when one ponders the huge pension and health care funding
Ivo Welch (2002). Sharpening Sharpe Ratios. Yale School of             shortfalls on the balance sheets of the largest and oldest Ameri-
Management, Working Paper, February.                                   can companies.
Signer, Andreas and Laurent Favre (2002). The Difficulties of          Think of it this way: Even were GM and F to suddenly produce
Measuring the Benefits of Hedge Funds. Journal of Alterna-             products that were superior to those of the various foreign com-
tive Investments, Summer, pp. 31-41.                                   petitors, and at a lower price, the accumulated retirement and
                                                                       health care liabilities to current and retired workers would still
Singleton, J. Clay (2005). A Core-Satellite Approach to Portfo-        threaten their solvency. This is why F CEO Bill Ford and his
lio Management. In J.C. Singleton, ed. Core-Satellite Portfolio        counterpart at GM, Rick Wagoner, have consistently ham-
Management, McGraw Hill book, New York, pp. 3-4.                       mered away at the issue of health care reform, both in Wash-
                                                                       ington and in other venues.
A version of this article was published in the edited book,
Core-Satellite Portfolio Management (Edited by J. Clay Single-         We hate to say it, but Senator Hillary Clinton (D-NY) may
ton), McGraw Hill, 2005; and in the Singapore Economic Re-             have been right when she suggested a national solution to
view, April 2004.                                                      health care. Why do we invoke the name of a socialist like
                                                                       Hillary Clinton? Because one way or another, despite all of the


 Top Scores in Second Quarter 2005 (to-date)
                                                                      Exam III - Financial Risk Management Practices
 Exam I - Finance Theory, Financial Instruments
 and Markets                                                                     Bartosz Balcerowicz, Starachowice, Poland

 Vishnu Ramachandran, Mumbai, India

 Exam II - Mathematical Foundations of Risk                                      Exam IV - Case Studies, Standards of Best Practice,
 Measurement                                            Congratulations to the   Conduct and Ethics, PRMIA Governance
                                                        Top PRM Candidates

 Kanat Khussainov, Almaty, Kazakhstan                                            Tamara Burden, Chicago, USA




Volume 4 Issue 5                                                                                                              Page 4
free market, tax-cutting protestations of the Bush Administration       with the vastly stronger automaker that was a signal to the entire
and their conservative supporters in Congress and around the            industry that unions were about to claim their share of the pie. In
country, the health care liabilities of GM, F and many other in-        the first few months after taking over late in 1945, Henry II
dustrial companies are going to be handed to Washington. Talk-          made little progress with the UAW; but early in 1946 he gave an
ing about tax cuts in the face of this approaching fiscal tidal         acclaimed speech on "The Challenge of Human Engineering,"
wave is like a consumer using a high-interest credit card to make       setting out to change the tone and quality of the discussions with
mortgage payments. Seen in this light, talking about                    the increasingly powerful union.
"privatization" of Social Security is equally ridiculous.
                                                                        Already facing hostility from post-WWII Washington, which
We recently asked our friend Bill Rochelle, head of the bank-           effectively told Henry II to raise wages without increasing
ruptcy practice at Fulbright & Jaworski in New York how many            prices, the son of Edsel Ford showed himself the pragmatist and
US auto parts companies had filed for bankruptcy in the past            defused years of tension with the UAW in less than six months.
two years. His reply was telling: "I have stopped counting," said       He bought a peace that kept the UAW from striking F plants for
Rochelle, who has been deeply involved in airline bankruptcy            decades. But Henry II's compromise also marked the beginning
litigation. "It is easier to count the ones that have not yet filed."   of a long period of accommodation of union demands which
                                                                        have over the next half century become the single biggest factor
As the smaller suppliers supporting the US auto industry have           affecting the ability of the US auto industry to compete with
dwindled in numbers, already strapped communities across the            foreign-based manufacturers.
US are experiencing new waves of redundancies and plant clo-
sures, robbing cities and hamlets of employment and tax reve-           Today, the accumulated cost of the compromises made by F,
nues. Even though some significant names have already sought            GM and the entire auto industry with the UAW decades ago
the protection of the courts, these stories have mostly been rele-      threatens the very viability of that industry. While the credit
gates to the inside pages of the business section, thereby leaving      downgrades of F and GM were big news last week, few noticed
the rosy scenario beloved by the Bush Administration's eco-             when the major rating agencies severely downgraded VC and
nomic team apparently intact.                                           DPH a month earlier. For those credulous cretins on Wall Street
                                                                        who expressed surprise at S&P's downgrade of F and GM, the
To see how this scenario will unfold, study the relationship be-        impending insolvency of Detroit's largest parts makers will be a
tween F and its former subsidiary, Visteon (NYSE:VC). VC and            real thrill - and will bring home to Washington and Wall Street
its counterpart, Delphi Corp (NYSE:DPH), the two largest sup-           the full dimension of the larger American problem.
pliers of parts to Ford and GM, respectively, are both headed
inexorably for bankruptcy. The main reason for the filings will         Unfortunately, this story does not yet have a happy ending be-
be financial, but the larger context will be the need to use the        cause, unlike President Bush, the Congress lacks the courage to
legal authority of the US Bankruptcy Court to void onerous la-          address these issues with honesty, at least in public. We believe
bor agreements with the UAW and, in the process, walk away              that VC and DPH will be forced into bankruptcy, perhaps as
from pension and health care liabilities to hundreds of thousands       early as the end of 2005. These giants, who together have nearly
of current and retired auto workers.                                    $50 billion in revenue and directly employ 260,000 Americans,
                                                                        will use the power of the courts to void their labor contracts and
As in the case of the steel and airline industries, these commit-       other commitments to workers. The PBGC will assume the pen-
ment will be handed to the Pension Benefit Guarantee Corp.,             sion liabilities for VC and DPH workers, who are still covered
which will administer what real assets have been allocated to           by the global labor agreements with the automakers.
meet these commitments and haircut the benefits to meet the
available resources. This is a present day problem, but the roots       Then Bill Ford and Rick Wagoner will look at the recalcitrant
of the situation go back nearly half a century.                         leadership of the UAW and say very politely: "Can you hear me
                                                                        now?"
Near the end of 1945, a young naval officer named Henry Ford
II took control of his family's company as his enfeebled grandfa-       Third Enterprise Risk Management Sym-
ther neared death. Henry and the Ford family had fought for
several months earlier to wrest control of F from Henry I's cro-        posium Draws Five Hundred to Chicago
nies and, once this was accomplished, Henry II turned his atten-        Contributed by David Ingram
tion to making peace with the unions, which had fought to or-           PRMIA Member Since February 2002
ganize the Blue Oval's plants for nearly four decades. As today,        http://www.ermsymposium.org
F was in serious financial trouble and only the forbearance of
GM and Washington kept the company afloat after years of non-           We thank contributors: Hubert Mueller, Max Rudolph, Fred
management by the great inventor.                                       Tavan, David Ruhm, John Kollar, David Ingram, Sim Segal for
                                                                        their summary of several 2005 ERM Symposium sessions.
Even as Henry II was sitting down to talks with the union lead-
ership, the UAW struck GM in November 1945, starting a battle           Over 500 risk management professionals participated in the


Volume 4 Issue 5                                                                                                                Page 5
2005 ERM Symposium, held in Chicago on May 2,3. The Sym-           This workshop provided practical tools and techniques needed
posium featured six general sessions with presentations from       to get an ERM program off the ground. Mr. Tavan first pre-
Bob Stein, James Lam, Nassim Taleb, Leslie Rahl, Bennett           sented practical ERM tools that can be used to assess all risks
Stewart, Prakash Shimpi, Chris Duncan, Steve Manning, Robin        within a risk management framework. He gave examples of
Lenna, Larry Moews, and Don Watson. The meeting also of-           various risk metrics that can be used in the measurement of
fered over 30 concurrent presentations from over 100 ERM           risk. Fred also provided an introduction to the concepts of risk
practitioners. Here are summaries of a sampling of those ses-      appetite, tolerance, limits, triggers, and early waning indica-
sions…                                                             tors. Mr. Rudolph focused on the measurement of various fi-
                                                                   nancial risks and provided examples on the importance of these
General Session 3: Proper Alignment of Senior Management           to the overall risk profile of a company.
Measures and Incentives
                                                                   Concurrent Session A2: Creation of Value Through ERM
Mark Abbott, Managing Director of Risk Management and
Quantitative Research at Guardian Life and a PRMIA Board           Presenters: Jose Renato Carollo, Sim Segal, Tom Wilson,
member introduced Bennett Stewart and suggested that he could      Robert Kopech
help move management away from traditional accounting meas-
ures like ROE and more towards economic measures like EVA.         The ERM concept has recently evolved to a point that has many
                                                                   companies starting down the path of ERM implementation. In-
Bennett Stewart, Senior Partner, Stewart Stern & Co. discussed     tuitively recognizing the benefits of this ERM evolution, many
common pitfalls from several case studies that identified earn-    insurance companies have started implementing ERM in some
ings as can currently be manipulated by management as a poor       form. However, many others remain hesitant, due to a lack of
management performance metric. He went on to highlight that        clarity in making the business case for ERM. A good business
increasing transparency and offering more frequent financial       case should include a quantification of the potential impact of
reporting in the absence of earnings guidance actually decreased   ERM on shareholder value. Unfortunately, most ERM ap-
stock price volatility. He proposed that to optimally manage       proaches do not easily lend themselves to such quantification.
businesses an alignment of management performance measures
was needed and suggested that EVA could help achieve such.         However, there is one approach particularly well-suited for mak-
He also proposed that incentive caps could actually destroy        ing the business case for ERM: Value-Based ERM. Value-Based
value. His conclusion was that effective performance measures      ERM is an approach that makes the quantification of value cen-
are essential to balancing risk and reward, the competing inter-   tral to all aspects of the ERM process. This value-centric focus
ests among shareholders, customers, executive management and       has two key advantages. It quantifies the impact of ERM on
all employees, in order to achieving optimal growth in long-term   shareholder value. In addition, it creates a common “language”
firm value.                                                        that unifies otherwise disparate ERM processes. This session
                                                                   illustrates how a Value-Based ERM model, which is the heart of
General Session 5: CRO Forum                                       the Value-Based ERM approach, accomplishes these two impor-
                                                                   tant advantages. Speaker: Sim Segal
Shyam Venkat, Partner of PwC led the general session CRO
Forum, which was an outstanding senior insurance risk manage-      CS B1: Economic Capital vs Rating Agency Capital vs Regu-
ment practitioner panel on the 2nd morning of the event. A di-     latory Capital
verse panel of renowned insurance CROs including Robin
Lenna, CRO, Met Life; Steve Manning, Head of Risk Manage-          Moderator: Hubert Mueller (Towers Perrin)
ment, Lloyd’s of London; Larry Moews, CRO, Allstate; and           Presenters: Larry Bruning (KS Insurance Dept) and Peter Pa-
Don Watson, CRO, Ace. They discussed how they championed,          trino (Fitch Ratings).
established and executed development of ERM frameworks in
their organizations. They compared organizational structures/      The first session on EC provided an outside-in perspective on
committees, objectives, roles, current achievements, goals and     EC. First, Mr Mueller described current market trends for deter-
priorities. All voiced increasing demands of them being made       mining and using EC in the North American marketplace, using
by their Board, CEO and other parties such as regulators, rating   the results of several recent market surveys and a number of
agencies, analysts, etc. A common thread was that the risk man-    client assignments in this area. He is seeing a growing trend
agement process and improved senior management communica-          towards the use of EC in the marketplace, at a worldwide level.
tion around risk management was being recognized as a critical     Next, Peter Patrino provided the rating agency perspective on
competitive advantage.                                             insurance company capital models. While there are still some
                                                                   limitations as to the acceptance of company models, Fitch is
Workshop Session 3: ERM Tools & Techniques - The Build-            open to considering company-specific models in the determina-
ing Blocks                                                         tion of EC. Last, Larry Bruning discussed regulatory views on
                                                                   risk-based Capital (RBC), and how the current proposal for
Presenters: Fred Tavan (RGA International), and Max Rudolph        RBC on variable annuities (C-3 Phase II) is reshaping the indus-
(Mutual of Omaha                                                   try’s capital adequacy framework from a formula- based ap-

Volume 4 Issue 5                                                                                                          Page 6
proach to a principles-based model, using company-specific         Case studies into ERM practices at four large companies in a
stochastic modeling. All three speakers agreed that EC would be    variety of countries revealed an inconsistent understanding of
even more broadly used going forward, and become a key com-        ERM across insurance companies. Apparently the most signifi-
ponent of company’s ERM methodologies.                             cant driver of ERM development has been regulations. How-
                                                                   ever, inconsistency between the “design” and the
CS B3: Economic Capital Recent Trends in Implementation            “implementation” of ERM is high among companies. On the
                                                                   brighter side, there is a developing convergence between the
Moderator: Hubert Mueller (Towers Perrin; moderator)               “qualitative” and the “quantitative” phases of ERM. Looking
Presenters: Doug Brooks (CRO of Sun Life Financial), Robin         forward, development of a common Risk Language will be im-
Lenna (CRO of Met Life), and Kevin Reimer (Head of Risk            portant to develop a common Risk Culture.        A consistent
Management for ING’s Institutional Products Division)              Global Framework of ERM is far in the future. Speaker: Mad-
                                                                   husudan Acharyya
In this session, three Chief Risk Officers (CROs) from some of
the largest insurance companies in North America discussed         CS C5: ERM in Asset Management
how the implementation of EC at their companies has helped
them in risk management and business decision-making. Each         Moderator: Mark Abbott (Guardian Life & PRMIA Board
speaker also discussed some of the motivations behind the im-      Member)
plementation of EC at their companies. These include:              Presenters: Erwin Martens, SVP & CRO, (TIAA-CREF); Lars
                                                                   Toomre, Managing Director, (Toomre Capital Markets); and Jun
•   Linking risk and value in a consistent framework – when        Zhou, PhD, Risk Analytics Principal, Market Risk Management,
    using an Embedded Value framework, calculating EC al-          (AIG)
    lows a determination of the risk-adjusted value created;
•   Finding a way to calculate and allocate the “right amount”     The panelists presented very different introductions. Erwin
    of capital for non-financial (operational) risks, leveraging   talked about the roles, tools and process of a CRO, including the
    the knowledge available from the banking marketplace; and      importance of informal discussion at all levels; detailed exam-
•   Optimizing the use of capital when working in different        ples were covered. Lars first provided an overview of issues in
    accounting regimes.                                            asset management and then talked about - the importance of a
                                                                   common vocabulary; the convergence of three primary capital
CS B5: Earnings at Risk and Practical Considerations in            markets sectors (Assets, Liabilities and Liquidity); and the need
Developing a Risk Management System                                for successful integration and management of ALL 3 areas to
                                                                   optimize enterprise value and EVA. Jun went through the im-
Presenters: Jay Glacy and Cindy Sarna                              portance of listening and understanding the problems and used
                                                                   recent ALM and variable annuity modeling as an example. An
ERM practitioners face a profusion of business complexity as       excellent discussion followed.
they try to balance risk exposures with demands for earnings
and share performance. Earnings-at Risk is a multi-period,         CS D1: Risk Tolerances and Risk Metrics
multi-factor model of earnings emergence in the accounting
domain. Earnings-at-Risk can highlight the path to improved        Moderator: Fred Tavan, (RGA International)
financial performance by permitting insurers to more confi-        Presenters: Richard Goldfarb (E&Y), Fred Tavan, (RGA Inter-
dently understand and control real-world financial risks.          national), David Ruhm, (The Hartford Insurance Group)

Mounting business complexity creates a host of implementation      This session included various topics around risk tolerances and
challenges for the risk professional embarking on an Earnings-     risk metrics. Mr. Tavan spoke about various risk metrics that
at-Risk build-out. The intricacies of GAAP and FIT treatments      can be used for each of the risk subcategories in the AAA risk
and the highly technical nature of today’s insurance assets and    management framework. He gave an introduction to Fuzzy
liabilities, make for a difficult road. And the technology chal-   Logic and provided many examples to help the audience get
lenges, both hardware and software, can be intimidating. But       acquainted with this tool for operational risk measurement. Fred
the determined developer will be rewarded with a surer, firmer     also talked about challenging issues around setting risk appetite
grasp on risk and the means to thoughtfully mitigate exposures     and tolerance levels by presenting relevant research by Kahne-
in a rigorous and relevant modeling framework. .                   man and Tversky. Mr. Goldfarb spoke about the technique of
                                                                   using credit ratings for setting risk tolerance for a company. Mr.
CS C1: International and Cultural Issues in Enterprise Risk        Ruhm provided the advantages and disadvantages of several
Management                                                         well known risk metrics and introduced the audience to the Risk
                                                                   Coverage Ratio metric.
Moderator: Donald Howard (MetLife)
Presenters: Thakor Desai (Moores Rowland International),           Statistics for measuring risk (known as “risk metrics”) have
Donald Howard (MetLife)                                            evolved over the past several decades, successively addressing


Volume 4 Issue 5                                                                                                          Page 7
more meaningful questions about the extent of risk exposure and        Rudolph presented the case that, while we have the right skill set
the risk/return tradeoff. Each risk metric addresses a specific        to do the job, we often don’t have the combination of time, in-
question about risk and provides a piece of useful information         terest or confidence to do so. He then laid out various considera-
but has shortcomings that are specific to that metric. For exam-       tions for personal investing, and developed tools to utilize a bot-
ple, the Sharpe ratio provides useful insight into the risk/return     tom up, value based, methodology.
tradeoff but gives little information about the sizes of the most
extreme events, while the Conditional Tail Expectation (CTE)           CS G1: Procurement Risk Management at HP: Applying
can indicate how much capital is necessary to survive an aver-         Financial Engineering Techniques to Manage Risks in the
age catastrophe but doesn’t say anything about the risk/return         Supply Chain
tradeoff. Several risk metrics can be used in combination to
cover the various aspects of risk measurement and to obtain a          Moderator: Max Rudolph (Mutual of Omaha)
more complete perspective for assessing and managing risk.             Presenter: Venu Nagali, (Hewlett-Packard Company)

While risk metrics look different from each other in their formu-      Most of the presenters at the 2005 ERM Symposium discussed
lations, nearly all of them come from answering the same small         financial risks. Venu Nagali, Ph.D., from the HP Procurement
group of questions. Different combinations of answers to these         Risk Management Group, shared his success applying financial
key questions lead to the broad variety of risk metrics.               engineering tools in a manufacturing setting. There are only a
                                                                       few major producers, and only a few major buyers, of DRAM
CS D6: Topics in Risk Identification and Risk Measurement              chips. Currency risks (supply is almost exclusively from Tai-
for Insurers                                                           wan) are combined with demand uncertainties, volatile memory
                                                                       prices and rapidly changing technology to make DRAM pro-
Moderator: John Kollar (ISO)                                           curement a key driver of HP’s bottom line. As a recent example,
Presenters: Dave Ingram (Standard & Poors), John Kollar                chip orders did not anticipate the popularity of the iPod and had
(ISO), Marilyn Schlein Kramer (DxCG)                                   to adjust on the fly. Dr. Nagali shared how HP has provided
                                                                       stability of cost and supply through structured contracts with
John Kollar (ISO) described how a property/casualty insurer            suppliers, defining a fixed quantity and pricing terms.
could measure its underwriting risk including loss volatility, loss
reserve risk, and correlations. This measurement would allow           Concluding Remarks/Ask The Experts
the insurer to calculate implied capital, allocate capital, optimize
reinsurance, set combined ratio targets for pricing, reflect pric-     Ed Dumas (Chief Risk Officer, FHLBB), Erwin Martens (Chief
ing risk, plan growth, and provide robust risk analyses for its        Risk Officer, TIAA-CREF), Bill Panning (Executive Vice Presi-
Board, rating agencies, stock analysts, and regulators. Dave           dent, Willis Re, Inc) and Max Rudolph (Actuary, Mutual of
Ingram (Standard & Poors) presented an analysis of mortality           Omaha) finished the conference by responding to questions
risk including the impact of random fluctuations in mortality,         from the audience.
miss-estimation of claim levels, miss-estimation of trends that
are not smooth, and catastrophes. He also reported on the risk         Many of the presentation slides and audio files from the presen-
transfer securitization of mortality risk using mortality              tations   are    available    on     the    web     at    http://
bonds. Marilyn Schlein Kramer (DxCG) described how health              www.ermsymposium.com/.
predictive models can be used to normalize insured populations
for chronic conditions and acute illnesses (risk adjustment) for       The ERM Symposium will be back next year, again in Chicago.
purposes of making risk transfer payments and assisting payors         Watch this space for more information.
(employers), heath care providers, and health plans provide and
manage health care. She also described a study of how health           China: Beware What You Wish For
predictive models may be used to identify high cost Workers
Compensation claimants. The panelists concluded with a sum-            Contributed by Christopher Whalen
mary of commonalities and differences across the three insur-          PRMIA Member Since January 2004
ance lines.                                                            http://institutionalriskanalytics.com/index.html
CS E3: Do Risk Professionals Have What It Takes to Man-                The latest generation of Washington policy wonks and invest-
age Assets?                                                            ment bankers have discovered the world's oldest emerging mar-
                                                                       ket and have dutifully prescribed a currency float, this to adjust
Moderator: Stephen Paul Hodges (Nationwide Financial)                  China's massively one-sided trade balance with the rest of the
Presenter: Max Rudolph (Mutual Of Omaha)                               world. Our China correspondent comments on this and other
                                                                       topics below in the first of a series of on-the-scene reports .
The risk professional is often the only person in a company who
thinks about assets and liabilities in equal proportions. So why       Everyone has it wrong. If China's leaders relax currency controls
do most people in this position of knowledge continue to use           the slightest bit, every Chinaman is going to dump the Renminbi
investment professionals to manage their personal assets? Max

Volume 4 Issue 5                                                                                                               Page 8
for anything else that they can get. Gold, dollars, Yen, Euros,         channel is it when the articles and shows are sanitized to placate
Francs, Pounds, chickens, you name it. Enforced stability is all        China's political censors?
that people here understand.
                                                                        Or consider Communist Party's promulgation that they will pur-
In fact, the biggest concern for foreign players in the China mar-      sue stricter enforcement of intellectual property laws. This,
ket today is liquidity. How would banks handle a 80%+ over-             when regular property has no rights whatsoever. Orwell's vision
night cash redemption rate, especially when there are few play-         perfected - two legs are good, four legs are bad.
ers in the market other than the state banks? The entire Chinese
bond market only has 37 corporate issues and 32 convertibles.           The interesting questions are of course: "Who is in control?"
                                                                        and: "How is control maintained?" China has the benefit (dare
If its financial situation is fragile, China's taste in clothing is a   we say curse?) of enjoying a virtual zero cost for labor, as there
national tragedy. The entire population of China is both tone           is almost always another person waiting to do the job for less.
deaf and color blind. Nothing else could explain the volume at          This in turn provides those who control the economy many
which Chinese must be spoken and the hideous taste in clothes           benefits, but if and only if these elites in fact maintain control.
that is still on display. Material well-being has, on the surface,
improved over the past decade, but much of what foreigners see          But who are we to complain? Dinner out with beverages at a
is a garish veneer, the image of how China thinks it should look        local restaurant costs less than a dollar; ditto for the tailoring of
in 2005.                                                                some travel worn clothes. As long as the Communist Party and
                                                                        their clients in the West maintain control, everything will be just
The Hollywood back lot quality of modern China is apparent the          great.
second you arrive -- if you look for it. Dozens of brand new
automatic teller machines grace the airport concourses, but             PRMIA Names Regional Directors in San
nearly three-quarters of them do not work; hundreds of recently
planted uniform trees line the highway into town, offering a            Francisco, Denmark, Stamford & Pakistan
"green" image, but only slightly masking the gritty, dirty reality
of a population cooking over lumps of coal and living in a sea of       PRMIA has named four new Regional Directors to lead the local
pollution just beyond view. While modern glass buildings grace          development of risk professionals and the risk profession:
the main thoroughfares, they fail to hide the crammed, dreadful
and repulsive living quarters in which the majority of the popu-        In San Francisco, Jean Hinrichs, former Director of Risk Man-
lation continues to dwell.                                              agement for Barclays Global Investors assumes the role of co-
                                                                        Director with Dr. Carlos Blanco.
Try as the government may to project an image of progress and
modernity, cracks are apparent (for those who venture from the          In Denmark, Claus Madsen Found of FinE Analytic has been
two immediate blocks surrounding their hotel or the various             named as the new Regional Director. He assumes this role from
tourist attractions). Groups of homeless people, cripples and           Soren Plesner, one of the founding members of PRMIA.
beggars, which were never before allowed to be visible, are ever
present; prostitution, which was unthinkable a few years ago, is        In Stamford, Ed Grebeck, a Principal of TEMPUS, has been
now common; and, God forbid, if Chinese history repeats itself,         named the first Regional Director for that chapter. Ed has been a
drugs and gangs will be the next scourge to reassert themselves,        long-time member of the PRMIA New York Steering Commit-
as idleness is the devil's plaything.                                   tee

From the late Qing Dynasty (~1850's) up until the introduction          In Pakistan, Rahat Munir, Executive Director of the Institute of
of Communism in the 1920's, several Chinese scholars pursued            Bankers Pakistan has been named the first leader of PRMIA
KaoCheng scholarship. The premise was that China's salvation            Pakistan.
from the problems it faced - backwardness, subjection to foreign
imperialism and social unrest - could be found in the original          These chapters are part of a global network that provides over
classics of Mencius and Confucius, if only the unsullied "truth"        200 meetings annually, where over 20,000 delegates will con-
could be unearthed from the centuries of detritus layered on            gregate in the coming year.
them by innumerable scholars "interpretations."

What they called for then was a reification of names - that things
should mean and express what they were supposed to. A similar
undertaking is warranted today.                                             PRMIA receives no remuneration for articles that ap-
                                                                            pear in the Members Update. Any opinions expressed,
Just look at the newspapers, where Western media moguls                     or statements made in the articles above are those of the
proudly expound on their plans for 'their' magazines and televi-            author and are not necessarily those of PRMIA. Mem-
sion channels. But like the banks, the notion of private property           bers interested in contributing material to the PRMIA
is a convenient fiction. Who's magazine is it, who's television             Members Update should contact resources@prmia.org.

Volume 4 Issue 5                                                                                                                  Page 9
                 Announcing the 2005 PRM Candidate of
                                      the Year Finalists

                                                • Rickard Branvall, Nikko Citigroup, Tokyo, Japan
                                                • Matthias Friese, Cominvest Asset Management, Frankfurt, Germany
                                                • Giovanni Gentili, Banca Nazionale del Lavoro, Rome, Italy
                                                • Rene Sanda, Banco do Brasil, New York, United States of America
                                                • Peter Scheidler, WGZ-Bank, Düsseldorf, Germany
                                                • Stephan von Bismarck, Fidelity Investments Int’l Ltd., London, UK

                                                           Congratulations to the 2005 PRM Focus
                                                           Award of Distinction Winners

     Exam I      Dominik Dersch, HypoVere insbank München, München, Germany
                                                          Rafal Lerski, Poland
                                                      Kit Yee Ng, Hong Kong

     Exam II    Tianqi Fang, Bank of Ameri ca, Charlotte, United States of America

    Exam III         Frank Bensics, Central CT State University, New Britain, USA
                 Stephan von Bismarck, Fidelity Investments Int’l Ltd., London, UK

    Exam IV        Anthony Okuefuna, Abbey National, Glasgow, United Kingdom
               Alexander Wilson, Bank Nederlandse Gemeenten, The Hague, Neth-
                                                                       erlands
                  Chandramohan Ganapathi, Commercial Bank of Kuwait, Kuwait


Congratulations to the 2005 PRM Award of Merit Winners
•    Konrad Augustynski, Jagiellonian Univ., Krakow, Poland      •   Tianqi Fang, Bank of America, Charlotte, USA
•    Viktoria Baklanova, Moody's Investors Service, New York,    •   Keith Ganzer, AXA Financial Inc., New York, USA
     USA                                                         •   Michal Goss, SEB Investment Fund Company, Warsaw,
•    Till Baulig-Brand, DZ BANK AG, Frankfurt, Germany               Poland
•    Frank Bensics, Central Conn. St. University, New Britain,   •   Yat-Fai Lam, Hong Kong Monetary Authority, Hong Kong
     USA


    2004 PRMTM Candidates of the Year




            Francois Bourdon                                                              Tan You Leong
            Portfolio Manager                                                             Operational Risk
             and Quantitative                                                             Analyst
                     Strategist                                                           OCBC Bank
                 Fiera Capital                                                            Singapore
            Montreal, Canada

Volume 4 Issue 5                                                                                                    Page 10

								
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