ERM in Hong Kong – A Practical View

ERM for Insurers in Hong Kong – the Journey has Started

This series of blogposts ponders about the ERM in Hong Kong as it unfolds for Hong Kong based insurers. I chose Hong Kong for a number of reasons. First, the Insurance Authority (“IA”) launched the ERM process over the course of 2017/2018, so the implementation is in full swing. Second, Megrow has been fortunate to do quite a bit of ERM-related consulting work for companies in Hong Kong. And finally, the Hong Kong approach is a good example of a measured, gradual implementation of ERM, so it might serve well for both practical and theoretical considerations.

I will share my thoughts about some key steps, write about challenges and, of course, how Megrow Consulting can support your ERM-journey.

And most importantly, I keep advertising for ERM as a strategic tool to support your business and not to paralyze it.

All Set to Go?

Hong Kong’s IA has released draft ERM-guidelines for industry consultation. The document is comprehensive and doesn’t contain any surprises per se. However, a myriad of cogwheels needs to fall in place to make ERM work and add value to your company. Definitely, you have some well-established risk management practices already in your company and most certainly, ‘your’ board of directors has its own ideas about risk as well.

How to put this all together in an efficient and effective manner? Certainly, an experienced third party will make your journey efficient and effective. And: you can keep your focus on running your business.

step 1 – the tone from the top

In 2017 Hong Kong IA mandated insurers to establish a board risk committee and assign a risk officer function to a suitably qualified staff. Starting at the top was the right thing to do. Insurers have completed this step over the course of 2017 and early 2018 already. Time to move on.

step 2 – risk appetite

Now with the risk officer and the risk committee in place, what is the next step? In line with the philosophy of “starting from the top”, ideally companies move their attention to comprehensive risk appetite definitions and the implementation thereof. That is exactly what the proposed ERM guidelines suggest doing next on the Hong Kong ERM journey.

what is risk appetite?

I like to use the famous half-full glass analogy to describe my preferred definition of risk appetite.

 

the size of the glass = available capital

The capacity of the glass represents the total maximum net risk – across all business activities – your company can bear with the current capital, reinsurance and other hedging mechanisms in place.

Simply, the glass cannot hold more water than its volume.  (let’s omit surface tension and other considerations here, it’s not a science class….).

This capacity is largely given by the available capital and regulatory constraints, such as minimum solvency levels. This “capacity” is relatively stable.

How much water you actually decide to pour into the glass is almost entirely the company’s decision. If you overfill, the company will have challenges. If you leave it (almost) empty, then you are not making use of the capital that shareholders gave you. In other words, how full you want the glass to be is your specific risk appetite setting. The great thing is that the water level can vary over time, i.e. companies have some entrepreneurial freedom to accept more or less risk (as long as it doesn’t overflow).

how to set risk appetite?

Two challenges arise for management and the board. First, how full is the glass with the current business and second, how full (or empty…) do we want it to be going forward? In other words, is the glass big enough to support the company’s expansion strategy? The forward-looking angle is very important: that is the linkage of good ERM with strategy!

How to go about determining the “level of water” in the glass? All companies have risk appetite statements readily available. However, these statements might sometimes be insular and sometimes not of recent date. For instance, the investment department might use a different language to describe risk compared to the underwriting department. The true value of risk appetite definitions emerges, once the statements are quantified, comparable and the statements link risk taking to capital.

Ultimately, the best way of going about it to use a capital model, which allocates capital in a consistent way to the main business activities of the company. However, a few years will pass before RBC is mature enough in Hong Kong. So, what is an interim solution for Hong Kong based insurers?

options available
  1. purchase a third-party capital model (I won’t advertise for free here…)
  2. and/or you develop your own capital model
  3. and/or you find an interim, discrete solution and implement HK-RBC capital model along the way.

Every company is unique; hence it is difficult to make general recommendations. A practical view on risk appetite definitions: if you have a credit rating, using the rating agency’s capital model is certainly a way to go. If not, then taking the route via an interim solution would be my preference.

value proposition

Megrow is well-positioned to support you through the decision-making process and the subsequent development and implementation of the chosen path. We follow industry-standard good ERM-practice, always ensuring that our work is efficient and of practical use. The wheel has been invented, so we focus on other things!

If you would like to know more about putting ERM in place contact me via the buttons shown below and stay tuned for more blogposts about ERM in Hong Kong and elsewhere.