As a teetering Euro threatens more disruption in world financial markets, a new survey reveals widespread concern among those responsible for risk management at U.K.-based insurance companies.

The Towers Watson market risk calibration survey asked 60 representatives from a range of insurers operating in the U.K. about their strategies to confront market risk. The survey found increasing pessimism regarding the future of the financial markets, with 44% of respondents indicating expect the number of developed market sovereign defaults to significantly increase in the next 50 years. Surprisingly, the survey also found a continuing reliance on historical data for populating risk models, with only 28% of respondents prioritizing current market conditions over historic data in their risk assumptions.

“Historic data is only one pillar for market risk model calibration and assumption setting with good judgment also being essential,” says Alasdair MacDonald, Head of Investment Strategy at Towers Watson. “The current Euro-zone crisis is a good example of the dangers of “naive” data analysis without expert judgment. Prior to the current crisis, some dismissed data prior to the creation of the Euro as not being relevant. This resulted in calibrations predicting very tight ranges for Euro-zone sovereign debt yields. The fallacy of such an assumption is now clear to all.” 

One positive indicator from the survey was that just under two-thirds of respondents intend to use external independent validation of their market risk assumptions risk. “Company actuaries are experts in insurance risk, but not necessarily market risk, and have to date made limited use of the expertise of investment professionals,” MacDonald adds.

Another challenge for insurance risk managers comes from the regulatory front. For insurers domiciled in the European Union, risk management practice will need to be made more transparent under the forthcoming Solvency II regulations.

“Solvency II will raise the supervisory bar far beyond current ICA requirements, with much greater emphasis being placed on data analysis and expert judgment,” says Neil Chapman, director of Towers Watson’s Risk Consulting and Software business. “What makes this particularly important is that for many insurers market risk is the dominant driver and most manageable lever for capital requirements and real economic outcomes.”

Bill Kenealy writes for Insurance Networking News.


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