GR-NEAM
The earnings risk shown in Table 1 is, in part, based upon underlying
volatilities of product margins and asset returns and their respective correlations. In Table 2 we show correlations of selected indices and products used in the analysis. These correlations are based upon annual results for the period 1980 to 2010. In stress-testing, the correlations are recalibrated to unity to eliminate any diversification benefits, in particular the product/asset hedge.
Correlations among asset classes, even those with diverse credit and
maturity, are quite high except for equities and high yield. Product correlations are frequently quite high (CMP, Cauto and GL reflecting pricing) but can also be quite low (Comp and Allied reflecting the disparate impact of natural disasters). Correlations between products and assets are frequently negative, reflecting product pricing sensitivity to investment grade fixed income returns.
Correlations might be time (event) dependent. In Table 3 we show the
product and asset allocation weighted correlations based upon three time periods: annual 1980 to 2010, quarterly 1997 to 2010 and annual 1997 to 2010. The results demonstrate the sensitivity of correlation estimates based upon the time period and periodicity of the calculation. Again, we manage this issue with stress-testing that eliminates any presumed diversification benefits.
Table 4 displays four scenarios of varying leverage, periodicity of returns
(annual and annualised quarterly results) and time frames (1980 to 2010 and 1997 to 2010). Leverage is a key driver of VaR and T-VaR metrics in contrast to periodicity and time frames. The nominal impact of differing annual time frames (columns A and B) upon risk metrics is caused by changes in asset risk and hedge effects.
Correlations are a key driver of enterprise risk and VaR/T-VaR risk metrics. Practitioners frequently anguish over ‘getting it right’,
TABLE 3: WEIGHTED CORRELATIONS Annual
Sector/Product Allocation Weighted Correlation
Assets Products Asset/Products Source: GR-NEAM Analytics
TABLE 4: VAR AND T-VAR ALTERNATIVE MEASUREMENT BASES Scenario Leverage
A High
Calculation Basis Years
Total Return on Equity
Earnings Risk (Std Dev)
Capital Risk -10% VAR, t=1
99.50 VAR % Capital
99.50 T-VAR % Capital
B High 31 C Low 31 D Low 14
1980 - 2010 0.52
0.36 -0.23
Annual
1997 - 2010 0.31
0.51 -0.14
Quarterly 1997 - 2010
0.28 0.34
-0.04
E Low
Annual Annual Annual Quarterly Annual 14
14
15.45 24.66 50.45 55.68 61.75
Source: GR-NEAM Analytics
TABLE 5: LOW LEVERAGE VAR/T-VAR ESTIMATES Enterprise Results 99.5 VaR - SNEOP
Normal Markets 23.09
99.5 T-VaR- SNEOP 27.06 99.5 VaR - DIP 99.5 T-VaR - DIP
27.20 30.26
Source: GR-NEAM Analytics
TABLE 2: TOTAL RETURN ASSET CORRELATIONS AND REPORTED PRODUCT MARGINS, 1980 TO 2010 Asset/ Product Trsy 3-5
Trsy 3-5
Corp AA 5-7 Corp BBB 3-5 Inter Hyld MBS
Muni 15+ SPX
Allied
Hm/Fr CMP Comp GL
PPAuto Cauto
1.00 0.83 0.50
-0.36 0.90 0.57
-0.01 0.10
-0.13 -0.34 -0.20 -0.40 -0.55 -0.44
Source: GR-NEAM Analytics 32 | INTELLIGENT INSURER | Spring 2012
Corp AA 5-7
1.00 0.83 0.12 0.87 0.81 0.27 0.13
-0.07 -0.33 -0.27 -0.47 -0.51 -0.44
Corp BBB 3-5
1.00 0.58 0.66 0.74 0.50 0.21
-0.02 -0.20 -0.20 -0.43 -0.38 -0.37
Inter Hyld MBS Muni
1.00
-0.12 0.28 0.53 0.26 0.17 0.20 0.03 0.02 0.16 0.14
1.00 0.74 0.15 0.07
-0.07 -0.33 -0.19 -0.44 -0.51 -0.44
1.00 0.33 0.09
-0.02 -0.20 -0.25 -0.41 -0.31 -0.22
1.00 0.11 0.12 0.07 0.06
-0.13 0.10
-0.06
Armageddon 63.25 72.15 70.74 77.83
15.45 25.36 51.97 57.64 63.89
9.29
15.27 32.05 34.72 38.49
9.29
12.57 20.98 27.20 30.26
9.29
11.29 15.43 23.65 26.37
15+ SPX Allied Hm/Fr CMP Comp
GL PPAuto
Cauto
1.00 0.56 0.44 0.07 0.22
-0.11 0.19
1.00 0.61 0.34 0.34 0.22 0.26
1.00 0.28 0.73 0.39 0.80
1.00 0.18 0.69 0.35
1.00 0.39 0.64
1.00 0.64
1.00
Page 1 |
Page 2 |
Page 3 |
Page 4 |
Page 5 |
Page 6 |
Page 7 |
Page 8 |
Page 9 |
Page 10 |
Page 11 |
Page 12 |
Page 13 |
Page 14 |
Page 15 |
Page 16 |
Page 17 |
Page 18 |
Page 19 |
Page 20 |
Page 21 |
Page 22 |
Page 23 |
Page 24 |
Page 25 |
Page 26 |
Page 27 |
Page 28 |
Page 29 |
Page 30 |
Page 31 |
Page 32 |
Page 33 |
Page 34 |
Page 35 |
Page 36 |
Page 37 |
Page 38 |
Page 39 |
Page 40 |
Page 41 |
Page 42 |
Page 43 |
Page 44 |
Page 45 |
Page 46 |
Page 47 |
Page 48 |
Page 49 |
Page 50 |
Page 51 |
Page 52 |
Page 53 |
Page 54 |
Page 55 |
Page 56 |
Page 57 |
Page 58 |
Page 59 |
Page 60