Embedding a risk and value management culture
"We view risk not only as a threat or
uncertainty, but also as an opportunity to grow and develop the
business, within the context of our risk appetite."
Andrew Birrell
Group Risk and Actuarial Director
One of our major strategic objectives for 2010 was to align
capital management more closely with our risk profile at both Group
and business unit level, thus enhancing our capability to create
value within a clearly defined risk appetite. Our revised operating
model, in conjunction with a more robust risk management framework,
has enabled us to make more informed decisions to take risks in
areas where we:
- Understand the nature of the risks we are taking and the
consequences of those risks
- Demonstrate the ability to accurately determine the capital
required to assume these risks
- Model and validate the range of returns that we can earn on the
capital required to back these risks
- Optimise the risk adjusted rate of return we can earn by
reducing the range of adverse outcomes and increasing the range of
acceptable return.
We have made significant progress in implementing
a model framework where risk, capital and value are fully aligned
with commercial objectives and the new European Solvency II
regulations taking effect from 1 January 2013. This has been driven
by our integrated Capital, Risk and Financial Transformation
(iCRaFT) programme, which will deliver significant benefits to the
business - including compliance with the Solvency II requirements.
Our progress was recognised in August 2010 when the Financial
Services Authority accepted us into its Internal Model Approval
Process, enabling us to give both shareholders and stakeholders
assurance of our capability to deliver Solvency II readiness in
line with corporate objectives.
This section of the report describes the progress made by our
Group during 2010 in developing our risk and capital modelling
frameworks. Risk management is integral to the Group's corporate
vision and is an expression of how we consider potential downside
outcomes and upside value creating opportunity in the context of
sustainable, high-quality returns on capital utilised, to deliver
financial value for our shareholders and peace of mind to our
customers. We have strengthened operational, strategic and
financial risk processes to ensure that where we accept risk we do
so within an appetite and control environment supported by a
clearly defined 'three lines of defence' model:
First line of defence: day-to-day management of
risk is the responsibility of senior management in our businesses
and plays an integral part in their decision-making process.
Second line of defence: risk oversight is
provided by the Group and business unit Chief Risk Officers and
Board and Management Risk Committees, whose role is to provide
robust challenge to the management teams based on quantitative and
qualitative metrics. These committees are supported by the
specialist risk management and compliance functions across the
Group.
Third line of defence: independent verification
and challenge of the adequacy and effectiveness of the internal
risk and control management framework is provided by the Group and
business unit Internal Audit teams.
The pursuit of value requires us to balance risk assumed with
capital required - aiming to provide higher certainty of
risk-adjusted returns within an acceptable level of risk assumed
and capital required, without exposing ourselves to unacceptably
high risk of capital depletion in the event of adverse outcomes. In
2010 we completed one of the key steps towards achieving this
objective and bringing risk 'alive' by defining a clear risk
strategy. This outlines the risks that we believe give the Group
the appropriate risk/capital balance; it is aligned with the
Group's objectives and will be reviewed annually. The integration
of risk with performance and business strategy will build long-term
value and ensure that we avoid following short-term gain with later
disappointments.
We continually strive to enhance risk and capital management
methodologies by quantifying risk more consistently to identify
threats, uncertainties and opportunities and in turn develop
mitigation and management strategies that achieve optimal
outcomes.
Within our model, the Group's capital is quantified according to
the metrics described
later in this report. Businesses plan their capital consumption
using internally agreed targets, which have been set to ensure that
strategic objectives can be delivered under a wide range of market
and trading conditions. Business units need to consider these
capital requirements against the potential margin that can be
earned from their activities, and the resulting risk exposures are
assessed on the basis of the expected variance in key metrics in
response to specific risk events, covering the full range of risks
to which the Group is exposed.
Risk management forms an integral part of the strategic planning
process and is directly linked to the Group's corporate objectives.
It provides a group-wide overview that links all business units
within a single framework. This process enhances the Group's
capability to assess strategic allocation of capital and the
ability to identify, monitor and manage emerging risks.
We view risk not only as a threat or uncertainty, but also as an
opportunity to grow and develop the business, within the context of
our risk appetite. So our approach to risk management is not
limited to considering downside impacts or risk avoidance; it also
encompasses taking risk knowingly for competitive advantage.
Solvency II will require companies to consider their approach to
risk, capital and value management more robustly, and we believe
that our initiatives to date fit well with this.
Risk management is integral to the Group's decision-making and
management processes. The Group's ambition, which we continue to
embed through iCRaFT, is to make effective risk management part of
all our day-to-day roles, thus enhancing the quality of strategic,
capital allocation and day-to-day business decisions. This has to
be driven from the top of our organisation, and we made significant
progress in 2010 by starting the cultural change process through
extensive education and training sessions across our businesses at
all levels, including at Board level. This was aided in 2010 by the
Group Remuneration Committee, which requested explicit reports on
the extent to which risk exposures have linked into results
delivered, and whether these risk exposures have complied with the
agreed risk appetite. This information has been used as a factor in
determining incentive payments.
I believe we have continued to make great strides in 2010 on our
journey towards achieving and embedding best practice standards in
risk management - and applying and integrating them with
governance, capital, financial and performance management. I
believe the activities outlined in this report will give you a
better understanding of the progress we have made, provide insight
into how we intend to continue our journey towards better outcomes,
and ensure we fulfil the requirements of Solvency II.
Andrew Birrell
Group Risk and Actuarial Director
Optimising the upside and managing the downside
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Risk management is an integral part of our management's
decision-making process, enabling us to manage adverse impacts by
helping to ensure that:
- Risk-taking is a consciously chosen strategic decision and not
accidental
- Risk management is optimal and capital is effectively
employed
- The frequency and severity of surprises are reduced by timely
measurement, mitigation and control.
Successful risk management does not mean that downside events
will never occur, but that they happen infrequently and with low
severity.
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The Group also manages upside risk by exploring and exploiting
risk opportunities, while ensuring that risks associated with these
opportunities are fully understood and acceptable. This allows the
Group:
- Greater flexibility for reallocation of capital and risk
capacity when opportunities arise
- Competitive advantage through greater understanding of risk
types, pricing and management.
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