So, a lot has been said in the last decade or two about the cult of risk management...
Tom Wilson: Risk management is a culture, not a cult. It only works if everyone lives it, not if it's practiced by a few high priests.
What do you mean?
The principle is easy. Ultimately, the responsibility for risk, as well as rewards, rests with the front-line business, and this is where a risk-culture has to begin. After all, no amount of risk controlling or reporting can overcome the adverse effects of a poorly underwritten business or a life product which is poorly designed.
An independent risk function and the Chief Risk Officer play an important role in reinforcing this culture, being a partner with the business in order to ensure that we are doing good business, each and every day. As a business, we create value by taking well-priced, well-structured and well-managed risks. More and more companies are understanding that the chief risk officer can't just be a controller who gathers data and then reports it to senior management and to ratings agencies.
Isn't reporting what you do?
Of course, reporting is an essential part of my job. We need to be aware of our exposures and make them transparent to everyone. How else can managers make decisions or customers know if we are still capable of standing behind our products in 10 or 20 years time?
But there's a lot more to risk management than reporting and controlling, a lot of it closer to where the rubber meets the road. For instance, risk is involved in product development and approval and in the creation of underwriting guidelines, helping to ensure that we are writing business that we as an organization want to write.
We also look for what are called the "tall trees"...
Tall trees? What are those?
Those are the really big risks the company carries. Some examples are a loss in value due to a decline in interest rates on long-dated savings products, a major earthquake in California or windstorm in Europe, common tall trees for any global insurer. You have to make sure that these risks are identified and transparent to management, and that they fall within the risk tolerance set by the Board.
What's an example of how this culture is lived at Allianz?
A simple one is natural catastrophe limits. Insurers or reinsurers talk about probable maximum losses or modeled losses for natural catastrophes, but if you really want to remain solvent, you have to cap your losses somewhere. You need an internal limit. That means saying what we will cover, and above that, we get reinsurance or we just won't write certain risks. In addition, we also need to make sure that we are compensated for taking this risk by considering the risk-adjusted returns or combined ratio for the business.
What about financial market risks?
The same is equally true of financial market risks, such as our exposure to interest rates. These risks also need to be transparent, well managed within a prudent limit and, ultimately, adequately compensated. This is a more challenging task in today’s low interest rate environment and more turbulent financial markets. Nonetheless, we have to do this for the benefit of all stakeholders: It is fair to say that a significant amount of the changes in Allianz’s share value are directly related to changes in financial markets.
If a risk management culture isn't in place, the organization will not accept this simple line of thinking.
Is that unique to Allianz?
I think you'll find this in general in the insurance industry, certainly if the company has a solid risk culture based on underwriting discipline. It is certainly more common in insurance than in banking. Insurers can't depend on being able to sell or hedge the risks we put on our books today at any time we want to at a price which makes sense.
In insurance, we have to think long-term because we're underwriting long-term risks which cannot be hedged and cannot be traded. As a consequence, the business we write today is the “legacy block” that we will leave behind for the next generation of managers. We cannot think short-term.
I'd prefer to leave a “good” legacy, one based on solid underwriting and well managed. Everyone in a company with a strong risk culture will have the same orientation.
Well, you made it through the crisis of 2008. So what challenges do you see ahead?
Most people would probably say climate change and the ongoing financial crisis. They would be right in that these are areas that are causing a lot of uncertainty. For instance, we can't say now what the long-term effects of climate change will be on natural catastrophes, just that it's happening, but it's that uncertainty which we have to include in our calculations.
Obviously, the financial market turbulence did not end in 2008. We have been on a bumpy ride – almost a roller coaster – since then as central banks and politicians have attempted different actions to help the global de-leveraging process in a way which does not lead to an unnecessary decrease in economic activity. Given the ups and downs over the past two years, the lingering question is “What's next”? Are we finally in a gliding path towards more stable economic growth or will there be another crisis in confidence which needs to be addressed? That's really hard to predict right now. The euro zone is stabilizing, but there's still a lot of debt to deal with and growth is low.
What else is out there that you're looking at?
Looking beyond that, there are risks that are only now emerging with developments like nanotechnology and genetic modification. They seem to be benign, but we don't have enough experience to say if they're safe, and any reader of the popular fiction of Michael Crichton is bound to be concerned.
Should we be offering liability cover to companies in that sector? Is there an asbestos-like claim lurking in there somewhere? We don’t know about the ultimate outcome and so have to underwrite carefully and track our potential exposure to this unknown risk.
So these are challenging times?
All times are challenging. That's the essence of the risk management culture. Living it means managing your business to deal with today's specific issues but also the risks it will be exposed to over a decade or more. That's what my colleagues and I do every day. And this is what makes Allianz a strong and dependable partner, not only today but also in 20 years.