By: Jim Ramenda
When asked about risk, insurers generally identify operational, model, and investment risks among their greatest concerns. As the leading provider of insurance financial reporting and risk software and services, SS&C would agree. In fact, we would go further and suggest there is a combined effect among these three risks that, unless managed properly, can compound with potentially disastrous consequences.
We call this combined effect “OMI risk”. The three key phases of OMI risk (operating procedures, model management, and investment decision making) work in a cycle. Any error or misjudgment, in any phase of the cycle, is passed along to the next phase, then creates new errors and misjudgments that cycle back through the process. Overall risk grows each step of the way.
Every system and process in the OMI cycle must work together smoothly in order to minimize operational and model risk phases. Any errors are passed through to the investment decision-making process. This effect is more pronounced today than ever before because innovation in financial markets is accelerating much more rapidly than legacy analytical systems can keep pace. As this gap widens, it creates a need for workarounds, shortcuts, simplifying assumptions, etc. in the modeling approach, which increases model risk. Moreover, the impact on model risk is not unbiased. In our experience, workarounds and shortcuts almost always err on the side of understating risk, leading companies to take on more investment risk than they realize.
The current insurance industry environment increases insurer exposure to the compounding nature of OMI risk. Insurers are seeking higher yields among a wider range of generally more complex asset classes and engaging multi-manager platforms in the process. This creates much higher position counts and more varied data connections than traditional portfolios. At the same time, insurers must increase their risk and performance analysis capabilities in order to monitor and validate their manager allocations, plus meet the ever-increasing demands of regulators and rating agencies. All of this must be managed under the most intense expense pressure the industry has ever faced.
The combined effect of operational, model, and investment risks is much more than the sum of its parts. Unless properly managed, these risks can compound in ways that spell disaster for the bottom line. In this white paper we provide more information on how to build strategy around managing the OMI cycle.