Key risks are supported by risk and control maps and company policies and procedures.
Ownership of key risks and controls is clearly defined. Assessments are undertaken upon a consistent and regular basis to ensure that risks remain relevant and up-to-date.
When any residual risk i.e. a risk after the application of existing controls, falls outside the Company’s risk appetite, action plans are agreed, implemented and monitored. Risk mitigation actions have clearly defined owners and implementation timescales.
Control Environment
The control environment sets the tone of the business influencing the control consciousness of its Directors and employees, sometimes referred to as the “tone at the top”. It provides structure and discipline for the other four components, incorporating factors such as integrity, ethical values, management’s philosophy and operating style; assignment of authority and responsibility; employee competence; organisational structure; and the attention and direction provided by the Board of Directors.
As a small organisation, the Company’s culture is hands-on with extensive interaction between Executive Management and employees and one which takes pride in maintaining strong underwriting disciplines throughout the insurance cycle while acknowledging the potential volatility in short term results arising from catastrophe events.
The control environment is communicated to employees through the following key policies approved by the Board:
- Corporate objectives and risk appetite
- Code of ethics and conduct
- Whistle blower
- Insider trading
Risk Assesment
The Company’s risk appetite is recommended by the Executive Management to the Board of Directors for their approval. In addition, catastrophe exposures for Syndicate 780 to any one of the Lloyd’s RDS are maintained within the Lloyd’s franchise guidelines of a gross loss of 75% of capacity and a net loss of 20% of capacity, with the objective of allowing for a margin of safety from the Lloyd’s guidelines to allow for potential variations in actual catastrophe events compared with the RDS.
The Company faces a variety of risks from both internal and external sources that require identification, assessment and management. Risk management is the process that enables a business to:
- Identify and understand the risks that it faces in the pursuit of its business objectives
- Assess and prioritise the risks identified and the means of mitigating them
- Where possible and commercially feasible, reduce the probability and impact of those risks
- Regularly review, monitor and report on those risks in order to take informed actions
- Ensure that any new risks, or changes to existing risks, are captured
Key Risks
As the environment in which the Company is operating is constantly changing, the risk assessment process needs to be dynamic and updated on an ongoing basis.
The key risks, as assessed by the Company, are set out below:
- Insurance risk:
o Prices – The insurance and reinsurance industry is very competitive and prices are cyclical in nature. The risk is that insurance prices will fluctuate significantly and be below underlying costs for many years.
o Cost of revenue – Insurance costs are not fixed and known at the time a policy is issued. The risk is that these costs can significantly exceed premiums received.
o Underwriting - If underwriters fail to assess accurately the risks underwritten or if events or circumstances cause their risk assessment to be incorrect, the Company may not charge appropriate premiums and this could have a material adverse effect on the results of its operations.
o Catastrophe exposure – The Company is subject to catastrophe losses like earthquakes, hurricanes and other natural perils and terrorism. As the size, severity and frequency of these losses are unpredictable, the risk is that these losses could adversely affect the company’s results.
o Claims reserves – The risk that the provision for claims, which is an estimate of the ultimate cost of claims incurred, may be found to be deficient.
o Reinsurance recoverable – Reinsurance is a longer term credit risk with some amounts often received over a period of years. In a recessionary environment, there is an increased risk that reinsurance companies could fail or be unable to pay their claims, resulting in losses to the Company.
- Financial risk:
o Credit risk is the risk that a counterparty will be unable to pay amounts in full when due. The Company is exposed to credit risk through its investment portfolio, reinsurance recoverable and amounts due from intermediaries and policyholders. There is an increased risk of counterparty failure in a recessionary environment.
o Liquidity – is the risk that the Company may not have cash available to pay obligations when due at a reasonable cost, particularly for major catastrophe events where it has to post US situs funds on gross incurred claims or where it has to pay gross claims before collecting the related reinsurance.
- Foreign exchange:
As the Company’s operations and financing activities are conducted in a number of currencies, there is a risk that movements in exchange rates could adversely affect the Company’s results. The current turmoil in financial markets has resulted in significant volatility in foreign exchange rates across a number of currencies with the US dollar appreciating by more than 25% against sterling during the second half of 2008. With approximately 70% of Advent’s premiums denominated in US dollars, this has resulted in a significant increase in catastrophe exposures in key peak zones when expressed as a percentage of shareholders’ equity denominated in sterling.
- Capital management:
o Regulation – the risk that Advent is unable to obtain approval from Lloyd’s to access Syndicate profits and/or Funds at Lloyd’s.
o Capital adequacy –the risk that insurance regulators (FSA) or Lloyd’s could set capital requirements in excess of the Company’s resources or at levels where the Company cannot make an adequate return on capital deployed.
o Ratings – the risk that the Syndicate may face a downgrade in its claims paying financial strength ratings. As financial stability is very important to its customers, this may adversely affect its ability to attract and write business.
o Financial strength – if the company requires additional capital or liquidity but cannot obtain it on reasonable terms, its operations and financial position could be adversely impacted. Current financial market conditions make it more difficult for companies to raise equity or debt financing to expand their business or to bolster their capital in circumstances when they most need to.
- Other Risks:
o Taxation – the risk that deferred income tax assets arising from operating losses may not be realised as they are dependent on the future profitability of the Company.
o Goodwill and intangible assets – the risk that the value attributed to these assets may be reduced as it is dependent on the profitability of the operations which gave rise to the goodwill or intangible asset
- o Key Staff – the risk that the Company’s operations, as a small company, may be adversely affected by the unexpected loss of key management and key underwriter turnover.
Ian Hewitt: Head of Risk Management and Director of Advent Underwriting Limited.