Did we learn from Equitable Life? Professor says "No"...

A cracking thought paper was released this week by Professor Roberts from Kings College regarding the lessons one could reasonably have learned from British mutual Equitable Life's demise in early 2000s, and more importantly, did UK plc actually learn them! (simple timeline of recent events here for our non GB readers, but anyone whose website starts with a banner exclaiming "recreating value for policyholders" has clearly had a lean few years!)

This document works nicely as an aide-memoire for anyone working in a financial services risk function as to what one should be wary of in the day-job. Professor Roberts ties in some of the most recent work in this space (leaning heavily on the Cass Business School/AIRMIC Roads to Ruin research and its conclusions in particular), and comes to the inevitable conclusion that lessons are well publicised, but never learned.

My main concern as a risk specialist is that certain recurring themes in the failure of financial services firms appear to remain outside of the Risk function's control or indeed influence, notably;

• Hubris of Senior/Chief executives - Almost every example of failure in insurance and banking referenced in Prof. Roberts paper includes a flukey, unchallenged CEO who got bolder as circumstance rather than skill kept their businesses growing. I had flagged a couple of articles in a post last year touching on what makes an executive tick, and since then I have seen psychopathy and leadership (as opposed to cherubic faces!) examined further in a popular mainstream book. The legitimate concern here of course is that CROs are seemingly no nearer to being guaranteed seats at the top table, let alone a veto to keep the most dominant executives in check, regardless of their loud voices, when necessary.
• Poor quality governance from Non-Executive Director level - Risk functions simply must have the NEDs performing at their optimum in order to provide acceptable services to their employers. While the "old school tie" approach to recruiting NEDs may take a generation to phase out entirely (to be replaced by an army of Fembots, so Viviane Reding would have us think), Risk functions are left with tottering old fee-sweepers as their key route to early intervention. The more visceral approaches to documenting risk appetite/tolerance/preference now being supported by corporate governance codes and vocational/professional bodies may make it easier to raise concerns with NEDs in future (probably as it will be colour coded and in Excel...), but until they are actually prepared to risk their comfortable semi-retirement with some probing questions in the C-suite itself, should Risk functions ever think they can overcome such a void?
• Failure of regulation - Should Risk functions be banking on the (inevitable?) failure of the nascent regulatory environment, and reserve for subsequent claims/compensation if one or a number of products are "too" successful, thus providing the necessary quantum of dissatisfied customers for the regulator to act? I would have laughed this suggestion out of the room until a year ago, since when the FSA have made retrospective calls on interest rate swaps, PPI, and TLPs, all of which would have been presented as "compliant" products in the Boardroom.

For the Solvency II fans, it also notes on page 11-12 that Equitable Life featured in the research which grew up to be Solvency II! Maybe we did learn something after all - if we smash up the affordability of long-term guaranteed products, we can all go unit-linked and never have to worry about another Equitable...

AIRMIC and Cass Business School - Full study available (at a price)

Having already blogged on the executive summary of this paper, I was delighted to see the full version has been released (available here) - however, you may very well need to pay up (pdf version is around £100). I would suggest if you have reverse stress testing work to do that it would be money well spent.

AIRMIC Conference 2011 - Presentations now available

Was very kindly directed to these by the AIRMIC guys - two of use in my line of work were the Solvency II specific presentation from some Allianz reps and a good one from Lloyds on emerging risk - the former gives some decent insights as to how a massive organisation has to administrate the Solvency II project, while the latter is a decent benchmarking piece for performing qualitative risk identification, analysis and synthesis.

AIRMIC and Cass Business School - Study of Major Risk Events

I blogged last week about a number of references at the AIRMIC 2011 conference regarding some research conducted by the Cass Business School. A sneak preview of this substantial piece of research on the origins, impact and implications of major risk events is available here (you may need to do a quick registration).

This is an excellet idea in principle, with a very astute summary in this document, so I cannot wait for the full research to come out in July. My take on this summary document was;

• 18 companies who experience "high profile corporate crises", but thankfully they have selected a range of crises, not just straight-up financial implosions (much better for reverse stress testing purposes)
• Talk of "severe, uninsurable" losses as the effect of the crises, which again will make for good reverse stress testing
• The seven "underlying" risks that they identify as being present across industries all seem fair, some more than others.
• That the risk profession is identified as being unable, through lack of experience, remit or courage, to intervene in the materialisation and occurrence of these 7 types of risk is a bold statement (bearing in mind who commissioned the research!) is also fair to varying degrees. It is not so much that the profession is not cognisant of them, more that one is generally not in a room full of strategists as an equal.
• Strong comment that many of the 7 underlying risks are "taboo", as tabling them as a risk professional is tantamount to questioning a director's professional competence.
• "Risk of self-deception" by not receiving this challenge from either an INED or a CRO-type
• Strange comment that Risk and Internal Audit would not be comfortable questioning strategy and leadership risks without further training/experience - personally, if it is in my remit, it gets done.
• Followed by a more conventional flag that questioning leadership can put careers at risk (true for Risk professionals, but not for internal audit surely.

Concluding points were;

1. Rethink risk analysis techniques to cover non-routine risk
2. Extend skills of profession to be able to analyse risk emerging from ethos/culture/strategy/behaviour
3. Change role and status of Risk to ensure open discussion at all levels, including board
4. Boards need to recognise importance of non-routine risks

Unsackable CRO and robust reverse stress testing should do most of that...

AIRMIC Conference 2011 - No presentations yet, but...

The AIRMIC conference is chugging away nicely in Bournemouth, and whilst I am not there, I have clocked a few bits of output, most notably a piece of reserach due out next month from Cass Business School called "Asleep at the Wheel" about 7 categories of underlying risks that lead to corporate failure - brief outline here.

The risk profession willl love the seventh item about the Risk Function's concerns hitting the "glass ceiling" - the research will apparently encourage the re-evaluation of procedures and structures in order to avoid this, while auditors and risk professionals will be encouraged to develop "additional skills".

If reverse stress testing is your bag, then this research should be on your shopping list.