Actuarial Notes

Stress Testing and Scenario Analysis

By Insurance Regulation Committee of the International Actuarial Association · International Actuarial Association · 2013

Study guide: Exam 6I

An International Actuarial Association paper (July 2013) giving an actuarial perspective on scenario analysis and stress testing. It was produced and approved by the IAA's Insurance Regulation Committee. A scenario describes a consistent future state of the world over time, resulting from a plausible and possibly adverse set of events; a stress test assesses an extreme scenario, usually with a severe impact on the firm. The paper covers their uses, the types of scenarios, governance, formulation, risk dependencies and evaluation, with three case studies.

On the syllabus

  • Exam 6I — objectives B3, C1; the whole paper (July 2013).

Executive Summary

Introduction

Definitions

Uses of scenarios

  • Solvency testing and financial condition reporting
  • Risk management
  • Analysis of non-quantifiable risks
  • Senior management and Board involvement
  • Regulators and scenarios

Assessment of internal models

Defining the firm's risk appetite

Developing scenarios

Types of scenarios

  • Reverse scenarios
  • Historical scenarios

Synthetic scenarios

  • Company-specific scenarios
  • Single event scenarios
  • Multi-event scenarios
  • Global scenarios

Scenario/testing governance

  • Behavioral factors
  • Time frame
  • Interdisciplinary approach
  • Own Risk & Solvency Assessment (ORSA)

Formulation of a scenario

  • Narrative
  • Initial event
  • Time evolution

Risk Dependencies

  • Immediate Dependencies
  • Time-lagged Dependencies
  • Feedback
  • Phase-Shift

Evaluation of Scenarios

  • Secondary Consequences
  • Scenario rollout over time
  • Risk mitigation
  • Management Actions

Analysis

Case study 1: Effect of possible economic scenarios

Case study 2: Pandemic

Case study 3: Sovereign default

Conclusion and outlook

Sources