Guideline 31. Measurement of risk

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The social security institution sets out appropriate processes and structures to measure risk.

The measurement of risk consists of assessing the frequency and severity of the risks identified as well as the likely distribution of outcomes. The frequency of a risk is the probability the event will occur; the severity is the financial implication; while the distribution refers to how widely outcomes are likely to vary from the mean expected event.

Guideline code

ACT_03600

Mechanism

The measurement of risk should be carried out using appropriate methodology and assumptions. There should be a proper peer review process to monitor how the risk has been assessed. Previous assessments of risk should be revisited, as they provide useful information about the risk management process.
The likelihood of an event occurring should be assessed based on the professional expertise of risk owners and other relevant parties, including the risk management function. This assessment should take into account past events and the likely evolution of the internal and external environments in the future. Discussion with those involved in different functions of the institution should be undertaken.
The measure of the severity of risk should be based on the expected financial implication of an event. Though the assessment of the severity will vary by type of risk, the methodology and assumptions used should be detailed for risks which are material. Past experience may be useful in providing a guide to likely outcomes; however, the actuary should incorporate a forward-looking approach in the calculation to reflect changes in the external and internal environment. For some events (e.g. political) and risks (e.g. operational), assessing the financial implication is less straightforward, and other qualitative metrics should also be considered. The sources of information to assess risks include those identified in Guidelines 33 and 34. In particular, the actuarial valuation may provide useful information in the determination of the risk (e.g. Guidelines 7 and 8).
The assessment of the distribution of risk is important, as it is notably the extreme events at both ends of the distribution that may have the most impact on the social security institution. At the same time, a large accumulation of low severity risks can also be challenging, with potentially significant financial implications. The distribution of outcomes should be considered by assessing the distribution of both frequency and severity, as well as the correlation between risks. The reporting of outcomes will probably seek to look at a limited number of scenarios (e.g. central, optimistic, pessimistic and extreme).

Parent

E. Risk Management and Analysis

Structure

Principles

Actuarial input should be solicited for the task of measurement of risk. The process requires good information on the risk (Guidelines 30, 33 and 34) and other supporting information which will assist in an assessment and measurement of the risk. In some situations information regarding frequency and severity of risk will be available and detailed (e.g. investment risk), while in other situations the analysis will be more subjective (e.g. reputational risk) and rely on the experience and expertise of those involved in the process, including the actuary.
The area within the social security institution responsible for risk management (e.g. the risk function) should define the roles and responsibilities of different stakeholders, including actuaries, involved in the process. This includes the peer review process.
Risk should be assessed and monitored on a regular basis. The process by which this is carried out should be defined and monitored. Relevant reporting procedures assist in the management of risk. The risk function should provide input into which risk measures and reporting should be provided by other functions and departments in the institution, to ensure consistency of methods and reporting format.

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