Best stress testing & scenario solution: Conning, GEMS
Stress testing and scenario analysis are part of the foundation of an effective enterprise risk management programme. They serve as crucial complement to stochastic modelling, and are required or strongly encouraged by important regulatory regimes such as the NAIC Own Risk and Solvency Assessment (Orsa) and Solvency II.
Stress testing using historical scenarios has particular benefits. Since it is a matter of past experience and not a hypothetical situation, there is no question as to whether the scenario is truly within the realm of possibility.
A historical scenario also has a plausible relationship between all its economic and financial variables, as opposed to a modeller simply adjusting a selection of variables to their extremes while leaving others untouched.
For these reasons, the use of historical scenarios can help to make a case for a call to action to management. In addition, the results are able to help ensure that the existing stochastic analysis is sufficiently robust.
But the downside of historical events is that the data is often lacking. In response to this, Conning developed a package of stress test scenarios which simulate eight significant financial events over the last forty years including the 2008 financial crisis, the Great Recession and Black Monday.
Recreations of these events were created using Conning's economic scenario generator and the firm addressed three main questions: when did the event start, how long did the event last and what happened afterwards, and how would it be different today?
According to Conning, the scenarios are designed using all available historical data and when data is missing or questionable, it is extrapolated using a documented methodology.
The package is already proving its worth with clients, Conning says, with one large multinational property and casualty client successfully incorporating the scenarios into its US Orsa, and with plans to extend the process to the entire organisation.