Page 122 - Risk Management in current scenario

based capital, one is an internal model approach where Value at risk (VaR)
is 99.5th percentile value of loss due to each risk and second is Stress
testing or based on the value of Assets and Liabilities once calculated
on base assumption and again calculated on Stressed assumption.

Under this methodology, the risk capital is calculated for each risk and
then aggregated. The stressed assumption is equivalent to 99.5%
confidence level for each risk "r" or at any other desired level of
confidence.

o Internal models
Value at risk (VaR) = 99.5th percentile value of loss due to each risk

o Stress testing
Risk Capital(r)= [Assets - Liabilities ]
@ Base assumption
@ Stressed assumption

The stressed assumption is equivalent to 99.5% confidence level for each
risk "r" or at any other desired level of confidence.

For example, if 7% interest rate is a base assumption and, 5% down
stressed assumption at 99.5% confidence level, then the risk-based capital
for interest rate risk will be calculated as the difference between the value
of assets and liabilities calculated at 7% and 5%.

Risk Diversification
The aggregation of all risks at Company level is not just the sum of all
the individual risk capitals because many of the risks are correlated, for
example, Interest rate risk and lapse risks are correlated, lapse risk and
mortality risks are correlated, longevity risks and mortality risks are
correlated. The benefit of these correlations reduces the total risks as a
benefit of diversification. This means that if lapse rate increases, this
leaves the portfolio with substandard lives, as good lives have lapsed their

120 | Risk Management in Current Scenario