How to Define Your Insurance Risk Appetite Statement at Board Level

Risk Appetite Statement - Define your risk appetite at board level

Why a Risk Appetite Statement Matters for Insurers

A well-defined risk appetite statement is not just a regulatory requirement. It is the foundation of strategic decision-making for an insurance company. It determines where an insurer operates, which risks it assumes, and how it structures its reinsurance and investments. Despite its importance, many insurers fail to create precise risk appetite statements, relying instead on vague or copied templates. This article demystifies the process of defining a risk appetite statement at the board level, ensuring insurers can translate high-level risk tolerance into actionable guidelines.

What is an Insurer’s Risk Appetite Statement?

An insurer’s risk appetite statement defines, in clear language, the level of risk the company is willing to accept across various domains. It is a top-down directive that begins with the board and cascades down to middle management and frontline employees. The risk appetite statement is typically composed of three components:

• The Financial Risk Statement (Mandatory): Defines financial dangers and assigns maximum acceptable frequencies.

• The Operational Risk Statement (Optional): Identifies key operational risks and their acceptable occurrence frequency.

• The Where to Play Statement (Optional): Outlines which risks, markets, and products the insurer is willing - or unwilling -to engage with.

The Mandatory Component: Financial Risk Statement

Regulatory Intervention: A Nightmare for Insurers

Every insurer must navigate regulatory solvency requirements. Regulatory bodies set solvency ratio thresholds, and breaching these levels can trigger severe consequences. For instance:

• Below 150% solvency ratio: The regulator requests a recovery plan.

• Below 120% solvency ratio: A regulator-appointed representative joins the board with veto rights.

• Below 100% solvency ratio: The regulator takes full control of the insurer’s management.

Given the catastrophic impact of regulatory intervention, boards typically aim to limit the probability of dropping below 100% solvency to no more than once in 100 or even 200 years.

Loss of Minimum Rating: A Commercial Insurer’s Challenge

For commercial insurers and reinsurers, maintaining a strong rating (typically A- or higher by S&P or Moody’s) is critical. A downgrade can lead to exclusion from lucrative insurance programs, eroding business viability. Converium’s 60% business loss following a downgrade to BBB illustrates this stark reality. Boards often set a maximum probability of rating downgrades to no more than once every 50 to 100 years.

Drop in Profit: The Risk for Publicly Listed Insurers

In the past, fluctuations in insurance profits were widely accepted. However, modern publicly listed insurers now issue precise profit forecasts, making financial predictability a key expectation. Falling short of these targets can erode investor confidence and lead to leadership changes. Many large insurers set clear profitability ranges, reinforcing the need for boards to establish defined thresholds for acceptable profit fluctuations. To maintain market trust, insurers should aim to limit significant profit shortfalls to no more than once per decade.

The Optional Component: Operational Risk Statement

While financial risk statements address macro-level threats, operational risk statements serve as early warning signals. Examples include:

• Customer response times exceeding two months.

• A backlog of more than 50,000 unresolved customer requests.

• Successful ransomware attacks.

Boards should define clear thresholds for operational risks to prevent financial deterioration. Typical frequencies for operational failures range between once every 3 to 10 years.

The Where to Play Statement: Defining Your Strategic Boundaries

Many insurers fail to define their strategic risk-taking boundaries, leading to inconsistency and internal conflicts. A Where to Play statement outlines risk inclusions and exclusions, answering questions like:

• Should we underwrite cyber risk?

• Do we engage in fossil fuel industries?

• Do we operate in complex jurisdictions like the US or China?

• Should we expand into adjacent sectors like banking or car sales?

By explicitly documenting these decisions, insurers create strategic clarity and prevent operational drift.

How to Define and Implement a Risk Appetite Statement

Step 1: Establish the Where to Play Statement

The board should first determine which markets, risks, and asset classes are off-limits. This helps provide clear direction for underwriting and investment teams.

Step 2: Define Financial Risk Scenarios

Boards must discuss the financial dangers most relevant to their insurer, such as regulatory intervention, rating downgrades, or profit shortfalls. Each risk must be assigned a maximum frequency, ensuring alignment between business strategy and capital allocation.

Step 3: Identify Key Operational Risks

Operational risks should be selected based on previous experience and industry trends. Boards should decide which operational failures are unacceptable and set clear frequency limits to prevent them.

Step 4: Convert the Risk Appetite Statement into Actionable Policies

Once established, the risk appetite statement must be translated into measurable limits, thresholds, and controls. This includes:

• Limits: Maximum exposure levels for different risks.

• Thresholds: Trigger points for reinsurance coverage.

• Guidelines: Decision-making frameworks for risk-taking.

• Processes & Controls: Mechanisms to monitor compliance.

Conclusion: Elevating Risk Appetite Statements to a Competitive Advantage

A strong risk appetite statement provides more than regulatory compliance - it enhances strategic clarity, optimises capital efficiency, and fosters resilience in crisis situations. By defining clear financial, operational, and strategic boundaries, insurers can not only survive but thrive in an increasingly volatile environment. Boards that invest in this process will position their insurers among the industry’s most disciplined and forward-thinking players.