OSFI.Stress

OSFI.Stress is yet another elaboration of the central actuarial theme of risk management. It's a general discussion of stress-testing that applies to any FRFI (Federally Regulated Financial Institution.) Contrast this with the CIA's educational note on FCT (Financial Condition Testing) that applies only to insurers. There is overlap between the two, but CIA.FCT-1 is significantly more important.

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Pop Quiz

What is the purpose of stress-testing? (See CIA.FCT-1) [Hint: risk-complement-Cap-Liq]

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• purpose of stress-testing
• roles & responsibilities of Board of Directors versus senior management regarding stress-testing program
• compare scenario-testing versus sensitivity-testing
• definition of stress-testing
• SCENARIO: analyze a given scenario for quality of risk management & stress-testing, and suggest improvements
• rudimentary considerations in a stress-testing program [Hint: RUDI]

Top Questions ← Questions you absolutely need to know!

Questions held out from Fall 2019 exam: #20. (Skip these now to have a fresh exam to practice on later. For links to these questions, see Exam Summaries.)

reference	part (a)	part (b)	part (c)	part (d)
E (2018.Fall #22)	purpose: - of stress-testing	roles & responsibilities: - BoD v management	purpose: - of stress-testing (details)
E (2017.Fall #24)	purpose: - of stress-testing
E (2017.Spring #22)	SCENARIO: - improve stress-testing	SCENARIO: - improve stress-testing	SCENARIO: - improve stress-testing
E (2016.Fall #20)	defn: - of stress-testing	purpose: - of stress-testing	compare: scenario v sensitivity testing	roles & responsibilities: - BoD v management
E (2014.Fall #26)	see CIA.FCT-1 - (reverses stress-testing)	SCENARIO: - improve stress-testing	roles & responsibilities: - BoD v management
E (2014.Spring #27)	defn: - of stress-testing	considerations: - of stress-testing	see CIA.FCT-1 - (reverses stress-testing)
E (2013.Fall #31)	purpose: - of stress-testing	compare: scenario v sensitivity testing
E (2012.Fall #28)	purpose: - of stress-testing	roles & responsibilities: - BoD v management

In Plain English!

Intro

It might be a good idea to first review CIA.FCT-1 because it's closely related to OSFI.Stress. (The FCT article began by addressing the why and the how for stress-testing.)

OSFI's paper on stress-testing doesn't discuss any specific stress-testing methodology, but it does address a few key issues that were not addressed CIA.FCT-1.

Question: define the term stress-testing

stress testing is a risk management technique...

to evaluate

...effects on financial condition of specified changes...

corresponding to

...exceptional but plausible events.

Recall that stress-testing applies to any type of company whereas FCT applies only to insurance companies.

Note: The role of the BoD (Board of Directors) versus the role of management in the stress-testing program is important to understand:

• As an analyst, your role is to build and maintain the spreadsheets that do the actual calculations.
• When you're promoted to management, you'll do less of the technical work and more of the planning.
• If you're ever on the Board of Directors, your involvement would be very high level, but the BoD has ultimate responsibility for integrity of the stress-testing program.

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Considerations in Stress-Testing Programs

Question: identify 4 rudimentary considerations in stress-testing [Hint: RUDI]

R: RANGE (stress-testing should use a range of perspectives & techniques)

U: UPDATE (the stress-testing framework should be updated regularly)

D: DOCUMENTATION (proper documentation of methodology should be available)

I: INFRASTRUCTURE (the stress-testing infrastructure should be flexible if assumptions or methods change.)

This specific question is rarely asked. A better question is one that describes a company's stress-testing program and asks how it could be improved. An example is:

E (2014.Fall #26)

And it was worth 2.0 points! To answer it properly, you had to use common sense and knowledge of these rudimentary considerations.

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Methods, Focus, OSFI Supervision

There was a good question from (2017.Spring #22) on creating scenarios in a stress-testing program.

• (Note that this is different from RUDI, which lists general considerations in designing the overall program, as opposed to creating specific scenarios.)

Comprehensive	scenarios should cover all important BUSINESS & PRODUCT lines
Non-historical	create NON-HISTORICAL scenarios (events that haven't happened but COULD happen)
Downturn	severe & sustained DOWNTURNS (includes large losses, loss of reputation, legal problems,..)

• The exam didn't specifically ask you to list these considerations. Instead, you were given a description of a company's stress-testing program and asked to comment on various different aspects. The way to solve the problem was to ask yourself whether the above considerations were followed (or not followed.)

A related idea is what OSFI looks for in assessing a stress-testing program. The text lists 9 items, but I think you can get away with memorizing just 4. (This has not appeared on a prior exam, and it seems a little too detailed. Nonetheless, the first, and most basic thing OSFI would look for is:

• Are the scenarios appropriate for institution's risk profile?
• (See the BattleCards for a few more.)

Let's close with a question that has appeared on the exam more than once. (See BattleTable for exam references.)

Question: compare and contrast scenario-testing with sensitivity-testing

scenario-testing:

- significant changes to risk factors

- observe future state including ripple effects & management actions over a longer time horizon

- more complex & comprehensive

sensitivity-testing:

- incremental changes to risk factors

- shock is more immediate & time horizon shorter

- simpler fewer resources required

(The main point is that scenario-testing is more complex and requires more resources than sensitivity-testing.)

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BattleCodes

Memorize:

• defn of stress-testing
• role of Board of Directors & management in stress-testing program
• 4 considerations in designing an overall stress-testing program (RUDI).
• 3 considerations in creating scenarios for a stress-testing program
• how OSFI assesses a stress-testing program (probably not too important)
• scenario-testing versus sensitivity-testing

Conceptual:

• You should think about how OSFI.Stress relates to CIA.FCT-1.
  • Recall that in the BattleCodes for CIA.FCT-1, I asked you to think about how these readings are similar and how they are different.
  • The obvious similarity is that they are both about stress-testing. The obvious difference is that CIA.FCT-1 pertains to insurance companies (since it was written by the Canadian Institute of Actuaries!) and OSFI.Stress applies to any type of company.
  • (This is an open-ended question - something fun to think about the next time you're in a boring meeting!)

Calculational:

• none

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POP QUIZ ANSWERS

The purpose of stress-testing is:

risk: risk identification & control (stress-testing helps identify and control risk)

complement: stress-testing complements other risk management tools such as Best's Capital Adequacy Ratio as described in BCAR.Cat (may also involve simulation of shocks like earthquakes)

Cap: stress-testing supports capital management

Liq: stress-testing improves liquidity management