TD Bank 2014 Annual Report Download - page 90

TD BANK GROUP ANNUAL REPORT 2014 MANAGEMENT’S DISCUSSION AND ANALYSIS88
Financial Crime
Detecting fraud and other forms of financial crime is very important to
the Bank. To do this, TD maintains extensive security systems, protocols
and practices to detect and mitigate financial crimes against the Bank.
Excluding those events involving litigation, the Bank did not experience
any material single operational risk loss event in 2014. Refer to Note
29 of the 2014 Consolidated Financial Statements for further informa-
tion on material legal or regulatory actions.
Model Risk Management
TD defines Model Risk as the potential for adverse consequences arising
from decisions based on incorrect or misused models and their outputs.
It can lead to financial loss or incorrect business and strategic decisions.
The Bank manages this risk in accordance with management
approved model risk, policies, and supervisory guidance which encom-
pass the entire life cycle of a model, including proof of concept, devel-
opment, initial and ongoing validation, implementation, usage, and
ongoing model performance monitoring. The model risk management
regime also captures key processes that may be partially or wholly
qualitative, or based on expert judgment. Examples of key processes
include ICAAP, liquidity management, and Basel frameworks.
Business segments identify the need for a new model or process and
are responsible for development and documentation according to Bank
policies and standards. During model development, all controls with
respect to code generation, acceptance testing, and usage are estab-
lished and documented to a level of detail and comprehensiveness
matching the materiality and complexity of the model. Once models
are implemented, business owners are responsible for ongoing perfor-
mance monitoring and usage in accordance with the Bank’s model risk
policy to ensure there is no inappropriate use of models. In cases where
a model is deemed obsolete or unsuitable for its originally intended
purposes, it is decommissioned in accordance with the Bank’s policies.
Risk Management maintains a centralized model inventory and
provides oversight of all models defined in the Bank’s model risk policy
and is responsible for validation and approval of new models, the peri-
odic validation of all existing models on a pre-determined schedule
depending on regulatory requirements and materiality, and regular
monitoring of model performance. The validation process varies in
rigour, depending on the model type and use, but generally includes
a detailed determination of:
• the conceptual soundness of model methodologies and underlying
quantitative and qualitative assumptions;
• the risk associated with a model based on complexity and materiality;
• the sensitivity of a model to model assumptions and changes in data
inputs including stress testing; and
• the limitations of a model and the compensating risk mitigation
mechanisms in place to address the limitations.
When appropriate, initial validation includes a benchmarking exercise
which may include the building of an independent model based on a
similar or alternative validation approach. The results of the benchmark
model are compared to the model being assessed to validate the
appropriateness of the model’s methodology and its implementation.
At the conclusion of the validation process, a model will either be
approved for use, or should a model fail validation, require redevelop-
ment or other courses of action. Models or processes identified as
obsolete, or no longer appropriate for use through changes in industry
practice, the business environment, or Bank strategies are subject to
decommissioning. Decommissioning responsibilities are shared between
business owners and Risk Management. In order to effectively mitigate
model risk in this phase, implementation of Risk Management approved
interim risk mitigation mechanisms is required before the model can be
decommissioned or replaced.
Insurance Risk
Insurance risk is the risk of financial loss due to actual experience
emerging differently from expectations in insurance product
pricing or reserving. Unfavourable experience could emerge due
to adverse fluctuations in timing, actual size, and/or frequency of
claims (for example, non-life premium risk, non-life reserving risk,
catastrophic risk, mortality risk, morbidity risk, and longevity risk),
policyholder behaviour, or associated expenses.
Insurance contracts provide financial protection by transferring
insured risks to the issuer in exchange for premiums. The Bank is
exposed to insurance risk through its property and casualty insurance
business, life and health insurance business, and reinsurance business.
WHO MANAGES INSURANCE RISK
Senior management within the insurance business units has primary
responsibility for managing insurance risk with oversight by the
Chief Risk Officer for Insurance who reports into Risk Management.
The Audit Committee of the Board acts as the Audit and Conduct
Review Committee for the Canadian Insurance company subsidiaries.
The Insurance company subsidiaries also have their own Boards of
Directors who provide additional risk management oversight.
HOW TD MANAGES INSURANCE RISK
The Bank’s risk governance practices ensure strong independent
oversight and control of risk within the insurance business. The Risk
Committee for the insurance business provides critical oversight of the
risk management activities within the business. The Bank’s Insurance
Risk Management Framework and Insurance Risk Policy collectively
outline the internal risk and control structure to manage insurance
risk and include risk appetite, policies, processes, as well as limits and
governance. These documents are maintained by Risk Management
and support alignment with the Bank’s risk appetite for insurance risk.
The assessment of reserves for claim liabilities is central to the insur-
ance operation. The Bank establishes reserves to cover estimated future
payments (including loss adjustment expenses) on all claims arising
from insurance contracts underwritten. The reserves cannot be estab-
lished with complete certainty, and represent management’s best esti-
mate for future claim payments. As such, the Bank regularly monitors
liability estimates against claims experience and adjusts reserves as
appropriate if experience emerges differently than anticipated. Claim
liabilities are governed by the Bank’s general insurance reserving policy.
Sound product design is an essential element of managing risk.
The Bank’s exposure to insurance risk is generally short-term in nature
as the principal underwriting risk relates to automobile and home
insurance for individuals.
Insurance market cycles, as well as changes in automobile insurance
legislation, the judicial environment, trends in court awards, climate
patterns, and the economic environment may impact the performance
of the insurance business. Consistent pricing policies and underwriting
standards are maintained and compliance with such policies is moni-
tored by the Risk Committee for the insurance business.
Automobile insurance is provincially legislated and as such, policy-
holder benefits may differ between provinces. There is also exposure
to geographic concentration risk associated with personal property
coverage. Exposure to insurance risk concentrations is managed
through established underwriting guidelines, limits, and authorization
levels that govern the acceptance of risk. Concentration risk is also
mitigated through the purchase of reinsurance.
Strategies are in place to manage the risk to the Bank’s reinsurance
business. Underwriting risk on business assumed is managed through
a policy that limits exposure to certain types of business and countries.
The vast majority of reinsurance treaties are annually renewable,
which minimizes long term risk. Pandemic exposure is reviewed
and estimated annually.