107th Mid-Atlantic Mutual Advantage Convention

Enterprise Risk Management Framework

For Small to Mid-Sized Property & Casualty Insurance Companies

Presented byJoseph F. Morris CPA, MBA

President & CEO, American European Insurance Group, Inc.

Why Companies Have Not Implemented ERM?

It’s not required

I’ve been managing risks my entire career; form over substance

I see no benefits

I view ERM as adding time and expense

ERM is operating by committee

Why do I need to involve the Board?; It’s management’s responsibility to manage risks

My company is too small; ERM is only for large companies

I understand the theory, but how do you put it into practice?

2

Learning Goals

Recent Regulatory Developments

Expectations of Rating Agencies

Enterprise Risk Management Framework

Definition and Benefits

Creating a Risk-Aware Culture

Determining Key Risk Factors

3

ERM – Regulatory Developments

2013 Annual Registration Statement Includes:– “the insurer’s board of directors oversees corporate governance and

internal controls and that the insurer’s officers or senior management have approved, implemented and continue to maintain and monitor corporate governance and internal control procedures.”

2014 Form F (Enterprise Risk Management Report)

2015 Own Risk Solvency Assessment (ORSA)

2016 Corporate Governance Annual Filing (Proposed)

4

A.M. Best: ERM in the Rating Evaluation Process

Busines

s Profile

Operating Performance

Balance

Sheet

Strength

Enterprise Risk Management is the common thread that links balance

sheet strength, operating performance, and business profile

Source: A. M. Best Company

5

A.M. Best ERM Expectations

All insurers need to establish an ERM framework ERM capabilities should be proportionate to risk profile of

insurer Insurers need to establish firm-wide risk tolerance metrics Insurers need to have their own view of capital adequacy A low risk profile and high ERM capability will produce a ratings

“lift” Leading insurers are utilizing stochastic-based capital modeling

to better support risk-reward decisions

Source: A. M. Best Company 6

Enterprise Risk Management Framework

What is an ERM Framework?

Enterprise RiskManagement Framework

A disciplined process to systematically identify measure and manage various types of risk

Establish Risk-Aware

Culture

Identify Measure

Manage & Mitigate

Risks

Measure Enterprise Risk and

Risk Correlation

Source: A. M. Best Company

8

Benefits of Enterprise Risk Management Framework

Maximize value to the organization’s various stakeholders Manage exposure to earnings and capital volatility Ensures future capital levels exceed regulatory and rating agency

required capital levels Create a risk-aware culture that encourages risk-taking Develop consistent metrics to measure risk and to establish risk

tolerance levels Assign roles and responsibilities to board, Sr. management and others Maintain excellent rating from rating agencies

9

Enterprise Risk ManagementRisk-Aware Culture

ERM – Risk Aware Culture

ERM Tone Established by Board of Directors and Senior Management

ERM roles and responsibilities clearly defined Define risk profile, risk appetite and risk tolerance parameters Mission, Strategic Planning and ERM documents shared with all

employees Executive compensation includes ERM objectives / results Financial results and risk management initiatives reviewed with

employees

11

ERM Tone Established by Board of Directors and Senior Management

ERM Terminology

What is Risk Profile?

A narrative description of the parameters for executing the company’s business strategy

12

ERM Terminology

What is Risk Appetite?

The boundary level of uncertainty a company is willing to assume given the corresponding reward

associated with the risk

13

Risk Profile and Risk Appetite Examples

External Environment

Regulatory Legal/Judicial Economic Industry Competition

Capital Management

Financial Ratings Access to Capital Debt and Holding Company

Structure Capital Adequacy

Balance Sheet

Loss Reserves Investment Portfolio

14

Written Premium Profile

Line of Business, Geographic, Product, Class of Business, Agency Concentration

Limits of Liability Coverage

Reinsurance Profile

Reinsurance Credit Quality CAT Exposure Per Risk Retentions

Operational Profile

Underwriting & Claim Practices IT Performance, Data Quality &

Business Continuity and Recovery

ERM Terminology

What is Risk Tolerance Level?

The financial metrics that establish thresholds for levels of risk that the company is willing to accept

in order to accomplish its strategic objectives.

15

Risk Tolerance Level Examples

Enterprise-Wide Risk tolerance Levels

Economic Capital Model: Probability of Ruin at 99.5% VaR, One-Year Out

Best Capital Adequacy Ratio, One Year Out to Achieve/Maintain A- Rating

NAIC Risk Based Capital Greater Than 300

Net Written Premium to Surplus ratio of Less than 1.5 to1

No Greater Than a 10% Loss of Capital From all Risk Factors in Any One Year

Holding Company Debt to Total Capitalization Ratio

16

Risk Tolerance Level Examples

Individual Risk Tolerance Levels

Net of Reinsurance Underwriting per Risk Retention Equal to 5% or Less of Capital (net of tax).

Loss and LAE Reserves Set at or Above Mid-Point of Actuarial Range of Estimates

No Greater than a 5% Loss of Capital in Any One Year Due to a 100 Basis Change in Interest Rates

17

Identification, Measuring and Monitoring

Key Risk Factors

Primary Causes of Financial Impairment

Deficient loss reserves/Inadequate

pricing43.4%

Rapid growth12.6%

Alleged fraud7.2%

Investment problems (overstated assets)

6.6%

Miscellaneous8.4%

Significant change in business

3.5%

Reinsurance failure3.1%

Catastrophe losses7.1%

Affiliate problems8.0%

U.S. Property/Casualty – Primary Causes of Financial Impairment (1969-2012)

Note: Exhibit % are based on companies where the cause of impairment was identif ied. Source: A.M. Best data & research

19

Key Risk Factor Categories - Definitions

Credit - exposure from all potential creditors including agents, reinsurers, bond issuers and insureds

Market – exposure to liquidity events, asset/liability mismatches and risks in investment portfolios due to changes in interest rates, equity prices and exchange rates

• Underwriting – exposure from underwriting insurance products including: product development, regulation, loss reserves, pricing metrics and catastrophic events

• Operational – exposure to management change, business interruption, fraud, data capture and security, claim handling and employee retention and other operating activities

• Strategic – exposure to economic downturn, industry competition, rating agencies and availability of capital

20

Categories of Key Risk Factors

Credit Market

Bond Issuer Default/Downgrade Agency/policyholder credit risk Reinsurer default Sovereign Currency

Liquidity events Asset / Liability Matching Interest Rate Risk Common Stock Market Price Reinvestment

Underwriting Operational

Product Development Regulatory Catastrophic Event Loss Reserve Loss Experience Pricing

Data Capture/Data Security Agency Automation Management Change/Employee Turnover Fraud/Financial Controls Claim Handling Delegation of Underwriting Authority Financial Reporting

Strategic

A. M. Best Downgrade Industry Competition Economic Downturn

Reputational Capital Availability Competitor technology Advances

21

Frequent

Probable

Often

Occasion

al

Possible

Remote

< 1% 1 – 5% 5 – 10% 10 – 15% 15 – 20% >20%

Low Severity of Event (% of Surplus) High

12

11

9

8

6

7

4 5

2

3

10

1

L

ow

Pro

bab

ilit

y

H

igh

ERM Key Risk Factors – Heat Map

22

ERM – #1 Risk Factor: Pricing Dashboard

Description of Risk: The Company may not price its policies adequately in order to produce acceptable loss ratios.

Oversight:

ERM Committee

Board Committee

Frequency of Oversight:

Quarterly

Quarterly

Risk Owner:

VP - Underwriting

Risk Tolerance Level:

(1) Achieve a 6.2% renewal rate level increase over expiring.

(2) New and renewal policies written with average RMF of .85.

Risk Score:

(1) June 30, 2013 – 7.2%

(2) June 30, 2013 - .86 renewals; .80 new business

Monitoring or Control Activity:

1. All ISO filed manual rate changes are reviewed & analyzed by actuary and discussed at rate committee before adoption.

2. Underwriters are given pricing goals at beginning of year and required to document every file with explanations for use of discretionary pricing credits.

3. Underwriting quality assurance process in place to review 25 policies per underwriter per quarter.

Date and Result of Testing Monitoring or Control Activity:

1. Tested successfully on May 15, 2013

2. Goals discussed with each underwriter by January 10, 2013.

3. Results of all UQAP completed quarterly and an overall summary distributed to management – completed on July 31, 2013.

Control Effectiveness:

1. Medium

2. Medium

3. High

Severity of Event (Low 1 to High 6)

4Frequency of Event (Low 1 to High 6)

5Issues for Remediation:

The Company does not have the capability to produce pricing reports indicating renewal rate level change and RMF charged for new and renewal policies. An IT project has been created to address this remediation issue.

Status – – June 30, 2013 All monitoring controls are operating effectively. Producing pricing reports is a key issue to ensure that this risk is being properly mitigated and managed at the individual underwriter level and on an aggregate book of business basis.

Change from Last Quarter

Status – September 30, 2013 Change from Last Quarter

Status – December 31, 2013 Change from Last Quarter

Status – March 30, 2014 Change from Last Quarter

23

Is Your Company Capable of Managing Key Risks?

24

Industry Operating Practices Best Operating Practices

Pricing - No price monitoring reportsNew business and renewal price monitoring reports

track manual and discretionary price changes

Loss Reserves - Calendar Year Loss Ratio/Loss Reserve Adequacy Reviewed Annually by Outside Actuary

Accident Year Loss Ratios/ Loss Reserve Adequacy Reviewed Quarterly Internally and Annually by

Outside Actuary

CAT Management - Determined annually by reinsurance broker

Property Values Managed Monthly in Concentrated Territories

Claims Best Practices - No written claims best practices and no claim audit process

Written Claims Best Practices and Claim Files Audited Monthly

Investment Portfolio - Risk Metrics not calculatedInvestment Manager Monitors Risk Metrics of

Investment Portfolio and Meets with Board Investment Committee Quarterly

Financial Forecasts – one-year budgets are created for operating statements only

Three-Year Financial Forecasts prepared including operating statements, balance sheets and RBC and

BCAR ratios

Enterprise Risk Management Framework

Integrate ERM Process into Standard Operating Practices of Company

25

Risk Identification

Risk Measurement

Risk Controls, Monitoring Activities & Reporting

Business Strategies &

Operating Practices

Financial Goals & Capital

ManagementRisk-Aware Culture

Risk Profile

Risk Tolerance

Roles/Responsibilities

ERM Process

26

Joseph F. Morris, CPA, MBA, has over thirty-four years of insurance industry experience. Prior to

founding P&C Insurance Company Strategies, LLC, Mr. Morris was President of Stonecreek Specialty Underwriters, LLC. Previously, Mr. Morris was President and CEO of James River Insurance Company from 2008 until 2010 after serving as President and CEO of The Philadelphia Contributionship, the oldest insurance company in the United States. Mr. Morris also held several positions with United America Indemnity, Ltd. (UAI) including President, President & CEO Penn-America, UAI’s excess & surplus lines subsidiary, and SVP and CFO of Penn-America. Mr. Morris began his insurance career at Reliance Insurance Company where, over a twenty-one year career, he held a number of financial and operating positions.

Mr. Morris has been a member of the Board of Directors of The Insurance Society of Philadelphia since 1989 and was its Chairperson in 1997-1999.

 

Joseph F. Morris, CPA, MBA Bio

27

Disclaimer of Warranties

The content of the presentation materials has been prepared by P&C Insurance Company Strategies, LLC (PCIC Strategies) “as is”, for informational purposes only and without warranties of any kind, either express or implied. PCIC Strategies disclaims all warranties including but not limited to warranties of title, implied warranties of merchantability, fitness for a particular purpose, compatibility, security, accuracy, reliability or infringement.

28