ERM RoundtableWhere Are We?
CAS Spring Meeting
May 8, 2006
John Kollar, ISO
Dave Ingram, S&P
Steve Lowe, Tillinghast
Don Mango, Guy Carpenter
CAS ERM Definition
• Process Assess Control Exploit Finance Monitor risk
• Holistic treatment of risk
• Senior management function
• Upside and downside
ERM “Drivers”
• Improved corporate governance
• Consolidation
• Financial services convergence
• Globalization Intl. Assoc. of Insurance Supervisors (IAIS) Basel II/Solvency II Intl. Accounting Standards Board (IASB)
• Risk management evolution
Underwriting Risk Model (URM) Experience
• “Missionary work” Why change?
• Senior management commitment Priority item Clear objectives Adequate resources Start small
Underwriting Risk Model (URM) Experience
• Availability & quality of data Less is easier
• Coordination of functions
• Risk integration
• ERM A lot of potential Long way to go
Value Statement
PricingRisk
RiskAnalysis
RiskParameters
EconomicCapital
RiskAllocation
Reinsurance
CombinedRatios
InterestRate Risk
URM
ERM EvaluationsInsurance Sector
David Ingram
Director
Enterprise Risk Management
Financial Services Ratings
CAS Spring MeetingMay 2005
904/18/23
S&P’s Evaluation of ERM
Risk Management Culture
Strategic Risk Management
Ris
k C
on
t ro
l P
roc
ess
es
Ex
tre
me
Ev
en
t s
Ma
na
ge
men
t
Ris
k &
Ec
on
om
ic
Ca
pi t
a l M
od
e ls
1104/18/23
ERM within the S&P Rating Profile
Stronger ERM
Investments
Competitive Position
Management & Corporate Strategy
Operating Performance
Capitalization
Liquidity
Financial Flexibility
1204/18/23
Financial Flexibility
Investments
Liquidity
Capitalization
Operating Performance
Management & Corporate Strategy
Competitive Position
ERM within the S&P Rating Profile
Stronger ERM
1304/18/23
Financial Flexibility
Investments
Liquidity
Capitalization
Operating Performance
Management & Corporate Strategy
Competitive Position
ERM within the S&P Rating Profile
Stronger ERM
1. ERM is a new organizing concept
– For looking at a collection of issues we have always covered
2. ERM will apply to all insurers globally
3. ERM evaluation will be tailored to the risks of each insurer
4. ERM will recognize all the risk management of the insurer
• even if the company does not do “ERM”!!!
5. ERM will be reflected in insurer ratings
• Importance of ERM will vary among companies – just as every other factor does
6. ERM will be a new section in the ratings report
7. ERM is not a new Capital Model
• ERM is not primarily concerned with looking at an insurer’s Economic Capital Model
ERM – Key Points
© 2006 Towers Perrin
ERM Value Framework
How much capital do I
need?
What type of capital do
I need?
Risk and Capital
Management
Value Management
CapitalCosts
Returnon Risk
Risk Structure
Capital Structure
Capital AdequacyPortfolio of
Capital Resources
Portfolio of Enterprise
Risks
Economic Capital
Value Creation
Maximize value by relating a firm’s decisions on the risks it takes to the decisions on the capital it uses to finance its business
Reconcilesactuarial and corporate finance perspectives
© 2006 Towers Perrin
Value creation can come from optimizing the structure of the risk portfolio
Capacity-based pricing of catastrophe exposure Marginal return on marginal capital
Asset allocation strategy Is risk minimized by matching bond maturities to the
expected cash flows of Workers Compensation claims?
Is risk minimized by matching the assets by currency to liabilities by currency?
© 2006 Towers Perrin
Value creation can come from optimizing the capital structure of the firm
Reinsurance optimization
Choosing Best Retention for Contract With $1 Million Limit
0%
5%
10%
15%
20%
25%
30%
35%
40%
0 1000 2000 3000 4000 5000 6000
Retention ($ Millions)
Co
st o
f C
apit
al
Too much "trading of dollars" Too far out "of the money"
Choosing Best Retention for Contract With $1 Million Limit
0%
5%
10%
15%
20%
25%
30%
35%
40%
0 1000 2000 3000 4000 5000 6000
Retention ($ Millions)
Co
st o
f C
apit
al
Too much "trading of dollars" Too far out "of the money"
ERM in Reinsurance Industry
• Hold-to-maturity, levered portfolio of long-dated, illiquid, OTC derivatives on untraded underlyings
• Less transparency than primaries (one layer removed)
• More volatility (we take the tails)
• Global platforms, Diversified offerings Complex organizations
• Significant model and parameter risk
ERM in Reinsurance Industry
• Munich Re, Swiss Re, Allianz, Zurich, Hartford have large risk organizations with significant actuarial leadership
– But they probably need large risk organizations!
• “Franchise” of a reinsurer = non-public information purchased @ UW results, stored in minable format, used to build proprietary forecast models
– Appalling data quality and no data transfer standards• Compare with banking and lending
– See www.fpml.com
Threats to Reinsurance Industry
• Business: – Mega cat ($100B)– Concentration of risk (~mercury at the top
of the food chain)
• Structural:– Underwriter incentive comp plans– Ease of entry, undifferentiated product– Optimism and overconfidence (Morton Lane:
the perfume of the premium overwhelms thestink of the risk)
Where is the CAS Today?
• Centennial Goal
• ERM Symposium
• Risk Management Section
• New VP position
• ERM Vision
• ERM Institute International (ERM-II)