Enterprise Risk Management Framework

For Small to Mid-Sized Property & Casualty Insurance Companies

Presented byJoseph F. Morris CPA, MBA

jmorris@pcicStrategies.com215-901-0334

Business and financial services for property & casualty insurance companies

Learning Goals

Recent Regulatory Developments

2013 Holding Company Registration Statement on Governance and Internal Controls

2014 Form F (Enterprise Risk Management Report) 2015 Own Risk Solvency Assessment

2016 Corporate Governance Annual Filing (Proposed)

Expectations of Rating Agencies

Definition and Benefits of ERM Framework

Business and Financial Services for Property and Casualty Insurance Companies 2

Learning Goals (continued)

Creating a Risk-Aware Culture

Setting Tone at the Top Defining Risk Profile, Risk Appetite and Risk Tolerance Levels Roles and Responsibilities Reporting and Monitoring

Determining Key Risk Factors

Five Categories of Risk Risk Tolerance Parameters Controls or Monitoring Activities Issues for Remediation Risk Factor Dashboard

Business and Financial Services for Property and Casualty Insurance Companies 3

ERM – Regulatory Developments

NAIC’s Solvency Modernization Initiative and Risk-Focused Financial Examinations

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)

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ERM – Regulatory Developments (continued)

2014 Form F (Enterprise Risk Management Report)

Filed annually by ultimate controlling person No size exemption “Enterprise Risk in ten areas “Enterprise Risk” is defined as: “Any activity, circumstance, event or

series of events involving one or more affiliates of an insurer that, if not remedied promptly, is likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system…”

If no response, must indicate “To the best of its knowledge and belief, Registrant has not identified enterprise risk subject to this disclosure.”

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ERM – Regulatory Developments (continued)

2014 Form F (Enterprise Risk Management Report) Material developments regarding strategy, internal audit findings,

compliance or risk management; Acquisition or disposal of insurance entities; Changes of shareholders exceeding 10% or more of voting securities; Developments in investigations, regulatory activities or litigation; Business plan and summarized strategies for next 12 months; Identification of material concerns raised by supervisory college; Identification of capital resources and material distribution patterns; Identification of any negative movement with rating agencies; Information on corporate or parental guarantees; Identification of any material development that could adversely affect

the company.6Business and Financial Services for Property and Casualty Insurance Companies

ERM – Regulatory Developments (continued)

2015 Own Risk and Solvency Assessment Model Law

Insurers with less than $500 million in gross written premium and insurance groups with less than $1 billion in gross written premium are exempt;

Requires insurers to maintain a risk management framework and complete an ORSA Summary Report;

ORSA Summary Report: Section 1 – Description of the Insurer’s Risk Management Framework Section 2 – Insurer’s Assessment of Risk Exposure Section 3 – Group Assessment of Risk Capital and Prospective Solvency

Assessment Additional Information – organization chart, basis of accounting, signature

of chief risk officer

7Business and Financial Services for Property and Casualty Insurance Companies

ERM – Regulatory Developments (continued)

2016 Corporate Governance Annual Filing Model Law

Provide a summary of an insurer’s corporate governance structure, policies and practices

No size exemption

Annual Filing: Section 1 – Description of Corporate Governance Framework

Section 2 – Description of Board of Directors; and Committee Policies and Practices

Section 3 – Description of Management Policies and Practices

Section 4 – Description of Management and Oversight of Critical Risk Areas

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

Business Profile

Operating Performan

ce

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

9

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 10Business and Financial Services for Property and Casualty Insurance Companies

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

Business and Financial Services for Property and Casualty Insurance Companies 11

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 required regulatory capital 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

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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 achievement of risk management

objectives Financial results and risk management initiatives reviewed with

employees

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ERM – Risk Aware Culture (continued)

ERM Roles and Responsibilities Board establishes Risk Committee as oversight function Senior Management is responsible for identification, measurement,

monitoring and communication of risk goals, metrics and activities Chief Risk Officer is responsible for leading ERM activities within

company

Reporting of Enterprise Risk Management Activities Quarterly reporting of ERM metrics and activities to Risk Committee

of Board of Directors via ERM Dashboard

15Business and Financial Services for Property and Casualty Insurance Companies

ERM Terminology

What is Risk Profile?

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

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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

17Business and Financial Services for Property and Casualty Insurance Companies

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

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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.

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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

20Business and Financial Services for Property and Casualty Insurance Companies

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

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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

23Business and Financial Services for Property and Casualty Insurance Companies

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

24Business and Financial Services for Property and Casualty Insurance Companies

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

25Business and Financial Services for Property and Casualty Insurance Companies

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

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ERM – #1 Risk Factor: Pricing Dashboard

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Will be Included in Live Presentation

Is Your Company Capable of Managing Key Risks?

28Business and Financial Services for Property and Casualty Insurance Companies

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

29Business and Financial Services for Property and Casualty Insurance Companies

Risk Identification

Risk Measurement

Risk Controls, Monitoring Activities

& Reporting

Business Strategies &

Operating Practices

Financial Goals & Capital

Management Risk-Aware Culture

Risk Profile

Risk Tolerance

Roles/Responsibilities

ERM Process

30

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

31Business and Financial Services for Property and Casualty Insurance Companies

Joseph F. Morris jmorris@pcicstrategies.com

215-901-0334www.pcicstrategies.com

Disclaimer of Warranties

The content of this webinar and the presentation materials have 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.

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