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

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

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1004/18/23

Overall ERM Evaluation45 companies

Excellent7%

Adequate60%

Weak9% Strong

24%

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

ERM

© 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

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apit

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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

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)

ERM

Where is the CAS Today?

• Centennial Goal

• ERM Symposium

• Risk Management Section

• New VP position

• ERM Vision

• ERM Institute International (ERM-II)

Where Should theCAS be Going?