Enterprise Risk Management: Enterprise Risk Management: What’s the Fuss All About? Brian C....

Enterprise Risk Management:Enterprise Risk Management: What’s the Fuss All About?

Brian C. Schneider, CPA, CPCU - Director

Casualty Loss Reserve Seminar

September 11, 2006

www.fitchratings.com 2

TakeawaysTakeaways

Next Logical Step in Risk Management

Measure What You Manage

Enterprise “Reward” Management


Premise #1: Premise #1: Next Logical Step in Risk ManagementNext Logical Step in Risk Management


“ERM is the discipline by which an organization in

any industry assesses, controls, exploits, finances,

and monitors risks from all sources for the purpose

of increasing the organization’s short- and long-

term value to its stakeholders.”


ERM is nothing “new” – improves existing skillsERM is nothing “new” – improves existing skills

Insurance is the business of risk assumption (or risk trading)

Insurers must be the pre-eminent risk managers

Evolution of Three Letter Acronyms: ALM: Asset / liability management DFA: Dynamic financial analysis ERM: The latest trend

Aided by vast improvements in technology and data management Greater regulatory oversight due to corporate malfeasance


Risk Management FeaturesRisk Management FeaturesMonitoring,

Assessment, ReportingRisk

Governance

(people, process)

Capital Modeling, Allocation

Crisis Management

(catastrophe, operational)

What else?What if?


Benefits of ERM – “squishy”Benefits of ERM – “squishy”

Common “risk

language” throughout

organization

Better risk and crisis

management

Earlier identification of problems

Potential to eliminate

inefficiencies

Improved Board and statement disclosure

Consistent strategic and

financial decision-making


What Goes Into Fitch’s Rating Analysis?

IndustryAnalysis

FinancialReview

OperationalAnalysis

ManagementQuality

OrganizationalReview

RatingAnalysis


Has Our Rating Methodology Changed?Has Our Rating Methodology Changed?

Since Risk Management is not new, no reason to create a

new component to our rating methodology

Not a new “pillar”

Risk management is a fundamental component of rating

analysis

Analysis is updated to understand / utilize today's management

techniques and related information output


ERM Cuts Across All Aspects

Industry Review

Operational Review

Organizational Review

Financial Review

Management Review

ERM


Overall Rating Analysis - MethodologyOverall Rating Analysis - Methodology

ManagementQuality


Industry Analysis

OperationalAnalysis

FinancialReview

ERMERM

ERM

ERM ERM

RATING OPINIONRATING OPINION


Premise #2:Premise #2:Measure What You ManageMeasure What You Manage


Measure What You ManageMeasure What You Manage

Financial analysis “proves” the success of ERM process How successful were limits / reinsurance programs How successful were underwriting / pricing decisions Did management have crisis programs in place - liquidity backstops Number of “exceptions”

Economic Capital is a Cornerstone Fuels growth opportunities Offers protection to stakeholders Maximizes value – not too much, not too little


Considerable Time Spent on “the Numbers”Considerable Time Spent on “the Numbers”

ManagementQuality


Industry Analysis

OperationalAnalysis

FinancialReview

ERMERM

ERM

ERM ERM

RATING OPINIONRATING OPINION

1. Earnings2. Reserves3. Capital 4. Investments5. Asset / Liability

Management6. Liquidity7. Financial flexibility


Where does Prism come in?

IndustryAnalysis

FinancialReview

OperationalAnalysis

ManagementQuality


RatingAnalysis

EarningsReservesCapital

InvestmentsAsset / Liability Management

LiquidityFinancial flexibility

Prism


Capital Adequacy Requires Three PerspectivesCapital Adequacy Requires Three Perspectives

Regulatory Requirements

Insurer’s Internal Capital Models

Prism

• Official “scorekeeper”• May be insufficient for

today’s products / issues

• Independent, third-party review• Consistency – universal model /

work with the data provided

• Granular data / product analysis• Moral hazard of opportunistic

assumptions


Simple Complex

Current Current regulatory modelsregulatory models

Insurer’s In-Insurer’s In-House Capital House Capital

ModelModel

Stochastic platform with interactive surveys Stochastic platform with interactive surveys using consistent assumptionsusing consistent assumptions

Optimal Spot for Fitch Optimal Spot for Fitch is Verticalis Vertical

Less than vertical is unresponsiveLess than vertical is unresponsive> Arbitrary adjustmentsArbitrary adjustments> Incomplete scopeIncomplete scope

Past vertical is inefficientPast vertical is inefficient> Too much dataToo much data> Too much timeToo much time> Lack of comparabilityLack of comparability

Prism’s Targeted Approach


Prism FeaturesPrism Features

Uses country-specific data for insurance

risk parameterization

Powered by a realistic, economically

based stochastic engine

Adaptable to more closely reflect an

insurer's unique financial profile

Integrates and analyzes

risk on a fully aggregated

basis A sophisticated, stochastic

methodology

A common platform from

which to evaluate insurers

globally


Many papers available at www.fitchratings.com/prism


Premise #3:Premise #3:Enterprise “Reward” ManagementEnterprise “Reward” Management


ERM PitfallsERM Pitfalls Model over-reliance

Garbage In, Garbage Out Over-optimization

Inappropriate diversification Must have fundamental skills

Greatest asset: People A few can bring firm down SBU become risk-averse

Pass up opportunities since business line hurt but firm benefits

Resource issues Objectives Benefits Complexity

Modeling / measurement issues Data / IT constraints Credibility of results


Business 101Business 101

Adequate compensation for risks undertaken

Cannot mitigate all risks – leaves no profit opportunity

Firm’s appetite for risk

Past performance is not always a good future predictor

Equity markets

Catastrophe events

Knowing the unknown


ERM Sample QuestionsERM Sample Questions

IndustryAnalysis

FinancialReview

OperationalAnalysis

ManagementQuality


RatingAnalysis• Assess current regulatory,

legal and accounting risks• Describe ensuing

competitive factors

• What crisis management plans do you have

• List top threats to franchise

• What risk reports are monitored by your Board

• Define your risk appetite

• List support agreements amongst entities

• Stress-test upstream dividend capabilities

• Show expected variability in future earnings

• What is your risk exposure• What is economic capital

threshold


Enterprise “Reward” - Sample QuestionsEnterprise “Reward” - Sample Questions What is your expected variability in future earnings projections - by

business line and in aggregate? What is your estimated redundancy or deficiency in your liabilities – by

business lines and in aggregate? How much capital is considered in place to support the current book of

business on balance sheet versus expected new sales? What do you determine your capital needs to be related to operational risk? At what thresholds do you target for economic capital? How does your risk mitigation efforts – reinsurance, securitization, hedging

– lower your required capital needs? How do hedging strategies influence your earnings profile?

Do you consider potential liquidity charges in your various economic scenarios? If yes, what are they?


RecapRecap

ERM: Next Logical Step in Risk Management

Measure What You Manage

Enterprise “Reward” Management

Fitch Ratings

www.fitchratings.com

London

Eldon House

2 Eldon Street

London EC2M 7UA

UK

+44 207 417 4222

Singapore

7 Temasek Blvd.

Singapore 038987

+65 6336 6801

New York

One State Street Plaza

New York, NY 10004

+1 212 908 0500

+1 800 75 FITCH

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