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ERM in the ERM in the Rating EvaluationRating Evaluation
CAMAR Fall MeetingCAMAR Fall MeetingNovember 29, 2007November 29, 2007
Thomas M. Mount, ACAS, MAAAThomas M. Mount, ACAS, MAAAAndrew Colannino, Vice PresidentAndrew Colannino, Vice PresidentA.M.Best CompanyA.M.Best Company
What is Risk Management?
Risk managementRisk management is a is a processprocess which which helps insurers helps insurers identifyidentify, , measuremeasure and and managemanage the various types of risk within the various types of risk within their operations. their operations.
What are the objectives of Risk Management?
Objectives of Objectives of Risk Risk
ManagementManagement To To managemanage the organization’s exposure to the organization’s exposure to
potential earnings & capital potential earnings & capital volatilityvolatility
To To maximizemaximize the the valuevalue of the firm to the of the firm to the organization’s various stakeholdersorganization’s various stakeholders
Goal is to understand and manage risk, Goal is to understand and manage risk, NOTNOT to eliminate risk to eliminate risk
How does A. M. Best view Risk Management?
Risk Risk ManagementManagement
Risk management is the common thread Risk management is the common thread that links balance sheet strength, that links balance sheet strength, operating performance and business operating performance and business profileprofile
Risk management fundamentals can be Risk management fundamentals can be found in a company’s…found in a company’s… Strategic decision making process Strategic decision making process Financial management and control practicesFinancial management and control practices Daily operating proceduresDaily operating procedures
Traditional Risk Managementvs.
Enterprise Risk Management
Traditional Traditional Risk ManagementRisk Management
Fundamental policies and procedures of Fundamental policies and procedures of identifying, quantifying, and managing specific identifying, quantifying, and managing specific risks risks individuallyindividually
Categories of RiskCategories of Risk Credit RiskCredit Risk Market RiskMarket Risk Underwriting RiskUnderwriting Risk Operational RiskOperational Risk Strategic RiskStrategic Risk
Little or no interaction/communication/alignment Little or no interaction/communication/alignment among risk managersamong risk managers
““Silo” approachSilo” approach
Enterprise Enterprise Risk ManagementRisk Management
ERM is the process through which ERM is the process through which insurers identify, quantify, and manage insurers identify, quantify, and manage risk on an risk on an enterprise wideenterprise wide, , holisticholistic basis basis
The underlying premise of ERM is based The underlying premise of ERM is based on on increasingincreasing value to shareholders and value to shareholders and providing providing financial securityfinancial security to the to the organizationorganization
Will A. M. Best perform a separate rating analysis of
Enterprise Risk Management?
ERM in the ERM in the Rating Rating
EvaluationEvaluation NotNot a separate component a separate component Impacts all three areas of the rating Impacts all three areas of the rating
evaluation evaluation CapitalizationCapitalization Operating performanceOperating performance Business profileBusiness profile
Integrated into agendaIntegrated into agenda Clearly the potential to weigh heavily on Clearly the potential to weigh heavily on
a ratinga rating
Does A. M. Best expect all companiesto implement
Enterprise Risk Management?
ERM in the ERM in the Rating Rating
EvaluationEvaluation NeedNeed for ERM will vary based on: for ERM will vary based on: ComplexityComplexity of a company of a company
type of products offeredtype of products offered Number of products offeredNumber of products offered InvestmentsInvestments
VolatilityVolatility of Earnings/potential significant of Earnings/potential significant capital loss (Risk profile)capital loss (Risk profile)
Financial FlexibilityFinancial Flexibility Strength of its Strength of its TraditionalTraditional Risk management Risk management
ERM in the ERM in the Rating Rating
EvaluationEvaluationHowever, implementing the concept of
overall risk management, or even selected elements
of ERM can help any company – regardless of size
ERMERM in the in the Rating Rating
EvaluationEvaluationThe development of principles-based
solvency approaches, such as Solvency II in Europe, and the significant efforts of
sophisticated insurer’s to raise the bar on the risk-management front, will ultimately
become a competitive issue driving continued improvement and integration of ERM
concepts for all insurers regardless of size
What is the impact of Enterprise Risk Management
on ratings?
Impact of ERM Impact of ERM on the Ratingon the Rating
ERM will benefit company in one of two ways:ERM will benefit company in one of two ways:
ERM will motivate the company to ERM will motivate the company to reduce riskreduce risk • shift its business strategy from volatile lines to more shift its business strategy from volatile lines to more
stabile linesstabile lines• Aggregate reinsuranceAggregate reinsurance• Less volatile investmentsLess volatile investments
ERM will motivate the company to obtain ERM will motivate the company to obtain higher higher returnsreturns for its existing risk for its existing risk• Charge higher ratesCharge higher rates
Impact of ERM - Example Impact of ERM - Example of Changing Business of Changing Business
StrategyStrategyFrom Volatile to Stabile From Volatile to Stabile
LinesLines
Today Future
Time
BC
AR
160 = Minimum for A+
Average Return
Volatile Strategy A-
Stabile Strategy will become A+ sooner
Impact of ERM - Example Impact of ERM - Example of of
Receiving Adequate Return Receiving Adequate Return for Riskfor Risk
Today Future
Time
BC
AR
130 = Minimum for A-
Inadeq Avg Return
Ins Co w/Inadeq Return for Risk = B+
Ins Co w/Adeq Return will become A- sooner
Adeq Avg Return
Risk Management and Risk Management and BCAR – BCAR –
Best’s Revised ApproachBest’s Revised Approach
LOW HIGH
EARNINGS and CAPITAL VOLATILITY
BC
AR
BCAR Guideline
Weak Risk Management
Strong Risk ManagementWhat’s New…
AMB Requirements: Superior traditional risk management fundamentalsSuperior capital management and financial flexibility
Strong ERM characteristicsStrong Economic Capital modeling capabilities
LOW relative earnings and capital volatility
Risk Management and Risk Management and BCAR – BCAR –
Best’s Revised ApproachBest’s Revised Approach
LOW HIGH
EXPOSURE to EARNINGS and CAPITAL VOLATILTY
BC
AR
BCAR Guideline
Weak Risk Management
Strong Risk Management
What’s New…A.M. Best will consider allowing companies with STRONG risk management to maintain lower BCAR levels relative to the guideline for its rating
What is “Strong” Enterprise Risk Management?
Assessment of Assessment of ERMERM
CultureCulture Identification & Management of RisksIdentification & Management of Risks Measurement of RisksMeasurement of Risks
ERM - CultureERM - Culture Board & Senior Management establish
risk profile risk tolerances risk management objectives/incentives Risk aware culture throughout organization
All levels of management/employees Accountability
CRO responsibilities
Strategic decision making based on risk adjusted returns & other risk metrics Business strategy – plan and execution Capital allocation
ERMERM Identification & Identification &
ManagementManagement An objective framework which identifies, An objective framework which identifies,
monitors, and manages monitors, and manages emergingemerging risks, risks, risk risk accumulation,accumulation, and and correlationscorrelations within within and across the and across the entireentire organization organization
On going processOn going process Exception reportsException reports Reinsurance purchases based on risk Reinsurance purchases based on risk
tolerancetolerance Contingency plans in placeContingency plans in place
ERMERMMeasurement of Measurement of
RiskRisk Risk/Return measuresRisk/Return measures Correlation of RisksCorrelation of Risks Impact of general economyImpact of general economy Impact of industry specific events / extreme Impact of industry specific events / extreme
eventsevents Catastrophe ModelsCatastrophe Models Economic Capital ModelsEconomic Capital Models Data collectionData collection
Quality of dataQuality of data Data verification proceduresData verification procedures Access to the dataAccess to the data
ERMERMMeasurement of Measurement of
RiskRisk Economic Capital Models - Management Economic Capital Models - Management
must demonstrate how the model is used must demonstrate how the model is used To make strategic decisionsTo make strategic decisions To allocate capitalTo allocate capital To understand volatility To understand volatility To understand risk correlationsTo understand risk correlations
Quality of the modelQuality of the model Sensitivity of the modelSensitivity of the model Internal Model is given consideration in the Internal Model is given consideration in the
evaluation of required capitalevaluation of required capital
SummarySummary ERM is evaluated, but no separate rating is ERM is evaluated, but no separate rating is
publishedpublished Importance of ERM will vary depending on Importance of ERM will vary depending on
the complexity/volatility/financial the complexity/volatility/financial flexibility/traditional Risk Management of flexibility/traditional Risk Management of the companythe company
Credit for Companies implementing ERM Credit for Companies implementing ERM will be recognized over timewill be recognized over time
Credit given to strong internal company Credit given to strong internal company capital models that are used in ERM capital models that are used in ERM processprocess
Questions?Questions?