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?