AAMGA / A.M. Best / Lloyd’s Conference - London
25 September 2014
Enterprise Risk Management
Rating Analysis & Industry Best Practices
Stefan HolzbergerManaging Director, Analytics - EMEA
AAMGA / A.M. Best / Lloyd's Conference - London 2
Disclaimer
25 September 2014
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Enterprise Risk Management
AAMGA / A.M. Best / Lloyd's Conference - London 25 September 2014 3
Risk profile versus risk management capabilityHow Enterprise Risk Management can make a difference
Enterprise Risk Management in the rating process
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ERM - A Hot Topic
25 September 2014
Insurance and reinsurance undertakings shall have in place an effective risk-management system comprising strategies, pro cesses and reporting procedures necessary to identify, measure, monitor, manage and report, on a continuous basis the risks, at an individual and at an aggregated level, to which they are or could be exposed, and their interdependencies.
Source: SII Directive - Article 44 - Risk Management
AAMGA / A.M. Best / Lloyd's Conference - London
Enterprise Risk ManagementRating Analysis & Industry Best Practices
Enterprise Risk Management in the Rating Process
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AAMGA / A.M. Best / Lloyd's Conference - London
Rating Analysis Overview
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Balance SheetStrength
Operating Performance
Business Profile
Enterprise Risk Management
+ Country Risk
Rating
Insurance Company Financial Strength
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Strong Operating Performance Builds Balance Sheet Strength
Weak Operating Performance Erodes Balance Sheet Strength
Dateof lastbalance sheet
Present Future
Operating Performance and Business Profile
Leading Indicators of the Future Balance Sheet
Bal
ance
Sh
eet
Str
eng
th
- Time -
BCAR GuidelineBusiness Profile Drives Strong and Sustainable Operating Performance
Rating Analysis Overview
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BCAR
Exposure to Earnings and Capital VolatilityLow High
ERM & Capital Requirements
Will consider allowing insurers to maintain lower BCAR levels relative to the guideline for its rating if they demonstrate:
Superior traditional risk management fundamentals Superior capital management and financial flexibility Strong ERM characteristics Strong EC modeling capabilities
Weak Risk ManagementWeak Risk Management
Strong Risk ManagementStrong Risk Management
BCAR GuidelinesBCAR Guidelines
AAMGA / A.M. Best / Lloyd's Conference - London
ERM - Definition
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ERM is the process through which insurers identify, quantify and manage risk on an enterprise-wide, holistic basis; it takes into
consideration the individual risks at hand, as well as any correlations and inter-dependencies of risk across the organization.
Three key areas: culture ● identification and management ● measurement
AAMGA / A.M. Best / Lloyd's Conference - London
ERM – A Practical Approach
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Risk management capability is viewed in light of the company’s risk profile
A.M. Best wants companies to show us how their risk and capital management process provides a stable, sustainable operating
platform that can weather challenging times
Risk management is not a box ticking exercise
AAMGA / A.M. Best / Lloyd's Conference - London
Enterprise Risk ManagementRating Analysis & Industry Best Practices
Risk Profileversus
Risk Management Capability
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AAMGA / A.M. Best / Lloyd's Conference - London
ERM Capabilities
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• Risk Culture• Risk Identification and Controls:
– Risk Dashboards– Scenario Testing
• Risk Measurement:– Correlations– Capital Modelling– Risk-Based Decisions
• Risk Appetite:– Well-Quantified Risk Tolerances
• Market Risk• Credit Risk• Underwriting Risks:
– Pricing (attritional loss ratio)– Cat losses (PMLs; cat loads)– Reserves
• Non-Financial Risks:– Strategic (business plan)– Operational– Off-Balance Sheet
Traditional Risk Management Enterprise Risk Management
Overall Risk Management Capability
AAMGA / A.M. Best / Lloyd's Conference - London
A.M. Best’s Approach to Risk Management
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What is the impact of a company’s Risk Managementon its rating? Need to know two things:
Company’srisk management
capability
Company’srisk
profile
AAMGA / A.M. Best / Lloyd's Conference - London
Risk Profile Assessment
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• Investments• Liquidity• Financial Flexibility• Volatility in Earnings and Capital• Concentrations• Data Quality• Credit Quality of Reinsurance • Ceded Leverage/Potential Disputes• Reinsurance Program• Management Philosophy
• Line of Business• Correlations• Policy Limits• Product / Coverage Changes• Competitive Environment• Legislative/Regulatory Environment• Judicial Environment• Economic Environment• Growth
AAMGA / A.M. Best / Lloyd's Conference - London
A.M. Best’s Approach to Risk Management
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SUPERIOR
Risk Management
Capability
RM Capability ExceedsRisk Profile
RM CapabilityShortfall Relative to Risk
Profile
LOW MODERATE HIGH
Risk Profile
WEAK
RM Adequate
For Risk Profile
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HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
RiskProfile
Risk Management Capability
A company’s risk management capability needs to meet its risk profile
SUPERIOR
STRONG
GOOD
WEAK
Negative Rating Factor / Potentially Higher Capital
Requirements
A.M. Best’s Approach to Risk Management
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HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
RiskProfile
Risk Management Capability
A company’s risk management capability needs to meet its risk profile
SUPERIOR
STRONG
GOOD
WEAK
Positive Rating Factor / Potentially Lower Capital
Requirements
A.M. Best’s Approach to Risk Management
AAMGA / A.M. Best / Lloyd's Conference - London
RiskProfile
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Low Risk Profile
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Characteristics of a Low Risk Profile
Low volatility in earnings and capitalLow severity claims / low limit policiesLimited competition / stable pricingLow leverage measuresStrong reinsurance protectionStrong financial flexibilityHighly liquid / stable investmentsStable economic environmentStrong data capture / quality
AAMGA / A.M. Best / Lloyd's Conference - London
RiskProfile
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High Risk Profile
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
Characteristics of a High Risk Profile
High volatility in earnings and capitalHigh severity claimsHigh policy limits / excess layersStrong competition / inadequate pricingHigh leverage measuresWeak financial flexibilityIlliquid / volatile / complex investmentsUnstable economic environmentWeak data capture / data quality
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Risk Management Capability
E&S Market Exhibits Strong ERM
SUPERIOR
STRONG
GOOD
WEAK
Characteristics of Strong Risk Management Capability
Dynamic capital managementCorporate wide risk aware cultureWell quantified risk appetite & risk toleranceIdentify, quantify, monitor & control risksInternal economic capital modelIdentifying correlationsCompensation based on risk metricsFrequent deterministic scenario testing
AAMGA / A.M. Best / Lloyd's Conference - London
ERM Questions: Risk Appetite
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• What is your risk appetite?• How frequently is it revised?• What happens if it is
breached?• How is it cascaded to your
business units?• How does it relate to risk
tolerances and risk limits?
Risk Appetite
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ERM Questions for E&S Insurers
• How is the credit risk of your MGAs or TPAs monitored?– Review of premium trust funds –
segregated accounts– Audited financial statements –
going concern opinion
• How are risks associated with delegated u/w authority handled?– Pricing, coverage, manuscript
endorsements, exclusions, data quality, fraud
– Underwriting audits, IT systems• How confident are you that your
MGA is sourcing quality business?– Ranking in MGA office– MGA compensation
arrangement: volume based or profit share
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ERM Questions for E&S Insurers
• What is the data quality, timeliness and reliability for setting loss reserves & IBNR post event?– Track record of loss adjusters– Pre-arranged team of loss
adjusters for catastrophe response
• Are risks associated with outsourced claims handling identified?– Leakage, fraud, salvage &
subrogation, regulatory requirements
– Are you a key client for the TPA• What mechanism ensures proper
and timely premium collection?– Automated web portal– Real time data or monthly
bordereaux
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Some of these threats are also opportunities for the industry.To provide governments, industry and individuals enhanced risk transfer
opportunities.
ERM can Protect Insurer Solvency
25 September 2014
1. Risk Management Shortfall – Loss Reserving and Pricing
2. Model Error
3. Emerging Underwriting Risks
3 Key Threats and How They are Managed Through ERM
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1. Risk Management Shortfall
25 September 2014
a mismatch is created between risk appetite and risk management capability. This leads to excessive risk taking and sudden, unanticipated losses that impair the insurer
Threat
• More of a company-by-company issue today• But with capital model and risk metric
standardisation the potential exists for an industry-wide view on risk that fails to identify emerging threats to the balance sheet
AAMGA / A.M. Best / Lloyd's Conference - London
Risk Management Shortfall
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• Poor Risk Management leads to under reserving– Failure to identify loss trends– Providing unintended coverage
Reserving Snapshot
Vicious Cycle: Inadequate reserving leads to false sense of underwriting profit which leads to underpricing
• Uncertainty around financial strength– Lost business partners and
distributions sources– Rating triggers
• Rapid spiral toward insolvency
Reserve charges lead to loss of credibility
AAMGA / A.M. Best / Lloyd's Conference - London
Risk Management Shortfall
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• Deficient loss reserves:– BCAR contemplates loss
reserving trends – Industry and company specific
trends contrasted– Capital factors well-developed– Discount applied conservatively
Reserving Snapshot A.M. Best’s Analysis
• Third-party and in-house actuarial reports
• Advanced pricing models– Multivariate pricing– Telematics
• More granular underwriting data
Reserving Snapshot
AAMGA / A.M. Best / Lloyd's Conference - London
Risk Management Shortfall
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• Poor ERM leads to under pricing– Unaware of technical rate– Throwing in free coverage
• IT systems inadequate to price risks and monitor performance
• Underwriting controls weaken as business expands
Pricing Snapshot
Risk of under pricing reduced through improved risk management, data quality, policy wording and caps imposed on long-tail liability lines
• Movement of rates, exposures, terms & conditions
• Monitor accident year performance
• Peer analysis• Capital charge for excessive growth
A.M. Best’s Analysis
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2. Model Error
25 September 2014
capital management is driven by risk modelling that underestimates extreme scenarios that can impair insurer balance sheets
Threat
Taking too much diversification creditGetting the PMLs wrong and blowing out of the top end of reinsurance protectionDanger that event scenarios in models are not rigorous enough (e.g. financial markets shock)
AAMGA / A.M. Best / Lloyd's Conference - London
Model Error
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What should insurers consider?
• Risk of placing too much reliance on economic capital models
• Be aware of un-modeled perils• Consider PMLs as a range and not
as the number• Don’t disregard more basic metrics
such as TIV, zonal aggregates and gross underwriting leverage
How are insurers handlingthese risks?
• Using multiple models– Challenging the models
• Developing their own risk models• Rigorous model validation process• Management and Board• Reverse stress testing /
deterministic scenarios (realistic disaster scenarios)
• Back-testing post event
AAMGA / A.M. Best / Lloyd's Conference - London
3. Emerging Underwriting Risk
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Source: The Geneva Association – Annual Report 2013/14
‘The Geneva Association has highlighted the changing nature
of liability insurance. [The Liability Project] was initiated in
2013 in recognition that unexpected liability loss
conditions were the leading causes of every industry crisis of
the past 30 years.’
Companies fail to detect emerging loss exposure before extensive business is underwritten leading to class action level claims emergence
Threat
AAMGA / A.M. Best / Lloyd's Conference - London
Emerging Underwriting Risk
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Cyber Risk
• Considered by many to be the underrated risk¹
• Opportunities abound– Cloud computing– Social media– On-line financial transactions– Electronic personal information
Cybercrime costs global economy estimated USD 575bn annually²
• Forms of attack– Theft– Fraud– Hacking– Sabotage
• Risk and opportunity as an insurance product
¹Source Aon Risk Solutions: Underrated Threats ² McAfee & Centre for Strategic International Studies
AAMGA / A.M. Best / Lloyd's Conference - London
Emerging Underwriting Risk
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Source: The Geneva Association – Risk Management Newsletter No. 54 June 2014
Solar Storms
• What would a 1:200 year solar storm do to the power supply?
• Power failure estimates range from 16 days to 1 – 2 years
• Potential economic costs between USD 600bn to USD 2.6tr
AAMGA / A.M. Best / Lloyd's Conference - London
Emerging Underwriting Risk
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Insurer Actions
• Better data quality & ERM– Early detection system
• Tightening of policy wording to reduce potential for unintended coverage
• Better communication between underwriters and claims adjustors
Soft Market Dangers
• Loosening terms and conditions– Free coverage thrown in
– E.g. cyber, terrorism – Exclusions and sublimits removed
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.Thank You
25 September 2014
Q & A
AAMGA / A.M. Best / Lloyd’s Conference - London
25 September 2014
Enterprise Risk Management
Rating Analysis & Industry Best Practices
Stefan HolzbergerManaging Director, Analytics - EMEA