ERM in the Rating
Evaluation
CAMAR Fall Meeting
November 29, 2007
Thomas M. Mount, ACAS, MAAA
Andrew Colannino, Vice President
A.M.Best Company
What is Risk Management?
Risk management is a process which
helps insurers identify, measure and
manage the various types of risk within
their operations.
What are the objectives of
Risk Management?
Objectives of
Risk Management

To manage the organization’s exposure to
potential earnings & capital volatility

To maximize the value of the firm to the
organization’s various stakeholders

Goal is to understand and manage risk,
NOT to eliminate risk
How does A. M. Best view
Risk Management?
Risk Management


Risk management is the common thread
that links balance sheet strength,
operating performance and business
profile
Risk management fundamentals can be
found in a company’s…
Strategic decision making process
 Financial management and control practices
 Daily operating procedures

Traditional Risk Management
vs.
Enterprise Risk Management
Traditional
Risk Management


Fundamental policies and procedures of
identifying, quantifying, and managing specific
risks individually
Categories of Risk







Credit Risk
Market Risk
Underwriting Risk
Operational Risk
Strategic Risk
Little or no interaction/communication/alignment
among risk managers
“Silo” approach
Enterprise
Risk Management


ERM is the process through which
insurers identify, quantify, and manage risk
on an enterprise wide, holistic basis
The underlying premise of ERM is based
on increasing value to shareholders and
providing financial security to the
organization
Will A. M. Best perform
a separate rating analysis of
Enterprise Risk Management?
ERM in the
Rating Evaluation

Not a separate component

Impacts all three areas of the rating
evaluation



Capitalization
Operating performance
Business profile

Integrated into agenda

Clearly the potential to weigh heavily
on a rating
Does A. M. Best expect all companies
to implement
Enterprise Risk Management?
ERM in the
Rating Evaluation
Need for ERM will vary based on:
Complexity of a company

type of products offered
Number of products offered

Investments

Volatility of Earnings/potential significant
capital loss (Risk profile)
Financial Flexibility
Strength of its Traditional Risk management
ERM in the
Rating Evaluation
However, implementing the concept of
overall risk management, or even
selected elements
of ERM can help any company –
regardless of size
ERM in the
Rating Evaluation
The 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
on the Rating
 ERM will benefit company in one of two ways:
 ERM will motivate the company to reduce risk
• shift its business strategy from volatile lines to more
stabile lines
• Aggregate reinsurance
• Less volatile investments
 ERM will motivate the company to obtain higher
returns for its existing risk
• Charge higher rates
Impact of ERM - Example of
Changing Business Strategy
From Volatile to Stabile Lines
Volatile Strategy AStabile Strategy will
become A+ sooner
BCAR
Average Return
160 = Minimum for A+
Today
Future
Time
Impact of ERM - Example of
Receiving Adequate Return for Risk
Ins Co w/Inadeq
Return for Risk = B+
Ins Co w/Adeq
Return will become
A- sooner
BCAR
Adeq Avg Return
Inadeq Avg Return
130 = Minimum for AToday
Future
Time
Risk Management and BCAR –
Best’s Revised Approach
AMB Requirements:
Weak Risk
Management
BCAR
Superior traditional risk management fundamentals
Superior capital management and financial flexibility
Strong ERM characteristics
Strong Economic Capital modeling capabilities
LOW relative earnings and capital volatility
Strong Risk
Management
What’s New…
BCAR Guideline
LOW
HIGH
EARNINGS and CAPITAL VOLATILITY
Risk Management and BCAR –
Best’s Revised Approach
Weak Risk
Management
BCAR
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
Strong Risk
Management
BCAR Guideline
LOW
HIGH
EXPOSURE to EARNINGS and
CAPITAL VOLATILTY
What is “Strong”
Enterprise Risk Management?
Assessment of ERM
Culture
 Identification & Management of Risks


Measurement of Risks
ERM - 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
ERM
Identification & Management





An objective framework which identifies,
monitors, and manages emerging risks,
risk accumulation, and correlations within
and across the entire organization
On going process
Exception reports
Reinsurance purchases based on risk
tolerance
Contingency plans in place
ERM
Measurement of Risk







Risk/Return measures
Correlation of Risks
Impact of general economy
Impact of industry specific events / extreme
events
Catastrophe Models
Economic Capital Models
Data collection



Quality of data
Data verification procedures
Access to the data
ERM
Measurement of Risk

Economic Capital Models - Management
must demonstrate how the model is used
To make strategic decisions
 To allocate capital
 To understand volatility
 To understand risk correlations




Quality of the model
Sensitivity of the model
Internal Model is given consideration in the
evaluation of required capital
Summary




ERM is evaluated, but no separate rating is
published
Importance of ERM will vary depending on
the complexity/volatility/financial
flexibility/traditional Risk Management of
the company
Credit for Companies implementing ERM
will be recognized over time
Credit given to strong internal company
capital models that are used in ERM
process
Questions?