AAMGA / A.M. Best / Lloyd’s Conference - London
Enterprise Risk Management
Rating Analysis & Industry Best Practices
Stefan Holzberger
Managing Director, Analytics - EMEA
25 September 2014
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AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Enterprise Risk Management
Enterprise Risk Management in the
rating process
Risk profile versus risk management
capability
How Enterprise Risk Management can
make a difference
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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ERM - A Hot Topic
Insurance and reinsurance undertakings shall have in place an effective
risk-management system comprising strategies, processes 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
25 September 2014
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Enterprise Risk Management
Rating Analysis & Industry Best Practices
Enterprise Risk Management
in the Rating Process
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Rating Analysis Overview
Insurance Company Financial Strength
Balance Sheet
Strength
Operating
Performance
Business
Profile
Enterprise Risk
Management
+
Country Risk
Rating
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Rating Analysis Overview
Balance Sheet Strength
Operating Performance and Business Profile
Leading Indicators of the Future Balance Sheet
Strong Operating Performance
Builds Balance Sheet Strength
BCAR Guideline
Business Profile Drives
Strong and Sustainable
Operating Performance
Weak Operating Performance
Erodes Balance Sheet Strength
Date
Present
of last
balance sheet
AAMGA / A.M. Best / Lloyd's Conference - London
Future
- Time 25 September 2014
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ERM & Capital Requirements
Will consider allowing insurers to maintain lower BCAR
levels relative to the guideline for its rating if they
demonstrate:
Weak Risk Management
 Superior traditional risk management fundamentals
 Superior capital management and financial flexibility
BCAR
 Strong ERM characteristics
 Strong EC modeling capabilities
Strong Risk Management
BCAR Guidelines
Low
Exposure to Earnings and Capital Volatility
AAMGA / A.M. Best / Lloyd's Conference - London
High
25 September 2014
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ERM - Definition
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
25 September 2014
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ERM – A Practical Approach
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
25 September 2014
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Enterprise Risk Management
Rating Analysis & Industry Best Practices
Risk Profile
versus
Risk Management Capability
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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ERM Capabilities
Traditional Risk Management
• 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
Enterprise Risk Management
• Risk Culture
• Risk Identification and Controls:
– Risk Dashboards
– Scenario Testing
• Risk Measurement:
– Correlations
– Capital Modelling
– Risk-Based Decisions
• Risk Appetite:
– Well-Quantified Risk Tolerances
Overall Risk Management Capability
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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A.M. Best’s Approach to Risk
Management
What is the impact of a company’s Risk Management
on its rating? Need to know two things:
Company’s
risk
profile
AAMGA / A.M. Best / Lloyd's Conference - London
Company’s
risk management
capability
25 September 2014
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Risk Profile Assessment
• 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
• Investments
• Liquidity
• Financial Flexibility
• Volatility in Earnings and Capital
• Concentrations
• Data Quality
• Credit Quality of Reinsurance
• Ceded Leverage/Potential Disputes
• Reinsurance Program
• Management Philosophy
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A.M. Best’s Approach to Risk
Management
SUPERIOR
RM Capability Exceeds
Risk Profile
Risk
Management
Capability
RM Capability
Shortfall Relative to Risk
Profile
WEAK
LOW
MODERATE
HIGH
Risk Profile
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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A.M. Best’s Approach to Risk
Management
A company’s risk management capability needs to meet its risk profile
Risk
Profile
Risk Management
Capability
HIGH RISK
SUPERIOR
MODERATE RISK
Negative Rating Factor /
Potentially Higher Capital
Requirements
STRONG
LOW RISK
GOOD
MINIMAL RISK
WEAK
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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A.M. Best’s Approach to Risk
Management
A company’s risk management capability needs to meet its risk profile
Risk
Profile
Risk Management
Capability
HIGH RISK
SUPERIOR
MODERATE RISK
Positive Rating Factor /
Potentially Lower Capital
Requirements
STRONG
LOW RISK
GOOD
MINIMAL RISK
WEAK
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Low Risk Profile
Risk
Profile
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
AAMGA / A.M. Best / Lloyd's Conference - London
Characteristics of a Low Risk Profile
Low volatility in earnings and capital
Low severity claims / low limit policies
Limited competition / stable pricing
Low leverage measures
Strong reinsurance protection
Strong financial flexibility
Highly liquid / stable investments
Stable economic environment
Strong data capture / quality
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High Risk Profile
Risk
Profile
HIGH RISK
MODERATE RISK
LOW RISK
MINIMAL RISK
AAMGA / A.M. Best / Lloyd's Conference - London
Characteristics of a High Risk Profile
High volatility in earnings and capital
High severity claims
High policy limits / excess layers
Strong competition / inadequate pricing
High leverage measures
Weak financial flexibility
Illiquid / volatile / complex investments
Unstable economic environment
Weak data capture / data quality
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E&S Market Exhibits Strong ERM
Characteristics of Strong Risk
Management Capability
Dynamic capital management
Corporate wide risk aware culture
Well quantified risk appetite & risk tolerance
Identify, quantify, monitor & control risks
Internal economic capital model
Identifying correlations
Compensation based on risk metrics
Frequent deterministic scenario testing
AAMGA / A.M. Best / Lloyd's Conference - London
Risk Management
Capability
SUPERIOR
STRONG
GOOD
WEAK
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ERM Questions: Risk Appetite
Risk Appetite
• 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?
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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ERM Questions for E&S Insurers
• 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
AAMGA / A.M. Best / Lloyd's Conference - London
• How is the credit risk of your MGAs
or TPAs monitored?
– Review of premium trust funds –
segregated accounts
– Audited financial statements –
going concern opinion
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ERM Questions for E&S Insurers
• 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
– Realtimedata or monthly
bordereaux
AAMGA / A.M. Best / Lloyd's Conference - London
• 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
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ERM can Protect Insurer Solvency
3 Key Threats and How They are Managed Through ERM
1. Risk Management Shortfall – Loss Reserving and Pricing
2. Model Error
3. Emerging Underwriting Risks
Some of these threats are also opportunities for the industry.
To provide governments, industry and individuals enhanced risk transfer
opportunities.
AAMGA / A.M. Best / Lloyd's Conference - London
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1. Risk Management Shortfall
Threat
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
• 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
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Risk Management Shortfall
Reserving Snapshot
• Poor Risk Management leads to
under reserving
– Failure to identify loss trends
– Providing unintended coverage
Reserve charges lead to loss of
credibility
• Uncertainty around financial
strength
– Lost business partners and
distributions sources
– Rating triggers
• Rapid spiral toward insolvency
Vicious Cycle: Inadequate reserving leads to false sense of underwriting
profit which leads to underpricing
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Risk Management Shortfall
Reserving Snapshot
A.M. Best’s Analysis
• Deficient loss reserves:
– BCAR contemplates loss
reserving trends
– Industry and company specific
trends contrasted
– Capital factors well-developed
– Discount applied conservatively
AAMGA / A.M. Best / Lloyd's Conference - London
Reserving Snapshot
• Third-party and in-house actuarial
reports
• Advanced pricing models
– Multivariate pricing
– Telematics
• More granular underwriting data
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Risk Management Shortfall
Pricing Snapshot
• 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
A.M. Best’s Analysis
• Movement of rates, exposures,
terms & conditions
• Monitor accident year
performance
• Peer analysis
• Capital charge for excessive growth
Risk of under pricing reduced through improved risk management, data
quality, policy wording and caps imposed on long-tail liability lines
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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2. Model Error
Threat
capital management is driven by risk modelling
that underestimates extreme scenarios that can
impair insurer balance sheets
Taking too much diversification credit
Getting the PMLs wrong and blowing out of the
top end of reinsurance protection
Danger that event scenarios in models are not
rigorous enough (e.g. financial markets shock)
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Model Error
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
AAMGA / A.M. Best / Lloyd's Conference - London
How are insurers handling
these 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
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3. Emerging Underwriting Risk
Threat
Companies fail to detect
emerging loss exposure before
extensive business is
underwritten leading to class
action level claims emergence
‘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.’
Source: The Geneva Association – Annual Report 2013/14
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Emerging Underwriting Risk
Cyber Risk
• Considered by many to be the
underrated risk¹
• Opportunities abound
– Cloud computing
– Social media
– On-line financial transactions
– Electronic personal information
¹Source Aon Risk Solutions: Underrated Threats
AAMGA / A.M. Best / Lloyd's Conference - London
Cybercrime costs global economy
estimated USD 575bn annually²
• Forms of attack
– Theft
– Fraud
– Hacking
– Sabotage
• Risk and opportunity as an
insurance product
² McAfee & Centre for Strategic International Studies
25 September 2014
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Emerging Underwriting Risk
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
Source: The Geneva Association –
Risk Management Newsletter No. 54 June 2014
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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Emerging Underwriting Risk
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
AAMGA / A.M. Best / Lloyd's Conference - London
Soft Market Dangers
• Loosening terms and conditions
– Free coverage thrown in
– E.g. cyber, terrorism
– Exclusions and sublimits removed
25 September 2014
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.Thank You
AAMGA / A.M. Best / Lloyd's Conference - London
25 September 2014
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AAMGA / A.M. Best / Lloyd’s Conference - London
Enterprise Risk Management
Rating Analysis & Industry Best Practices
Stefan Holzberger
Managing Director, Analytics - EMEA
25 September 2014