A Case Study:
ERM Implementation
at Erie Insurance
Gene Connell, Senior Vice President – Actuarial
Erie Insurance Group
Casualty Actuarial Society Spring Meeting – June 2007
Chief Actuary’s perspective on ERM
• Background: Who is Erie Insurance?
– Regional
• Independent Agents
– Reciprocal
•
•
•
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3.8 million policies
$3.8 billion net written premium
$4.3 billion in surplus
$10.0 billion in invested assets
– 22nd largest P/C insurer in US
ERM is a hot topic
• MS Office
– Doesn’t recognize ERM
– Does recognize “hooey”
• Google:
– “ERM” has 10,700,000 hits
– “Hooey” has 483,000 hits
ERM is not well defined
• General Counsel – compliance
• Internal Audit – controls
• Actuaries – DFA
• Risk Managers – path to becoming king
of the world
ERM Goal: Increase the Mean and
Reduce the Standard Deviation
Corporate Earnings
ERM Goal: Increase the Mean and
Reduce the Standard Deviation
Efficient Frontier
11.00%
Efficient Frontier Analysis
10.00%
Return
Average Return
9.00%
8.00%
7.00%
6.00%
5.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
9.00%
10.00%
11.00%
12.00%
Standard Deviation of Return
Exchange Restricted
Risk Level
Exchange
Unrestricted
Restricted Optimal
Optimal
Indemnity
13.00%
ERM Identifies/Measures Risk Events
Corporate Earnings
ERM Identifies Strategies to Control Risk
Corporate Earnings
Absorb, reinsurance
Rate reduction, technology
Hedge, reallocate
Compensation, technology
Reinsurance, reduce exposure
Audit
ERM Optimizes Risk Management
Corporate Earnings
Absorb, reinsurance
Rate reduction, technology
Hedge, reallocate
Compensation, technology
Reinsurance, reduce exposure
Audit
Brief History of ERM at ERIE
• I was asked by CEO to “do ERM”
– Board inquiries
– Magazines and consultants: “hot topic”
• Created a “risk universe”
• Did high level risk inventory
– Senior management and Board involved
• Easy part
Partnering
Industry
Product Distribution
Change Readiness
Outsourcing
Competitor
Knowledge Capital
Alignment
Customer Service
Human Resource
Political
Strategic
Customer
Satisfaction
Innovation
Relationships
Leadership
Infrastructure
Info Integrity
Financial Markets
Operations
Info Relevance
Credit
Technology
Info Access
Liquidity
Capital Adequacy/
Availability
Measurement
Investment
Performance Gap
ERIE Risk
Universe
Litigation
Communications
Regulatory
Reporting
Insurance
Contractual
Obligations
Catastrophe
Financial
Compliance
Fiduciary
Terrorism
Business
Interruption
Product
Development
Pricing
Version 3: April 7, 2007
Customer Wants
Taxation
Regulatory
Regulatory
Policy/Procedure
Accounting Info
Governance
Legal
Budget/Planning
Internal Controls
Employee/Third
Party Fraud
Corporate
Governance
Illegal Acts
Conflicts of Interest
Management Fraud
Privacy
Reporting
Comparison of Top Ten Lists
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Management
Technology Innovation
Infrastructure
Change Readiness
Product Distribution
Performance Gap
Product Development
Measurement
Partnering
Competitor
Budget & Planning
–
–
–
–
–
–
–
–
–
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Board
Catastrophic Loss
Technology Innovation
Infrastructure
Change Readiness
Business Interruption
Competitor
Leadership
Pricing
Performance Gap
Product Distribution
Organizing for ERM at ERIE
• Have CEO, Board support
• ERM Steering Committee
– Executives: COO, CFO, and General Counsel
– Internal auditor and Chief IT officer
• ERM Working Group
– Representatives from investments,
underwriting, risk management, accounting,
actuarial, planning, internal audit, IT
• Consultant to help keep things moving
ERM Governance Structure
Board of
Directors
ERM
Steering
Committee
Executive
Mgt. Team
Senior
Mgt. Team
ERM
Working
Group
ERM Facilitation & Support
Divisional
ERM Reps.
ERM Responsibility
ERM Working Group Deliverables
•
•
•
•
•
Governance Structure
Policy Statement
Framework
Education, Tools and Metrics
Periodic Reporting
– Board Audit and Strategy Committees
– Ad hoc depending on Board’s concerns over
risk areas or ERM Committee’s need for
direction
Actuarial’s role in ERM at ERIE
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Chair the ERM Steering Committee
Pricing uncertainty (range of indications)
Loss reserve uncertainty (range of estimates)
Dynamic Financial Analysis
Reinsurance Evaluation and Decision Support
Economic capital concepts
ERM process and reports
Dynamic Financial Analysis (DFA)
Historical and Projected Ranges of Combined Ratios
150%
140%
130%
120%
110%
100%
90%
80%
70%
Historical
2002
2003
2004
2005
2006
2007
2008
Reinsurance Alternatives
Net Loss Ratio
105%
95%
85%
75%
65%
55%
Direct (No
reinsurance)
Layer A
1 in 10 Chance of Exceeding
1 in 500 Chance of Exceeding
1 in 1000 Chance of Exceeding
Layer B
1 in 100 Chance of Exceeding
1 in 50 Chance of Exceeding
Layer C
Capital Adequacy of P/C Operations
A+/A++ Benchmark Capital
Company Action Level
Q
4
20
09
Q
3
20
09
Q
2
20
09
Q
1
20
09
Q
4
20
08
Q
3
20
08
Q
2
20
08
Q
1
20
08
Q
4
20
07
Q
3
20
07
Q
2
20
07
Q
1
20
07
20
06
Q
4
Policyholder
millions
in millions)
Surplus(in
PolicyholderSurplus
Risk capital at 2006Q4 is $X.X billion, given risk tolerance of 0.25% and 3.0 year time horizon. Statutory
Capital held is $Y.Y billion. This results in discounted excess capital of $Z.Z million
Risk Capital (1-in-400, 3.0 Yr)
Capital Adequacy after Terrorism
A+/A++ Benchmark Capital
Company Action Level
Q
3
20
09
Q
2
20
09
Q
1
20
09
Q
4
20
08
Q
3
20
08
Q
2
20
08
Q
1
20
08
Q
4
20
07
Q
3
20
07
Q
2
20
07
Q
1
20
07
Q
4
20
06
20
06
Q
3
Policyholder Surplus
millions)
in millions
Surplus (in
Policyholder
Risk capital at 2006Q3 is $X.X billion, given risk tolerance of 0.25% and 3.0 year time horizon. Statutory
Capital held is $Y.Y billion. This results in discounted excess capital of $Z.Z million
Risk Capital (1-in-400, 3.0 Yr)
Capital Adequacy w/o Home
millions
Policyholder
PolicyholderSurplus
Surplus (in in
millions)
Risk capital at 2006Q4 is $X.X billion, given risk tolerance of 0.25% and 3.0 year time horizon. Statutory Capital
held is $Y.Y billion. This results in discounted excess capital of $Z.Z million
2006Q4 2007Q1 2007Q2 2007Q3 2007Q4 2008Q1 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4
A+/A++ Benchmark Capital
Company Action Level
Risk Capital (1-in-400, 3.0 Yr)
Other
Investment (nonadj)
Cat Net Reins
Cats NoReins
LOB 8 N onCat
LOB 7
LOB 6
LOB 5 N onCat
LOB 4 N onCat
LOB 3 N onCat
LOB 2 N oncat
LOB 1 N onCat
PHS
Change
Projected
3 Year
3 Year
Projected
Change
in PHSin(millions)
Source of Variation in Policyholder Surplus
3 Year Time Horizon ending 2009Q4
Box Represents Range of 99.5% of DFA Paths - Net FIT
ERM Process and Reports
• Huge potential impact on company
– Improve decision making by incorporating
financial discipline
• Risk identification and measurement
• Response prioritization and measurement
• Clearing house of risks and responses
– Reduce redundancy
– Sleep at night list for CEO, Board
My Opinion on ERM
• At this time:
– ERM is overblown
– Expectations are too high
– Those of us who have to deliver ERM
find that no one has done it well yet
– Easy to spend $$$ and resources
– Easy for it to be a bureaucratic drag
My Opinion on ERM
• BIG plus: Getting company to consider the
potential downside as well as upside of any
initiative
– ERM is potential antibiotic for “PowerPoint
disease”
– This alone has enough potential to pay for
ERM headaches
Actuaries are well-positioned
to be effective ERM officers
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•
•
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Quantitative skills
Financial knowledge
Understanding of stochastic methods
Familiar with translating business needs into
models
• Actuaries particularly well suited for insurance
industry ERM positions
Watch Out For:
• Overlooking the many, critical non-actuarial
aspects
• Resource drains
– It takes skilled staff; it is not trivial
• Reactions of rest of company
– Another bureaucratic headache
– Silos unwilling to give up their autonomy
• Unrealistic expectations
ERM is Today’s Reality
• ERM is a wave sweeping
through the industry
• A big wave – it will not
pass on by
• Ride it, don’t fight it