ERM Roundtable Where Are We? CAS Spring Meeting May 8, 2006 John Kollar, ISO Dave Ingram, S&P Steve Lowe, Tillinghast Don Mango, Guy Carpenter CAS ERM Definition • Process Assess Control Exploit Finance Monitor risk • Holistic treatment of risk • Senior management function • Upside and downside ERM “Drivers” • • • • Improved corporate governance Consolidation Financial services convergence Globalization Intl. Assoc. of Insurance Supervisors (IAIS) Basel II/Solvency II Intl. Accounting Standards Board (IASB) • Risk management evolution Underwriting Risk Model (URM) Experience • “Missionary work” Why change? • Senior management commitment Priority item Clear objectives Adequate resources Start small Underwriting Risk Model (URM) Experience • Availability & quality of data Less is easier • Coordination of functions • Risk integration • ERM A lot of potential Long way to go Value Statement Risk Parameters Risk Analysis Pricing Risk Economic Capital Risk Allocation URM Interest Rate Risk Reinsurance Combined Ratios ERM ERM Evaluations Insurance Sector CAS Spring Meeting May 2005 David Ingram Director Enterprise Risk Management Financial Services Ratings S&P’s Evaluation of ERM Strategic Risk Management Risk Management Culture 7/26/2016 9 Overall ERM Evaluation 45 companies Excellent 7% Weak 9% Adequate 60% 7/26/2016 10 Strong 24% ERM within the S&P Rating Profile Competitive Position Management & Corporate Strategy Operating Performance Capitalization Liquidity Investments Financial Flexibility ERM 7/26/2016 Stronger 11 ERM within the S&P Rating Profile Competitive Position Management & Corporate Strategy Operating Performance Capitalization Liquidity Investments Financial Flexibility ERM 7/26/2016 Stronger 12 ERM within the S&P Rating Profile Competitive Position Management & Corporate Strategy Operating Performance Capitalization Liquidity Investments Financial Flexibility ERM 7/26/2016 Stronger 13 ERM – Key Points 1. ERM is a new organizing concept – For looking at a collection of issues we have always covered 2. ERM will apply to all insurers globally 3. ERM evaluation will be tailored to the risks of each insurer 4. ERM will recognize all the risk management of the insurer • even if the company does not do “ERM”!!! 5. ERM will be reflected in insurer ratings • Importance of ERM will vary among companies – just as every other factor does 6. ERM will be a new section in the ratings report 7. ERM is not a new Capital Model • ERM is not primarily concerned with looking at an insurer’s Economic Capital Model ERM ERM Value Framework Maximize value by relating a firm’s decisions on the risks it takes to the decisions on the capital it uses to finance its business Reconciles actuarial and corporate finance perspectives © 2006 Towers Perrin Value Creation Capital Costs Return on Risk Value Management Portfolio of Enterprise Risks Risk Structure Capital Adequacy Risk and Capital Management How much capital do I need? Portfolio of Capital Resources Capital Structure What type of capital do I need? Economic Capital Value creation can come from optimizing the structure of the risk portfolio Capacity-based pricing of catastrophe exposure Marginal return on marginal capital Asset allocation strategy Is risk minimized by matching bond maturities to the expected cash flows of Workers Compensation claims? Is risk minimized by matching the assets by currency to liabilities by currency? © 2006 Towers Perrin Value creation can come from optimizing the capital structure of the firm Reinsurance optimization Choosing Best Retention for Contract With $1 Million Limit 40% Cost of Capital 35% Too much "trading of dollars" Too far out "of the money" 30% 25% 20% 15% 10% 5% 0% 0 1000 2000 3000 4000 Retention ($ Millions) © 2006 Towers Perrin 5000 6000 ERM ERM in Reinsurance Industry • Hold-to-maturity, levered portfolio of longdated, illiquid, OTC derivatives on untraded underlyings • Less transparency than primaries (one layer removed) • More volatility (we take the tails) • Global platforms, Diversified offerings Complex organizations • Significant model and parameter risk ERM in Reinsurance Industry • Munich Re, Swiss Re, Allianz, Zurich, Hartford have large risk organizations with significant actuarial leadership – But they probably need large risk organizations! • “Franchise” of a reinsurer = non-public information purchased @ UW results, stored in minable format, used to build proprietary forecast models – Appalling data quality and no data transfer standards • Compare with banking and lending – See www.fpml.com Threats to Reinsurance Industry • Business: – Mega cat ($100B) – Concentration of risk (~mercury at the top of the food chain) • Structural: – Underwriter incentive comp plans – Ease of entry, undifferentiated product – Optimism and overconfidence (Morton Lane: the perfume of the premium overwhelms the stink of the risk) ERM Where is the CAS Today? • • • • • • Centennial Goal ERM Symposium Risk Management Section New VP position ERM Vision ERM Institute International (ERM-II) Where Should the CAS be Going?