CAS: Risk and Capital Management Seminar
July 29, 2003
Washington, D.C
Claus S. Metzner, FSA, FCAS, MAAA, Aktuar-SAV
EPIC Actuaries, LLC

What is ERM?
 Is it a Tool?
 Is it a Theory?
 Is it a way of Managing?
 Is it a Benefit?
 Is it a Fad?

What is ERM?
 ERM is:
 Focusing on all risks
 Financial risks
 Operating risks
 Developing appropriate risk constraints
 Including checks and balances
 Assessing risk/return trade-offs
 Assuring the enterprise is operating within the predetermined risk constraints

What is ERM?
 ERM is Not
 Modeling
 Models can be very helpful in quantification of trade-offs
 Models can be very helpful in developing a “base case”
 Bureaucratic
 Stifling

 Extreme Events
 What are they

Severity/frequency
 Maximum Possible Loss
 How defined

Severity/frequency
 Price Adequacy
 Long term/short term

 Balance Sheet “Honesty”
 Risk Appetite



Level of assessment: Firm wide or subsets?
 % of Earnings?
 % of Revenue
 % of Capital
What fluctuation is “tolerable”
What fluctuation is “unacceptable”
 RAROC

Risk adjusted return on capital

 Is ERM prospective
 What is the relevant time frame?
 Does the time frame vary for different risks?

Pricing risk

Reserving risk

Reputation risk
 Considerations

When do we know something

How long before we can take corrective actions

 Asset Risk
 Liability Risk (including future business)
 Capital
 Operating Risks/Constraints
 People and processes are important

 Consider: ERM views the enterprise as a going concern
 What are the implications?
 Capital is not just balance sheet capital
 Capital includes the franchise value
 Balance sheet capital (and economic capital) are important since they serve as possible constraints (insolvency has consequences!)

ERM Open Issues
 Asset Risks
 Current models are tested, in existence
 Current models seem to work
 Current models can provide some operating metrics, e.g. Value at Risk

Cautionary Notes
 Remember the LTC debacle
 Who anticipated the drop in equity prices?

ERM Open Issues
 Liability Risks
 Models exist to develop maximum possible loss (e.g. earthquake, hurricanes) and distribution of outcomes for a portfolio of risks
 Output of models is relevant only if appropriate risk control measures are in place (e.g. operational risk management must be in place and effective)

ERM Open Issues
 Liability Risks (continued)
 Models need to consider risks associated with realizing the value of good will
 Reputation risk
 Dynamic responses to pricing/underwriting initiatives
 Responses by customers
 Responses by competitors
 Political responses

ERM Open Issues
 Operational Risk – People and Processes
 Internal perspective

Underwriting

Claims

Pricing

Marketing

Auditing (general financial discipline)

Etc, etc

ERM Open Issues
 Operational Risk – People and Processes
 External Perspective

Response of market to internal initiatives
 Customers
 Competitors

Response of rating agencies

Response of shareholders (publicly traded companies)

Response of regulators

Response of Legislators

Enterprise Risk Management: Benefit or Fad?
 Answer depends on
 How well the liability risks and the operational risks are addressed
 Consider – we may need to develop day to day operational metrics
 Quantification (modeling) comes after, not before, we understand the risks
 Holistic view of the risk management process
(RAROC)
 Many tools are available, but these appear to not yet be integrated into a cohesive risk management program

Enterprise Risk Management: Benefit or Fad?
 Considerations for Improvements
 Develop Operational Risk Assessment
 Function of Management
 Co-operative Effort across all disciplines
 Develop Operational Risk Management Tools
 Some exist (e.g. underwriting guidelines, etc.)
 Develop an Actuarial Control Cycle
 How do we know if experience is consistent with assumptions
 When do we know
 How do we bring information forward to foster adjustment to new reality

Enterprise Risk Management: Benefit or Fad?
 Let’s take a vote
 How many believe it is a benefit?
 How many believe it is a fad?