Enterprise Risk Management
in the Insurance Industry
July 30, 2003
Capital
Consistenc
y
Return
Growth
Value
What is Enterprise Risk Management
and why is it important to the insurance industry?
Agenda
 Key findings of the ERM benchmarking survey
 Results of related interviews and other intelligence
 Strategic implications
ERM benchmarking study
Why We Did it
What We Hoped to Accomplish
 Many believe ERM holds great promise  Determine current state of ERM in
insurance industry
 Approach to help companies
achieve financial and strategic
 Judge relevance of ERM to broader
objectives
business issues
 But it is unclear whether:
 Identify current management practices
 Senior managers see the value of
 Assess satisfaction with current
ERM
processes, tools and techniques
 Companies are realizing the value
We surveyed and interviewed
leading insurance executives around the world
 Surveyed 66 insurance industry chief financial officers, chief actuaries and chief risk
officers in major markets worldwide
 Geography: 60% North America, 40% rest of world
 Company structure: stock, mutual, other
 Type of operations: life insurance, property/casualty insurance, mutual funds,
banking
 Company size: $25 million to $10 billion in direct written premiums
 Supplemented with in-depth interviews/company visits
Nearly all respondents share a basic understanding of ERM
Definition
of ERM
Objective
of ERM
 Rigorous approach to assessing and addressing risks from
all sources that:
 Threaten strategic and financial objectives, or
 Represent an opportunity for competitive advantage
 Enhance enterprise value by:
 Improving capital efficiency
 Supporting strategic decision-making
 Building investor confidence
Here are our key findings in a nutshell
 Executives believe ERM is critical to helping them deal with their key business
issues
 They are not satisfied with current tools, techniques and processes to implement
ERM — especially for dealing with operational risks
 They want a more robust conceptual and methodological framework that:
 Encompasses all relevant risks — both financial and operational
 Integrates both financial and operational strategies to manage those risks
Detailed Findings
“Top Ten Issues Facing Insurers Today”
1. Earnings growth
2. Revenue growth
3. Return on capital
4. Expense control
5. Competition
6. Capital management and allocation
7. Earnings consistency
8. Pricing adequacy
9. Asset/liability management
10. M&A activity
Respondents believe that ERM will help
them address their top ten business issues
Will ERM help address the top ten issues?
Earnings growth
80%
Revenue growth
47%
Return on capital
97%
Expense control
57%
Competition
62%
Capital management/allocation
100%
Earnings consistency
100%
Pricing adequacy
72%
Asset/liability management
81%
M&A activity
80%
0%
10%
20%
30%
40%
50%
60%
70%
% of Respondents Selecting “Yes”
80%
90%
100%
Companies are trying to manage their
most important financial and operational risks
Are you actively managing important risks?
Technology
89%
Interest rate
85%
Distribution channel
81%
Reputation/rating
82%
Expenses
92%
Products
89%
People/intellectual capital
60%
Asset market value
75%
Liquidity
88%
Credit
77%
Reinvestment
67%
Political/regulatory
66%
Liability
76%
Catastrophe
71%
Capital markets
37%
Currency
44%
0%
10%
20%
30%
40%
50%
60%
70%
% of Respondents Actively Managing
80%
90%
100%
Respondents are generally satisfied with the
tools they are using to manage financial risks...
How satisfied are you with your current tools to manage risk?
87%
Interest rate
75%
69%
84%
Credit
78%
73%
82%
Reinvestment
63%
67%
80%
Asset market value
71%
64%
77%
Liability
71%
71%
76%
77%
Liquidity
66%
69%
Currency
74%
74%
69%
Capital markets
53%
Assessment/measurement
58%
Mitigation
Retention/transfer
…But they are less satisfied with the
tools they are using to manage operational risks
How satisfied are you with your current tools to manage risk?
69%
Reputation/rating
60%
57%
66%
Products
58%
62%
66%
Political/regulatory
61%
56%
64%
Expenses
43%
49%
63%
Technology
50%
48%
62%
Catastrophe
55%
54%
61%
Distribution channel
53%
49%
People/intellectual capital
28%
Assessment/measurement
34%
33%
Mitigation
Retention/transfer
Other key findings
 Very few companies have a chief risk officer (CRO), although the position is much
more prevalent outside of North America
 Companies recognize the importance of integrating risk into their company’s
strategic, operational and financial planning, but not all do so because of:
 Tools
 Organizational turf
 Processes
 Time
 Most companies include operational risk in the internal audit plan, but far fewer
include financial risk
Continued . . .
Other key findings
 Less than half of respondents are factoring interactions among risk sources into
their:
 Assessment/measurement
 Determination of diversification benefit
 Mitigation/financing strategies
 There is a high level of dissatisfaction with respect to:
 Stochastically modeling the important risks
 Including operational risk in determining economic capital
 Prioritizing disparate risks using a common metric
 Optimizing financial and operational strategies in light of risk/reward
requirements
 Coordinating all these activities within a coherent framework
Strategic Implications
We see several strategic implications of the study results
 Insurers face great uncertainty that challenges consistent high performance
 Investors, regulators and rating agencies are demanding consistent performance,
especially earnings
 Insurers do not believe they have the tools to manage the risks that create the
uncertainty — particularly operational risks
 Insurers need an industry-specific ERM
The study suggests an insurance-specific ERM conceptual framework
ERM is a process to optimize the dynamic relationship
between risk and value throughout the insurance enterprise
ERM Comprises:
Enterprise Value is Driven By:
 The development, implementation
and monitoring of financial and
operational strategies that treat the
assessment, measurement,
mitigation and financing of financial
and operational risks for the
purpose of increasing enterprise
value
 Providing appropriate level, structure
and allocation of capital
 Growing earnings and increasing
return on capital
 Improving consistency of earnings
This framework can also be illustrated graphically
Consistency
Return
Growth
Increase Value
Capital
Understand both internal
and external environments
Economic
conditions
Social/Legal
Trends
Expansion/
Diversificatio
n
Culture
Political/Regulatory
Climate
Natural
Catastrophes
Customer
Behavior
Competition
Investor
Expectations
Distribution
Risk
Appetite
People
Holistically
manage
all risks
Capital
Structure
Financial Risk
Exploit
natural hedges
and
portfolio effects
Pricing
Internal Controls
Incentive Programs
Product Mix
Dynamic
Hedging
Operational Risk
M&A
Technology
Investment
Strategy
Processes
Technology
Investigate both financial
and operational strategies
Hiring/Training
Customer Service
Market Strategy
Reinsurance
Distribution
The framework must recognize the unique nature of insurance
operations
 ERM for insurers and ERM for other financial services companies have some
similarities — and some fundamental differences
 Single-period value-at-risk approaches are not sufficient for insurance
enterprises
 Statistical approaches do not capture causal relationships
 Structural simulation models are needed to anticipate the complex
interrelationships among risks in dynamic environments
The right framework can yield the results
that insurers want but say they aren’t getting
The Right ERM Framework Can Help Insurers:
 Determine necessary capital level and structure, efficient deployment of capital and
improved return on capital
 Properly allocate capital to business segments, supporting performance tracking
 Ensure that owners receive proper compensation for risks they assume
 Determine the optimal risk financing strategy
And It Can Provide:
 Stability in earnings
 Improved information
In summary...
 Insurance executives believe ERM is critical to helping them deal with their top
business issues
 They are not satisfied with the current tools, techniques and processes they are
using to implement ERM
 They want a more robust conceptual framework and methodology that is unique to
their industry
 Analysis of survey results and interviews suggests what that framework would look
like — and that it would deliver on the promise of ERM for insurers