CLRS
September 2008
Basic ERM Primer for Reserving
Actuaries
Steve Hazelbaker, CPA
VP, Director of Corporate Enterprise Risk Management
STATE AUTO INSURANCE COMPANIES
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
ERM
• General Status at State Auto
• Rating Agencies and ERM
• Operational Risk
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
GENERAL STATUS
• State Auto Group
– 14 Companies
– Property/Casualty Operations in 33 States
– Approximately $1.5 Billion in Premiums and
Surplus
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
GENERAL STATUS
• Obtained Outside Consultation in
Developing ERM Roadmap
• Named ERM Director in November 2007
• Established ERM Committee Consisting of
Key Senior Management
• Clarified BOD Reporting
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
AREAS of INITIAL INVOLVEMENT
• Risk Identification
– Broad Definition of Risk
– Numerous Management and Board Interviews
– Identified Top 25 Risk Areas
– Ranked by Likelihood and Potential Impact
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
AREAS of INITIAL INVOLVEMENT
• Communication with Regulators and
Rating Agencies
• Legal and Regulatory Compliance
• Mergers and Acquisitions
• Business Continuity
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
AREAS of FUTURE FOCUS
• Refine Coastal Strategy
• Complete Assessment of Residual Risks
• Improve Quantification of Risk Appetite,
Tolerances and Other ERM Metrics
• Economic Capital Modeling
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Rating Agencies and ERM
What?
Why?
How?
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Rating Agencies & ERM
WHAT? WHY? HOW?
“Enterprise Risk Management (ERM) has been one of
the most significant and widespread additions to the
insurance industry’s vocabulary in recent memory.”
“What’s new about ERM is the “E”; which
represents the development of an enterprisewide view of risk where insurers can identify,
quantify and manage risk on a more holistic
basis.”
Source: A. M. Best Company, “Risk Management and the Rating
Process for Insurance Companies”, January 25, 2008
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
WHY INTERESTED?
• Enhanced Understanding/Assessment of
Management
• Forward-looking Ratings Focus
• Differentiation Among Insurers
• Value in External Communications
Objective: Improve ratings process by increasing
focus on insurers’ risk management practices.
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Increasingly Evaluating ERM as Part of
Overall Assessment
• Risk Management Culture, Monitoring and
Reporting
• Controls and Mitigation
• Effectiveness of Modeling and Risk-based
Capital Allocation
• Emerging Risk Identification and Preparation
• ERM Integration into Governance, Strategy and
Decision-making
ERM can have significant influence on rating and
outlook changes.
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Industry Risk Profile Trends
SOURCE: A. M. Best Company; “Risk Management and the Rating Process for Insurance Companies; January 25, 2008
High
High Risk
Profile
Earnings
and
Capital
Volatility
Low Risk
Profile
Low
Product Complexity
Low
Financial Strength
·
Reputation
·
Relationships
·
Reliability
High
·
Responsiveness
Enterprise Risk Management
IMPORTANCE
RATING PROCESS
• Importance Can Vary Depending on:
– Complexity of a Company
•
•
•
•
–
–
–
–
Types and number of products
Geographies
Investments
Diversification
Volatility of Earnings
Potential for Significant Loss of Capital
Financial Flexibility
Strength of Traditional Risk Management
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
IMPORTANCE
• Implementing ERM Concepts or Elements
Can Help Any Company
• ERM Will Motivate the Company to
Reduce Risk and/or
• ERM Will Motivate the Company to
Achieve Higher Returns on Risks Taken
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
IMPORTANCE
Limited Capital and Complex Risks
ERM Very Important
Excess Capital and Ordinary Risks
ERM Not As Crucial
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
PUBLISHED RATINGS & REPORTS
A. M. BEST
• Even highly rated insurers may face ratings
pressure over time if they lack ERM and EC
capabilities.
• Separate ERM Opinions Not Published
• Rating Rationales and press releases to provide
insights into relative ERM strength.
• ERM Comments May Appear in Best’s
Insurance Reports
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
PUBLISHED RATINGS & REPORTS
STANDARD & POOR’S
Overall ERM Evaluation, March 2008
3%
EXCELLENT
10%
STRONG
83%
ADEQUATE
4%
WEAK
0%
Financial Strength
·
10%
Reputation
20%
30%
·
40%
Relationships
50%
·
60%
Reliability
70%
·
80%
90%
Responsiveness
Enterprise Risk Management
BCAR, Internal Capital Models & Ratings
• BCAR Is An Important Quantitative Tool for A. M. Best
• Relative ERM Capabilities Can be a Key Factor in
Determining An Insurer’s BCAR Capital Requirement
• Will Expand Use of Companies’ Internal Capital Models
Within the Rating Process
• Independent Assessment of Internal Capital Model is
Necessary to Get “Credit” in Rating Analysis
• “Credit” Determined on a Case-by-Case Basis
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
RATING AGENCIES
Sample ERM Topics, Areas of Interest and Agenda
Items
• Senior Management and Board Involvement
• Risk Management Responsibilities
• Communication, Reporting, and Disclosure
• Traditional Risk Management
• Operational and Strategic Risks
• Impact of ERM on Strategic Decision Making
• Catastrophe Risk Exposure and Management
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
RATING AGENCIES
Sample ERM Topics, Areas of Interest and Agenda Items
•
•
•
•
Key Risk Metrics
Tools (Economic Capital Modeling or Other)
Data Integrity
Risk Aggregation and Correlation, Benefits of
Diversification
• Key Risk Exposures and Related Management and
Mitigation
• Emerging Risk Issues
• Next Steps in ERM Development
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
“The common sense and
discipline of senior
management is the most
important part of enterprise
risk management”
Stefan Holzbeger
A. M. Best Company
ISO ERM Forum
June 26, 2008
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
OPERATIONAL RISK
Operational Risk Components per A. M. Best Company
• Monetary Controls
• Distribution
• Training
• Financial Reporting
• IT Systems
• Turnover
• Legal Controls
• Regulatory
• Data Capture
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
OPERATIONAL RISK
• Can Occur in Any Activity, Functional Unit or
Organization
• Deals with People, Processes and Systems
Across All Business Functions
• Distinction Between Operations Risk and True
Operational Risk
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
OPERATIONAL RISK
Trend Toward Increased Focus on Operational
Risk Management and Quantification
• Regulatory and Modeling Developments
– Risk quantification as part of evaluation of capital
needs
• Quantification is a Technical Challenge
– Insufficient database of historic loss events upon
which to base loss distribution evaluations
– Dynamic risk environment makes it hard to capture
emerging and escalating risks
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
OPERATIONAL RISK
Operational Risk is a Challenging and Developing Frontier
• Less than a third of insurers responding to PWC ERM
survey published in June 2008 are at the stage of
embedding the measurement, monitoring and
management of operational risk into day-to-day
processes.
• Only 15% of respondents believe that their operational
risk data gathering is very capable.
• More than 40% of respondents plan to introduce risk
indicators or risk return metrics and develop loss event
databases in the coming year.
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
Enterprise Risk Management
OPERATIONAL RISK
• Quantification Issues Should Not Detract From
Addressing the Underlying Risks
• Scenario Testing and Expert Elicitation Are
Potential Tools
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness
CLRS
September 2008
Basic ERM Primer for Reserving
Actuaries
Steve Hazelbaker, CPA
VP, Director of Corporate Enterprise Risk Management
STATE AUTO INSURANCE COMPANIES
Financial Strength
·
Reputation
·
Relationships
·
Reliability
·
Responsiveness