Enterprise Risk Management:
What’s the Fuss All About?
Brian C. Schneider, CPA, CPCU - Director
Casualty Loss Reserve Seminar
September 11, 2006
Takeaways
 Next Logical Step in Risk Management
 Measure What You Manage
 Enterprise “Reward” Management
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Premise #1:
Next Logical Step in Risk Management
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“ERM is the discipline by which an organization in
any industry assesses, controls, exploits, finances,
and monitors risks from all sources for the purpose
of increasing the organization’s short- and longterm value to its stakeholders.”
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ERM is nothing “new” – improves existing skills
 Insurance is the business of risk assumption (or risk trading)
 Insurers must be the pre-eminent risk managers
 Evolution of Three Letter Acronyms:
 ALM: Asset / liability management
 DFA: Dynamic financial analysis
 ERM: The latest trend
 Aided by vast improvements in technology and data management
 Greater regulatory oversight due to corporate malfeasance
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Risk Management Features
Risk
Governanc
e
(people, process)
Monitoring,
Assessment,
Reporting
Capital
Modeling,
Allocation
Crisis
Management
(catastrophe, operational)
What else?
What if?
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Benefits of ERM – “squishy”
Consistent
strategic and
financial
decisionmaking
Common
“risk
language”
throughout
organization
Potential to
eliminate
inefficiencies
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Better risk
and crisis
management
Earlier
identification
of problems
Improved
Board and
statement
disclosure
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What Goes Into Fitch’s Rating Analysis?
Organizational
Review
Industry
Analysis
Management
Quality
Rating
Analysis
Financial
Review
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Operational
Analysis
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Has Our Rating Methodology Changed?
 Since Risk Management is not new, no reason to create a
new component to our rating methodology
 Not a new “pillar”
 Risk management is a fundamental component of rating
analysis
 Analysis is updated to understand / utilize today's management
techniques and related information output
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ERM Cuts Across All Aspects
Industry Review
Operational Review
Organizational Review
Financial Review
E
R
M
Management Review
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Overall Rating Analysis - Methodology
ERM
Organizational
Review
Industry
Analysis
ERM
ERM
RATING OPINION
Management
Quality
Financial
Review
ERM
ERM
Operational
Analysis
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Premise #2:
Measure What You Manage
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Measure What You Manage
 Financial analysis “proves” the success of ERM process




How successful were limits / reinsurance programs
How successful were underwriting / pricing decisions
Did management have crisis programs in place - liquidity backstops
Number of “exceptions”
 Economic Capital is a Cornerstone
 Fuels growth opportunities
 Offers protection to stakeholders
 Maximizes value – not too much, not too little
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Considerable Time Spent on “the Numbers”
ERM
Organizational
Review
Industry
Analysis
ERM
ERM
RATING OPINION
1.
2.
3.
4.
5.
Earnings
Reserves
Capital
Investments
Asset / Liability
Management
6. Liquidity
7. Financial flexibility
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Management
Quality
Financial
Review
ERM
ERM
Operational
Analysis
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Where does Prism come in?
Organizational
Review
Prism
Industry
Analysis
Management
Quality
Rating
Analysis
Earnings
Reserves
Capital
Investments
Asset / Liability Management
Liquidity
Financial flexibility
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Financial
Review
Operational
Analysis
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Capital Adequacy Requires Three Perspectives
Prism
•
•
•
•
Official “scorekeeper”
May be insufficient for
today’s products /
issues
Regulatory
Requirements
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Independent, third-party review
Consistency – universal model /
work with the data provided
•
•
Granular data / product analysis
Moral hazard of opportunistic
assumptions
Insurer’s Internal
Capital Models
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Prism’s Targeted Approach
Stochastic platform with interactive surveys
using consistent assumptions
Current
regulatory models
Simple
Less than vertical is unresponsive
>
Arbitrary adjustments
>
Incomplete scope
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Optimal Spot for Fitch
is Vertical
Insurer’s InHouse Capital
Model
Complex
Past vertical is inefficient
>
Too much data
>
Too much time
>
Lack of comparability
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Prism Features
Adaptable to more closely reflect an
insurer's unique financial profile
A common platform from
which to evaluate insurers
globally
A sophisticated, stochastic
methodology
Powered by a realistic, economically
based stochastic engine
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Integrates and
analyzes risk on a fully
aggregated basis
Uses country-specific data for insurance
risk parameterization
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Many papers available at www.fitchratings.com/prism
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Premise #3:
Enterprise “Reward” Management
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ERM Pitfalls
 Resource issues
 Objectives
 Benefits
 Complexity
 Modeling / measurement
issues
 Data / IT constraints
 Credibility of results
 Model over-reliance
 Garbage In, Garbage Out
 Over-optimization
 Inappropriate diversification
 Must have fundamental skills
 Greatest asset: People
 A few can bring firm down
 SBU become risk-averse
 Pass up opportunities since
business line hurt but firm
benefits
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Business 101
 Adequate compensation for risks undertaken
 Cannot mitigate all risks – leaves no profit opportunity
 Firm’s appetite for risk
 Past performance is not always a good future predictor
 Equity markets
 Catastrophe events
 Knowing the unknown
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ERM Sample Questions
•
•
•
Assess current regulatory,
legal and accounting risks
Describe ensuing
competitive factors
•
•
•
•
Show expected variability in
future earnings
What is your risk exposure
What is economic capital
threshold
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List support agreements
amongst entities
Stress-test upstream
dividend capabilities
•
What risk reports are
monitored by your Board
Define your risk appetite
•
•
•
What crisis management
plans do you have
List top threats to franchise
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Enterprise “Reward” - Sample Questions
 What is your expected variability in future earnings projections - by
business line and in aggregate?
 What is your estimated redundancy or deficiency in your liabilities – by
business lines and in aggregate?
 How much capital is considered in place to support the current book of
business on balance sheet versus expected new sales?
 What do you determine your capital needs to be related to operational
risk?
 At what thresholds do you target for economic capital?
 How does your risk mitigation efforts – reinsurance, securitization,
hedging – lower your required capital needs? How do hedging strategies
influence your earnings profile?
 Do you consider potential liquidity charges in your various economic
scenarios? If yes, what are they?
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Recap
 ERM: Next Logical Step in Risk Management
 Measure What You Manage
 Enterprise “Reward” Management
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Fitch Ratings
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