focus | support | accelerate
ERM Symposium
t
Jim Rozsypal
Partner Risk Management Practice Ernst & Young
Agenda
 Issues and trends in emerging risk management practices
 Best practices and implementation challenges
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Competing Pressures on Management
 Management must reconcile differences of views among key
constituents
Rating Agencies and
Investors
Risk
Default on Obligations
Loss of Value
Capital
Amount of Net Assets
Value of Investment
Accounting Returns
Return on Investment
Performance
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 Differences in focus and perspective can lead to conflicting
actions
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Risk Management Continuum Market Trends
Banks are leading the pack ; and
will continue to improve as they
rush to meet Basel by 2005/6
Most companies are
positioned here with leading
edge companies
moving up the continuum.
Stakeholder Value
ERM
Risk
Specialization
Treasury
Credit
Insurance
Legal
Enterprise-Wide
Risk Assessment
Value / Risk
Optimization
Risk
Management
Integration
Risk quantification, capital
measurement, KPI and KRI
Measurement Alignment with
balanced scorecard and broader
organization measures.
Sophistication
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What are Companies doing?
 Building a bridge across risk silos:
—Realigning management responsibilities to facilitate integrated
discussions of risk across the enterprise
—Aggregating risk through common issues and exposures
—Aggregating risk through capital measurement
 Strengthening the management of non-financial risks:
—Putting accountability for these risks back in the business
—Implementing operational risk management frameworks
—Developing internal control assessment methods, tools and
processes supporting compliance with Sarbanes-Oxley controls
certification
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Steady Movement Toward Integrated
Risk Management
Integrated Risk Policy Framework
Market Risk
 Market risk policy and limits
 Valuation and risk measurement
methods
 Market data and forward curve
modeling
 Stress and scenario testing
 FAS
Credit
Risk133 issues and considerations
 Credit risk policy and limits
 Counterparty hierarchy definition
 Internal ratings methodology
 Exposure and default probability
measures
 Stand alone and portfolio credit risk
Operational/Business Risk
 Risk control policy and framework
 Business risk definition and risk
assessment
 Measurement methodology and
assumptions
Economic
Capital
 Measureme
nt
methodolog
y
 Risk
Integration
 Capital
Allocation
Proactive Portfolio
Management
 Risk adjusted
performance
measurement
 Risk based pricing
 Risk management
strategies
Insurance Risk
 Underwriting and pricing policies
 Actuarial and financial modeling
 Loss/Reserve valuation methods
 Stat/Gaap/economic earnings
reconciliation
Risk Management Technology Infrastructure
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Capital Management, Performance
Measurement Alternatives
Financial Performance
Metrics
Accounting Based
Metrics
ROE
ROI
ROA
Economic Driven Metrics
Measures of Risk and
Capital Adequacy
External Risk Capital
Requirements
Measures of Return
Adequacy
Internal Economic
Capital Process
Regulatory
Bottom-up
Rating Agency
Volatility of
Asset/Liability Values
Best suited for:
 Determining capital adequacy
 Supporting risk-adjusted return
measurement
 Evaluating customer, product
and business risks, capital
consumption and profitability
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 Supporting marginal pricing
Single Period
Top-down
Multi Period
Economic Profit
Embedded Value
Shareholder Value Added
Appraisal Value
Earnings Volatility
Best suited for:
 Assessing adequacy of business
returns
 Business planning and financial
forecasting
 Evaluating strategic investments
 Linking to reward framework
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Trends in Risk Measurement
and Performance Reporting
 Greater interest in more aggressively managing capital and
returns due to stakeholder pressures
 Availability of company-specific economic capital measures of
growing importance in rating agency discussions
 Move toward common performance measures, cutting across
an enterprise and allowing all businesses and managers to be
evaluated on a consistent basis
 Numerous alternative performance measures are in use:
—Clear trend toward “economic” measures, away from accounting
measures
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—Consensus emerging around “Risk Adjusted Return on Capital”
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Emerging Best Practices in Methodology
 Market value measurements increasingly viewed as the best
conceptual framework, despite practical and management
challenges
 Recognition of limitations of regulatory/rating agency risk
measures as drivers of business change
—Excess regulatory/rating agency capital viewed as a cost of doing
business
 Risk and capital measures more commonly based on earnings
volatility, rather than insolvency considerations
 Growing interest in separation of investment and business
activities for capital allocation and performance measurement
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 Trend toward use of hurdle rates specific to each business
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Emerging Best Practices in Management
Processes
 Banks have been doing it longer, offering both good and bad
experiences
 Many insurers are designing and implementing RAPM, but far
fewer have been successful
 Rapid integration into management processes is crucial,
including:
—Quarterly performance reporting
—Business planning
—Incentive compensation programs
—Rating agency discussions
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—Pricing methodologies
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Implementation Challenges
 Data, Systems, Resources and Processes
— Relevant data for a rapidly growing business/enterprise
— Financial modeling expertise, adequacy of resources
— Dealing with dependencies on other management processes, e.g.,
planning, reporting
— Institutionalizing an efficient process
 Change Management
— Getting real buy-in
— Integrating into decision making processes, incentive compensation
programs
— Communicating with stakeholders, e.g. rating agencies and analysts
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Implementation Challenges
 Methodology
— Selecting among measurement alternatives to compare
heterogeneous businesses
— Reconciling to GAAP results
— Knowing when to stop drilling down
— Many complex technical issues
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