Advanced
PowerPoint
Presentation
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-1
This Advanced PowerPoint
Presentation accompanies the
“Tools & Techniques of Risk
Management & Insurance”
textbook. Each of the 28
chapters in the textbook are
presented here in the following
sections:
Outline
Key concepts
Major sections
Chapter summary
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-2
Contents
Techniques of Risk Management & Insurance
Ch 1 Introduction to Traditional Risk Management……………1-5
Ch 2 Enterprise Risk Management…………………………….2-1
Ch 3 Risk Assessment: Identification…………………………..3-1
Ch 4 Risk Assessment: Quantification…………………………4-1
Ch 5 Overview of Risk Treatment Alternatives………………. 5-1
Ch 6 Non-insurance Transfer of Risk…………………………. 6-1
Ch 7 Insurance as a Risk Transfer Mechanism……………….7-1
Ch 8 Overview of Alternative Risk Transfer Techniques……..8-1
Ch 9 Global Risk Management…………………………………9-1
Ch 10 Loss Control Techniques………………………………..10-1
Ch 11 Emergency Response Planning………………………..11-1
Ch 12 Business Continuity Planning…………………………..12-1
Ch 13 Claims Management……………………………………..13-1
Ch 14 Monitoring Claims for Financial Accuracy……………..14-1
Ch 15 Insurance Companies and Risk Management………..15-1
Ch 16 Working with an Agent or Broker……………………….16-1
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-3
Contents
Tools of Risk Management & Insurance
Ch 17 Commercial General Liability Insurance……………….17-1
Ch 18 The Workers’ Compensation System………………….18-1
Ch 19 Commercial Property Insurance………………………..19-1
Ch 20 Directors and Officers’ Liability Insurance……………..20-1
Ch 21 Employment-Related Practices Liability Insurance…..21-1
Ch 22 Business Automobile Insurance………………………..22-1
Ch 23 Crime Insurance………………………………………….23-1
Ch 24 Capital Markets Risk Transfer Tools…………………..24-1
Ch 25 Loss Control Tools……………………………………….25-1
Ch 26 The Certificate of Insurance…………………………….26-1
Ch 27 Surety Bonds……………………………………………..27-1
Ch 28 Claim Reviews……………………………………………28-1
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-4
Chapter 2
Enterprise Risk Management
Outline
• What is it?
• Purpose of ERM
• Risk Classifications in ERM
• Overlay of Risks
• Concepts in ERM
• Why Use ERM in Lieu of Conventional Risk Management?
• Risk Assessment and Analysis
• Financial Solutions in an ERM Environment
• The Chief Risk Officer
• The Future of the CRO
• Chapter Summary
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-5
Chapter 2
Enterprise Risk Management
What is it?
• ERM is a framework for managing all an organization’s material risks
• The discipline is new – there is not a consensus on ERM ideas
• Risk managers who can embrace ERM will flourish – traditional risk
managers may be dinosaurs
• ERM was first developed to help the financial services industry
• ERM is being adopted globally – some standards exist:
• Australia: ANZ Standard 4360:1995, 1999, 2000, 2004
• Canada: CSA-Q850-97
• Britain: BS 6079-3:2000
• ERM bridges pure risk management with speculative risk management
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-6
Chapter 2
Enterprise Risk Management
Purpose of ERM
•
ERM is an approach to managing risk – not a product or
service
•
ERM has two primary objectives:
1. The reduction of earnings volatility
2. The maintenance and growth of shareholder value
1) Reducing Volatility
•
Recall Risk is the variation from an expected outcome at some time
1) ERM stabilizes the expected earnings during a fiscal period
2) ERM sustains the desired growth of shareholder equity
time
2) Maintaining Shareholder value
P(NI)
Before ERM
Large earnings variance
After ERM
Reduced earnings variance
Fiscal period
Equity
Growth factor
1
2
3
4
5
6
50 52.5 55.1 57.9 60.8 63.8
1.05
One ERM purpose is to reduce
expected earnings (NI) volatility
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-7
Chapter 2
Enterprise Risk Management
Purpose of ERM
Supplement -- Volatility
• Newer ERM models suggest:
Create the desired level of variation
From the expected outcome
In the intended time horizon
•
Enables the risk manager to broaden the
perspective
from pure risks to include value-creating
speculative risks.
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-8
Chapter 2
Enterprise Risk Management
Purpose of ERM
Supplement – Shareholder Value
• Shareholder value vs. stakeholder value
• Stakeholders are parties that have an interest in the
organization’s success (e.g., management and labor,
suppliers and customers, owners and boards of directors,
government and non-government organizations
• Stakeholders demand “triple bottom line” concept
• environmental stewardship
• social justice values,
•
and economic performance
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-9
Chapter 2
Enterprise Risk Management
Risk Classifications in ERM
• There are four main categories:
• Strategic risks
• Hazard/event risks
• Operational risks
• Financial risks
• From two primary sources
• External sources
• Internal sources
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-10
Chapter 2
Enterprise Risk Management
Risk Classifications in ERM
• Strategic
risks
• Defined – long-term, high-level variations in attaining
the business plan.
• Examples:
• Compliance risks
• Planning risks
• Market risks (demand and supply)
• Joint venture risk
• Mergers & acquisitions
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-11
Chapter 2
Enterprise Risk Management
Risk Classifications in ERM
• Hazard/event
risks
• Defined – Variations to traditional risk management
exposures in an organization’s operation. Typically risks
that occur within one operating period. Hazard/ event
risks are generally insured or contractually transferred.
• Examples:
• Property exposures (building damage)
• Third-party legal liability exposures
• Human resources
• Net income exposures
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-12
Chapter 2
Enterprise Risk Management
Risk Classifications in ERM
• Operational
risks
• Defined – Variations to an organization’s operations
(other than traditional hazard/event risks).
• Examples:
• Quality control
• Hiring practices
• Customer satisfaction
• Reputational risks
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-13
Chapter 2
Enterprise Risk Management
Risk Classifications in ERM
• Financial
risks
• Defined – Variations to an organization’s expected
financial asset and financial liability values. These values
may be expressed in the balance sheet, income
statement, statement of cash flows, or notes. All financial
risks are externally derived.
• Examples:
• Earnings risk
• Interest rate risk
• Investment risk
• Credit risk
• Liquidity risk
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-14
Chapter 2
Enterprise Risk Management
Risk Classifications in ERM
Supplement
• Contemporary and simplifying update – reduces the number of risk
classifications to three
• strategic risks – reputation, compliance, market position
• operational risks – event/hazard risks
• economic risks – include traditional finance risks (exchange
rate, interest, and credit risks)
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-15
Chapter 2
Enterprise Risk Management
Overlay of Risks
Supplement
• Overlay of risks
(Figure 2.4) is
modified: the core
strategic risks are
surrounded by
operational risks,
which are then
surrounded on the
outside by the
economic risks
Macro – Economic Risks
Operational Risks
©2009 The National Underwriter Company
Core
Strategi
c Risks
Dr. James Kallman, ARM
2-16
Chapter 2
Enterprise Risk Management
Concepts in ERM
• ERM’s 3 main concepts (of horizontal integration)
• Risk interdependencies – interaction effects
• Correlation / non-correlation – statistical associations
• Modern Portfolio theory – combining exposures in a
balanced portfolio decreases risk
• Additional ERM concepts
 Vertical integration –
Strategic, Operational, & Tactical risks
 Positive Mental Attitude – focus on speculative risks and creating
shareholder value by taking risks
 Sophisticated financial, statistical, & management
concepts
 The CRO is a facilitator – everyone manages their own risks
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-17
Chapter 2
Enterprise Risk Management
Concepts in ERM
Supplement
• 5 main concepts (differentiating ERM from traditional RM)
Traditional RM
ERM
Horizontal integrations
risks quantified separately and
distinctly
interdependencies and correlations between variables
Vertical integrations
focus on operational goals
focus on goals at all of the organization's levels
Facilitation
one-person shop doing all risk
management functions
C-level leader who serves as an internal consultant
helping others achieve their risk-sensitive goals.
Integrated tools
N/A
use tools from finance (e.g., portfolio theory), statistics
(e.g., six-sigma), decision science, and general
management (e.g., behavior modification)
Focus on value creation
(speculative risks).
attempts to minimize silos of risk
focuses on enabling and enhancing portfolios’ desired
risks so as to achieve the commensurate returns
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-18
Chapter 2
Enterprise Risk Management
Why Use ERM in Lieu of
Conventional Risk Management?
• Increase cost predictability
• Decrease risk expenses
• Integrate risk financing plans
• Improve financial security
• Improve understanding of risks – better decisions
• Optimal resource allocation
• Reduce cash flow and earnings volatility
• Improve stock performance
• Decrease cost of capital
• Build stakeholder (shareholder) confidence
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-19
Chapter 2
Enterprise Risk Management
Risk Assessment and Analysis
• Risk Mapping – a graphical analytical tool that allows all material risks to
be plotted in one picture – improves understanding.
• A simple risk map
Hi
R1
R6
Analysis:
R4
 Risks in the green cells (R2, R3, & R5) p(L)
are tolerable probability/severity risks
 Risks in the yellow cells (R1) are
R2
R3,R5
R7
Lo
concerns and need risk control
lo
hi
 Risks in the red cells ( R6) are
$(L)
dangerous and may be catastrophic
The arrows indicate the risk’s movement over time.
 Risk 1 is becoming more severe
over time
 Risk 2 is becoming more likely over time – a loss prevention program is needed
 Risks 3, 4, and 5 are stable
 Risk 6 is become less likely and less severe – perhaps a risk prevention and reduction
program is being used on this risk
 Risk 7 is become less severe over time – perhaps a risk reduction program was used
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-20
Chapter 2
Enterprise Risk Management
Risk Assessment and Analysis
Probability
Supplement – Risk Mapping
• Risk maps continue to evolve
• Now plot all of the organization’s risks – both pure and speculative
• Show gains in value on right side of the origin and losses on the left
• Computers allow modern risk maps to plot events on a continuous scale
5
4
3
2
1
Frequent
Occassional
Infrequent
Seldom
Rare
-3
-2
-1
0
Values
©2009 The National Underwriter Company
+1
+2
Dr. James Kallman, ARM
+3
2-21
Chapter 2
Enterprise Risk Management
Financial Solutions in an ERM Environment
• Integrated Risk Insurance Structures – non-correlated risks are combined in
a portfolio. The result is decreased volatility and more predictable outcomes. This
makes a financial transfer cost effective.
Figure 2.7
Excess Property
Excess GL
Typical Structure – Integrated Risk
Integrated Risk Combined Excess Policy
Primary Policies
Self-Funded Retention
Annual
Aggregate
Retention
©2009 The National Underwriter Company
The primary policies
are non-correlated
risks
Dr. James Kallman, ARM
2-22
Chapter 2
Enterprise Risk Management
Financial Solutions in an ERM Environment
• Impact of Financial Accounting Standard 133 on IR
•A directive on the accounting for derivative contracts
• Derivatives derive their value from an underlying asset
•E.g., Forward, Futures, Swap, Option contracts
• Derivatives used for risk management must be hedge instruments
• A hedge stabilizes the variation from the expected outcome over
time
• Hedge accounting means a derivative’s gains or losses are recorded
in the same period as the underlying hedged item’s income effects
•Hedge instruments are ‘marked to market’ on the balance sheet; gains
and losses are recorded on the income statement
•The event risk and financial risk must not be bifurcatible
• Bifurcatable means the risks can be separated without the
integrated risk program collapsing
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-23
Chapter 2
Enterprise Risk Management
Financial Solutions in an ERM Environment
• Theoretical Benefits of Integrated Risk Structures
• The portfolio reduces variability
– which allows for lower risk transfer costs
• Fewer insurers are used – reducing credit risk
• Reduced administrative costs
• Decreases potential claims disputes among insurers
• Improved protection for balance sheet risks
• Overall risk management is more efficient
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-24
Chapter 2
Enterprise Risk Management
Financial Solutions in an ERM Environment
Perceived Disadvantages of Integrated Risk Structures
• Lack of expertise and experience
• Multi-line insurers and reinsurers may not support integrated risk
- especially in a hard market
• Corporate treasury personnel may be unwilling to cooperate with
risk managers over financial risk issues
• Integrated risk management is a new and untested area – it may
meet resistance
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-25
Chapter 2
Enterprise Risk Management
Financial Solutions in an ERM Environment
Types of Integrated Risk Structures
• Multi-line insurance packages
• Multi-year insurance policies
• Multiline-multiyear insurance program (cross-class program)
• Multiple Trigger Programs
• Combines (often independent)
risks into program that protects
against catastrophic
combinations of losses
• e.g., a Dual Trigger program:
• property loss from
climate event +
decrease in stock price
from financial event
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-26
Chapter 2
Enterprise Risk Management
The Chief Risk Officer
• A staff position reporting directly to the CEO
• The Goal of the CRO:
to protect and enhance shareholder value
• CRO Skills:
• Leadership
• Communication and persuasion
• Get support and buy-in
• Manage people and tasks
• See the big picture (think strategically)
• Understand all risk solutions (risk control and financial)
• Sophisticated financial and analytic skills
• Facilitator of other’s risk management efforts
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-27
Chapter 2
Enterprise Risk Management
The Chief Risk Officer
• Who reports to the Chief Risk Officer?
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-28
Chapter 2
Enterprise Risk Management
The Chief Risk Officer
• Benefits and Advantages
+ Able to make better decisions
+ Thorough and cost effective treatment of all risks
+ Consistent goals across the entire enterprise
• Drawbacks and Disadvantages
– Lack of buy-in
– Concentrates responsibility in one position
– Absence of managerial controls
– Disrupts established business relationships
– Requires a change in corporate culture
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-29
Chapter 2
Enterprise Risk Management
The Future of the CRO
• Audit committees are proactively enhancing the corporate
governance recommendation relative to the management of
financial, operational, and strategic risks
• The CRO must develop sophisticated skills to be capable of this
senior management position responsibilities
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-30
Chapter 2
Enterprise Risk Management
Chapter Summary
•
•
•
•
•
What is it?
• a framework for managing all an organization’s material risks
Purpose of ERM
• Reduce earnings volatility & Maintain shareholder value
Risk Classifications in ERM
• Strategic, Operational, Hazard, & Financial
Overlay of Risks
• A portfolio of integrated risks
Concepts in ERM
• Risk interdependencies, Correlation, Portfolio theory
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-31
Chapter 2
Enterprise Risk Management
Chapter Summary
•
•
•
•
•
Why Use ERM in Lieu of Conventional Risk Management?
• Increase cost predictability
• Decrease risk expenses
• Integrate risk financing plans
• Improve financial security
• Improve understanding of risks – better decisions
• Optimal resource allocation
• Reduce cash flow and earnings volatility
• Improve stock performance
• Decrease cost of capital
• Build stakeholder (shareholder) confidence
Risk Assessment and Analysis
• Risk Mapping
Financial Solutions in an ERM Environment
• Integrated Risk Structures
The Chief Risk Officer
• A leader facilitating the enhancement of shareholder value
The Future of the CRO
©2009 The National Underwriter Company
Dr. James Kallman, ARM
2-32