1 / 20

Enterprise Risk Management An Introduction to Best’s Enterprise Risk Model

Enterprise Risk Management An Introduction to Best’s Enterprise Risk Model (Developed Jointly with Seabury Insurance Capital, LLC). Michael L. Albanese Group Vice President April 2, 2001. Enterprise Risk Management & The New World of Risks. Where are we today?

xuefang-jun
Download Presentation

Enterprise Risk Management An Introduction to Best’s Enterprise Risk Model

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Enterprise Risk Management An Introduction to Best’s Enterprise Risk Model (Developed Jointly with Seabury Insurance Capital, LLC) Michael L. AlbaneseGroup Vice PresidentApril 2, 2001

  2. Enterprise Risk Management &The New World of Risks • Where are we today? • Best’s view of industry capitalization • Current evaluation process • Where are we going? • The performance imperative • New models for new times? • A holistic view of risk? • Enterprise risks • Role of capital adequacy in the rating process • Performance matters

  3. Best’s Capital Study: Key Findings As of year end 1999: • Over 75% of Best’s Domestic-Rated Groups Maintain “Extra” Capital above their Current Rating Requirements of Approximately $88B • Decapitalization of “Extra” Capital Modestly Boosts Anemic ROEs from 6.5% to 7.3% • Roughly 50% of the Groups Maintain “Excess” Capital above Best’s “A++” Standards • The Top 10 Groups Command 44% of Industry Writings, but Exhibit Little “Extra” Capital (excl. State Farm / Berkshire) Relative to their Ratings

  4. Size Segmentation X/S PHS vs Current Rating % Unit % PHS % NPW % Large (PHS > 250M) Medium (50 - 250) Small (10 - 50) Very Small ( < 10) 15 25 34 26 100 88 9 3 0 100 86 10 3 1 100 $76.1 8.2 3.3 0.6 $88.2 86 9 4 1 100

  5. Best’s Capital Study: Key Findings As of year end 1999: • Only 50% of Companies Rated as “Excellent” or “Superior” Generate Returns on Surplus that Exceed their Cost of Capital • Except for a Minority of Sophisticated Groups, Much of the Industry Lacks Effective Capital Management, Including a Basic Understanding of: • Enterprise Risk Management • Cost of Capital • Risk Adjusted Performance Measurement • Value-Creation

  6. Responding to Market Dynamics—Financial Management • Today “excess” capital likely much lower --market correction, loss reserve deficiencies • Capital allocation vs. capital accumulation • How much is enough? • The optimal capital structure? • Performance measurement • Historical measures • Forward/risk-adjusted view • Value added(Returns > risk-adjusted cost of capital) • Decision basis?

  7. The Performance Imperative • Equal playing field • Performance defines viability • Top line • Bottom line • Value-added products, services, relationships • Performance drives financial strength • Rating considerations • Adequacy, quality, stability • Growing differential among companies

  8. Where are we today? The Current View... • Relative financial strength • Best’s Capital Adequacy Ratio (BCAR) • Regulatory requirements • Risk-Based Capital (RBC) • Future needs • Growth, strategy, competitive positioning • Financial flexibility • Operating results, holding company • Sensitivity analysis

  9. Capital Adequacy — Rating Methodologies BCAR Structure Non-Life B1 - Fixed Income B2 - Equity Securities B3 - Interest Rate Capital B4 - Credit Capital B5 - Reserve Capital B6 - NPW Capital B7 - Business Risk Capital NRC= B12+B22+B32+(.5xB4)2+(.5xB4+B5)2+B62 + B7

  10. Catastrophe Risks — Non-Life • Direct charge to surplus • Higher of: • 100 year hurricane (Net PML) • 250 year earthquake (Net PML) • Include reinstatement costs • Tax-affected

  11. Where are we going? • Future capital needs... • Relative financial strength • Risk-adjusted capital remains important • Emerging risks • Dynamic analysis • VAR framework • DFA?

  12. Enterprise Risk Model — A VAR Framework? • Non-insurance and market related risks • Insurance risk component critically important • Based on mainstream risk management practices • Market metrics vs. regulatory requirements • More dynamic approach • Provides view of all risks, not just insurance • Currently, the financial services standard • Natural extensions -- RAROC, DFA

  13. Capital Adequacy Techniques Complexity Dynamic Financial Analysis Cash Flow Testing Value At Risk Reg. 126 Risk Based Capital Static Ratio Analysis Accuracy

  14. Defining VAR... The estimation of potential loss arising from a change in underlying risk variables (e.g., asset risk, insurance risk, interest rate risk, market risk, foreign exchange risk) over a defined holding period, for a given level of statistical confidence.

  15. Enterprise Risk Model ... ERM Calculation Inputs Capital Markets Data Insurance Risk Database GCM Calculation Engine Company-Specific ER VaR & Risk Cap. - LOB1 VaR & Risk Cap. - LOB2 VaR & Risk Cap. - LOBxx Total VaR & Risk Cap. • Company-Specific • Input • Statement • SRQ • Others Credit I.R. Insur. Market Exchan. Credit I.R. Insur. Market Exchan. Economic Capital* VaR Enterprise risk ratio = *Capital Adjusted for Reserves, Cat Exposures, Capital Gain, etc.

  16. Enterprise Risk--Insurance Risk Module (Non-Life) Premium related risks Loss ratio analysis Correlation matrix Direct writers Reinsurers Reserve related risks Loss reserve development (AY) Correlation matrix Direct writers Reinsurers Catastrophe related risks Non-normal distributions Consistent with BCAR 100 yr hurricane (PML) 250 yr earthquake (PML) Reinstatements Tax-affected Surplus

  17. Premium Related Risks -- Non-Life Company Loss Ratio: Home Owners 90 91 92 …. 2000 Var. Loss Ratio: Priv. Pass. Auto Liab 90 91 92 …... 2000 Var. Correlation Peer 1 Peer 2 Peer 3 . . . Peer 1042 80% 72% 88% . . . 80% 10% 85% 68% 82% . . . 78% 20% 90% 85% 92% . . . 94% 8% . . . . . . . . . . . . . . . 76% 82% 78% . . . 80% 6% 78% 76% 80% . . . 83% 4% 74% 72% 74% . . . 77% 2% 66% 74% 78% . . . 83% 12% . . . . . . . . . . . . . . . 75% 64% 72% . . . 80% 10% .06 .10 .12 . . . .08 .075 Industry Average 16% 8%

  18. Reserve Related Risks -- Non-Life Company Reserve: Home Owners 90 91 92 …. 2000 Var. Reserve: Priv. Pass. Auto Liab 90 91 92 …. 2000 Var. Correlation Accid. Yr. 90 Accid. Yr. 91 Accid. Yr. 92 . . Acc. Yr. 2000 $10 $18 $15 . . . $10 15% $21 $25 . . . $22 10% $12 . . . $13 5% . . . . . $12 0% $80 $78 $85 . . . $80 25% $68 $55 . . . $62 20% $54 . . . $52 5% . . . . . $52 0% .06 .10 .12 .04 .05 . . .11 Company Avg 13% 23% .03 Peer 1 Avg Peer 2 Avg . Industry Avg 20% 30% . 27% 18% 32% . 27%

  19. Why Does Value Matter? • Long-term obligations • Provides flexibility • Promotes financial strength • Vitality vs. survival • Separates the “advantaged” from the “disadvantaged”

  20. Performance Measurement —Rating Considerations • Where are profits being generated? • What drives them? • How adequate are they? • How sustainable/volatile are they? • What serves as the basis of strategic and financial decisions? • How are profits and capital measured and managed?

More Related