Emerging Trends in Risk Management Practices: Challenges and Best Practices

2. Agenda • Issues and trends in emerging risk management practices • Best practices and implementation challenges

3. Competing Pressures on Management • Management must reconcile differences of views among key constituents • Differences in focus and perspective can lead to conflicting actions

4. 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. ERM Value / Risk Optimization Risk Management Integration Risk Specialization Enterprise-Wide Risk Assessment Risk quantification, capital measurement, KPI and KRI Measurement Alignment with balanced scorecard and broader organization measures. Treasury Credit Insurance Legal Risk Management Continuum Market Trends Stakeholder Value Sophistication

5. 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

6. 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 133 issues and considerations • Economic Capital • Measurement methodology • Risk Integration • Capital Allocation • Credit Risk • Credit risk policy and limits • Counterparty hierarchy definition • Internal ratings methodology • Exposure and default probability measures • Stand alone and portfolio credit risk • Proactive Portfolio Management • Risk adjusted performance measurement • Risk based pricing • Risk management strategies • Operational/Business Risk • Risk control policy and framework • Business risk definition and risk assessment • Measurement methodology and assumptions • Insurance Risk • Underwriting and pricing policies • Actuarial and financial modeling • Loss/Reserve valuation methods • Stat/Gaap/economic earnings reconciliation Risk Management Technology Infrastructure

7. Determining capital adequacy Supporting risk-adjusted return measurement Evaluating customer, product and business risks, capital consumption and profitability Supporting marginal pricing Assessing adequacy of business returns Business planning and financial forecasting Evaluating strategic investments Linking to reward framework Financial Performance Metrics Accounting Based Metrics Economic Driven Metrics ROE Measures of Risk and Capital Adequacy Measures of Return Adequacy ROI ROA External Risk Capital Requirements Internal Economic Capital Process Single Period Multi Period Regulatory Economic Profit Shareholder Value Added Bottom-up Top-down Rating Agency Embedded Value Appraisal Value Volatility of Asset/Liability Values Earnings Volatility Capital Management, Performance Measurement Alternatives Best suited for: Best suited for:

8. 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 • Consensus emerging around “Risk Adjusted Return on Capital”

9. 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 • Trend toward use of hurdle rates specific to each business unit’s earnings risk profile

10. 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 • Pricing methodologies

11. 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

12. 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