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This case study explores how Ernst & Young LLP improved their enterprise risk management by enhancing their modeling techniques and establishing linkages between various components of their balance sheet, investment income, and external capital. The study discusses the benefits, expenses, taxes, and surplus expansion resulting from this approach, as well as the significance of RBC and RAROC.
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Enterprise Risk ManagementCase Study: Improved ModelingErnst & Young LLP
Balance Sheet Investment Income External Capital Service Improvement Contribution to Surplus Expanding the Dialogue – Linkages Benefits Expenses Taxes Premium Surplus Solvency Investment Viability
Capital Allocation RBC “ + ” RAROC Linking the Pieces Premium Investment Income Benefits Capital Costs Admin Expenses Taxes Surplus Regulatory Investment Viability Budgeting Capital Budget Strategic Plan Contribution to Surplus
Rate Increases Trend Renewal Distribution Stochastic Health Models
Trend Provider Contracting Benefit Buy-Down Stochastic Health Models
Process as Important as the Model • Forces logical thought process • Broaden the types of assumptions • Financial • Business • Range of assumptions – beyond point assumptions • Outcomes • Range of potential results • Ranges show sensitivity to specific assumptions/variables • Management dialog
Assumptions c Revenue Premium Increases Target Loss Ratios Renewal Distribution Investment Return Claims Current Loss Ratio Trend Provider Contracting Claims Liabilities c c c c c Expenses New Business Administration Capital Expenditure Exposure New Business Lapses c c c Net Income Targeted Surplus Aggregate Outcomes
Assumptions and Linkages Revenue Premium Increases Target Loss Ratios Renewal Distribution Investment Return Claims Current Loss Ratio Trend Provider Contracting Claims Liabilities Interactions Renewals: Shock Lapse Antiselection Expense Recovery Benefit Buy-Down Providers: New Business Lapses Trend Expenses New Business Administration Capital Expenditure Exposure New Business Lapses Net Income Targeted Surplus Aggregate Outcomes
Assumption probabilities Ending Surplus Monte Carlo Simulation Stochastic Health Models
Earnings Easy Step to Risk-Adjusted Returns • Itemization of risk assumptions • Process provides structure for addressing rate factors • Construction of assumptions includes variability • Easily accommodates capital expenditures • Assumptions are typically LOB-specific • Many have LOB-specific risks and outcomes • Include items like likelihood of obtaining needed rate increases • Range of outcomes • Variability is linked to risk spread • Surplus targets can be set based on risk/reward outcomes Probability of loss Uniform risk (e.g., 99.75%)