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Finance 590

Finance 590. Enterprise Risk Management Lecture 3 Mark C. Vonnahme Department of Finance University of Illinois at Urbana-Champaign. ERM. What is Enterprise Risk Management A quick review of our prior discussions Industry analysis v individual firm analysis

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Finance 590

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  1. Finance 590 Enterprise Risk Management Lecture 3 Mark C. Vonnahme Department of Finance University of Illinois at Urbana-Champaign

  2. ERM • What is Enterprise Risk Management • A quick review of our prior discussions • Industry analysis v individual firm analysis • Organization’s risk profile is unique • Similarities and differences to others

  3. ERM • An organization’s risks by their nature • Dynamic • Fluid • Highly interdependent • Cannot be broken into components • Need to be managed in an integrated approach

  4. ERM • Integrated approach v silos • Personal experiences • Property casualty • Surety

  5. ERM • Enterprise risk management –a definition • A comprehensive and integrated framework for managing credit risk,market risk,operational risk,economic capital,and risk transfer in order to maximize firm value. James Lam

  6. ERM • Enterprise risk management is all about integration • To be successful it requires • An integrated risk organization • The integration of risk transfer strategies • The integration of risk management into the business processes of the company

  7. ERM • Risk Organization • Centralized risk management unit reporting to the chief executive officer and the board • Broad policy setting across risk taking activities • May have CRO position

  8. ERM • Risk transfer strategies • Integration of risk transfer strategies • A portfolio view of all types of risk • Rationalize use of various strategies including derivatives,insurance and alternative risk transfer products to hedge/reduce risk deemed undesirable • Balanced approach

  9. ERM • Risk management into the business processes of the company • Offensive v defensive mechanism • Proactive v reactive management approach • Optimize business performance • Influence on pricing , resource allocation and other business decisions

  10. ERM • The benefits of ERM • Increased organizational effectiveness • Better risk reporting • Improved business performance

  11. ERM • Increased organizational efficiency • CRO plus enterprise risk approach provides top down approach for coordination • Address both individual risks plus the interdependencies

  12. ERM • Better risk reporting • Provides timely and relevant info to management • Info that allows them to manage the risks • Silo v integrated approach • Which is more effective • Increase risk transparency • Provide the appropriate detail to • Management • CEO • Board

  13. ERM • Improved business performance • Companies that have implemented ERM show improved results and ongoing support from CEO and Board to continue • What does that mean • Some examples • Market value improvement • Loss reduction • Insurance premium reduction • Reinsurance premium savings • Regulatory capital relief

  14. ERM • Improved performance plus • Pressure from outside for ERM plus performance • Rating agencies • Boards • Shareholders • Employees

  15. ERM • The CRO • Today and in the future • Will every company have a CRO • Is it necessary

  16. ERM • Components of ERM • Corporate Governance • Ensure organizational processes and controls to measure and manage risk • Line Management • Risk management into the revenue generating activities including business development, pricing and relationship management • Portfolio Management • Aggregate risk exposures, incorporate diversification effects and monitor risk concentrations against established risk limits

  17. ERM • Components of ERM continued • Risk Transfer • Mitigate risk exposures that are too high or more cost effective to transfer v hold • Risk Analytics • Risk measurement, analysis,and tools to quantify and track risk exposures

  18. ERM • Components of ERM continued • Data and Technology Resources • Support analytics and reporting processes • Stakeholder Management • Communicate and report the company’s risk information to key stakeholders

  19. ERM • Risk Analytics • Started to discuss last class • Will continue as we move forward • Corporate Governance • Will begin discussion today • Will continue throughout class • Line Management • Will start to share thoughts on it today • Share some experiences with you

  20. ERM • Questions

  21. Finance 590 Enterprise Risk Management Mark C. Vonnahme Department of Finance UIUC

  22. ERM • Corporate Governance • Ensures board of directors and senior management have established “appropriate” organizational processes and corporate controls to measure and manage risk • Mandate is worldwide in business • Regulatory agencies and legislative bodies are calling for stronger controls

  23. ERM • Corporate Governance • From ERM perspective, responsibilities of boards and senior management include • Defining the org’s risk appetite…risk policies, loss tolerance, risk to capital leverage and target debt rating • Ensuring they have the risk management skills and risk absorption capability to support business strategy • Establishing org structure and defining roles and responsibilities for risk management • Shaping the org’s risk culture …setting the tone from top and reinforcing with incentives • Providing opportunities for learning…from problems and ongoing training

  24. ERM • Corporate Governance • Commissions and reports have made recommendations for greater corp controls and emphasized responsibilities of board and senior management • Treadway Report – U.S. • Turnbull Report-U.K • Dey Report-Canada • Sarbanes-Oxley-U.S

  25. ERM • Codes of Conduct • Codes of Best Practices • Number of sources or sponsors • Stock exchanges • Exec associations • Individual companies • It continues to grow and develop in importance • Many call for voluntary compliance • Public v private companies

  26. ERM • Corporate Governance – Best Practices • Common areas of focus from various reports …will share experiences in each of these • Stakeholder communication • Board independence • Board performance assessment • Executive and Board Compensation

  27. ERM • Corp Gov Best Practices…Stakeholder Communication • Communication in annual reports on corporate governance practices and how org is doing in meeting guidelines • More emphasis after Sarbanes Oxley • NYSE and Nasdq have adopted more explicit reqs

  28. ERM • Corp Gov Best Practices … Board Independence • One of key changes …recommend independence of board from senior management • Objectivity in acting in best interests of company • Separate their oversight role from day to day operations • Chairman and CEO • Same individual v separate • Lead Director • Committees • Audit • Compensation

  29. ERM • Corp Gov Best Practices…Board Performance Assessment • Recommendation to assess individual and overall board performance • Will develop over time • Not universally in place today • Board positions are “hard work” • Difficult to find board members for public companies

  30. ERM • Corp Gov Best Practices …Executive and Board Comp • Performance evaluation of CEO • Set goals and objectives • Comp structure ... salary, bonus, LT incentives • Director Compensation • “Avoid overpayment” • Theory v reality • Should comp include stock in company • Most would say yes

  31. ERM • Linking Corporate Governance and ERM • Why is it important • What is the linkage

  32. ERM • Corp Gov and ERM • Impetus for change in corp governance has changed corp risk management practices • Similar focus on strategic direction, corporate integration, and motivation • Good board practices and corp governance are crucial for effective ERM

  33. ERM • Corp Governance and ERM • Areas of ERM allied to boards • Risk appetite and policy • Organizational structure • Risk culture and corporate values

  34. ERM • Questions • Discussion

  35. Finance 590 Enterprise Risk Management Line Management Mark C. Vonnahme Department of Finance UIUC

  36. ERM • Line Management • Key revenue producing activities • Structure generally involves SBUs • My experiences as head of SBU • Account for majority of assets and employees • Risks are/ or can be significant • Property casualty insurance • Surety

  37. ERM • Interaction of Line with Risk Management • Alignment of Line with RM strategies is crucial • Impact on new business development • Relationship between line and RM can impact customer relationships • Line managers need to understand pricing implications • Losses • Cost of capital • Other

  38. ERM • Key risk issues involving Line and RM • Relationship between line units and RM • Key challenges for line risk management • Best practices for line risk management

  39. ERM • Relationship between Line and RM • Adversarial relationship v a working partnership • Structural issues • Offense v defense • Policy and policing • Partnership

  40. ERM • Line management and RM • Structure • Offense v defense • Objectives may not be aligned • HO v Field • We v they • Some personal experiences in credit extension

  41. ERM • Line management and RM • Structure • Policy and policing • The government v citizenry model • Policy set • Line can operate unless exceptions • But RM is not involved on day to day • Policies become outmoded • No real incentives to report outsiders to policy

  42. ERM • Line Management and RM • Partnership • RM fully integrated into business

  43. ERM • Line management and risk management alignment • Key challenges • Conflict resolution • Role of line risk management • Incentive alignment • Non-financial risk management

  44. ERM • Line Management-Best Practices • ERM program should integrate risk management processes into business management processes • Business strategy and planning • New product and business development • Product pricing • Business performance measurement

  45. ERM • Summary • Questions

  46. Finance 590Enterprise Risk Management Steve D’ArcyDepartment of Finance Lecture 3 Hazard Risk Analytics April 5, 2005

  47. Reference Material • Chapter 8 – Enterprise Risk Management by Lam • Risk and Insurance by Anderson and Brown http://www.soa.org/ccm/cms-service/stream/asset/?asset_id=8027034

  48. Overview • Characteristics of Hazard Risk • Insurance Terminology • Examples

  49. Characteristics of Hazard Risk • Loss/no loss situations (pure risk) • Independence of individual exposures • Important for risk to be insurable • Types of hazard risk • Persons • Property • Liability

  50. Insurance Terminology • Exposures • Deductibles or retentions • Policy limits • Coinsurance • Claims or losses • Incurred • Paid • Loss adjustment expenses • Loss frequency and severity • Triggers

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