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Enterprise Risk Management: What’s the Fuss All About?

Explore the significance of ERM in risk assessment, control, and value creation. Learn about key features, benefits, and rating analysis components.

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Enterprise Risk Management: What’s the Fuss All About?

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  1. Enterprise Risk Management:What’s the Fuss All About? Brian C. Schneider, CPA, CPCU - Director Casualty Loss Reserve Seminar September 11, 2006

  2. Takeaways • Next Logical Step in Risk Management • Measure What You Manage • Enterprise “Reward” Management www.fitchratings.com

  3. Premise #1: Next Logical Step in Risk Management www.fitchratings.com

  4. “ERM is the discipline by which an organization in any industry assesses, controls, exploits, finances, and monitors risks from all sources for the purpose of increasing the organization’s short- and long-term value to its stakeholders.” www.fitchratings.com

  5. ERM is nothing “new” – improves existing skills • Insurance is the business of risk assumption (or risk trading) • Insurers must be the pre-eminent risk managers • Evolution of Three Letter Acronyms: • ALM: Asset / liability management • DFA: Dynamic financial analysis • ERM: The latest trend • Aided by vast improvements in technology and data management • Greater regulatory oversight due to corporate malfeasance www.fitchratings.com

  6. Risk Management Features Capital Modeling, Allocation Monitoring, Assessment, Reporting Risk Governance (people, process) Crisis Management (catastrophe, operational) What else? What if? www.fitchratings.com

  7. Benefits of ERM – “squishy” Better risk and crisis management Consistent strategic and financial decision-making Earlier identification of problems Common “risk language” throughout organization Potential to eliminate inefficiencies Improved Board and statement disclosure www.fitchratings.com

  8. What Goes Into Fitch’s Rating Analysis? www.fitchratings.com

  9. Has Our Rating Methodology Changed? • Since Risk Management is not new, no reason to create a new component to our rating methodology • Not a new “pillar” • Risk management is a fundamental component of rating analysis • Analysis is updated to understand / utilize today's management techniques and related information output www.fitchratings.com

  10. ERM Cuts Across All Aspects E R M Industry Review Operational Review Organizational Review Financial Review Management Review www.fitchratings.com

  11. Overall Rating Analysis - Methodology www.fitchratings.com

  12. Premise #2: Measure What You Manage www.fitchratings.com

  13. Measure What You Manage • Financial analysis “proves” the success of ERM process • How successful were limits / reinsurance programs • How successful were underwriting / pricing decisions • Did management have crisis programs in place - liquidity backstops • Number of “exceptions” • Economic Capital is a Cornerstone • Fuels growth opportunities • Offers protection to stakeholders • Maximizes value – not too much, not too little www.fitchratings.com

  14. Considerable Time Spent on “the Numbers” • Earnings • Reserves • Capital • Investments • Asset / Liability Management • Liquidity • Financial flexibility www.fitchratings.com

  15. Where does Prism come in? Prism Earnings Reserves Capital Investments Asset / Liability Management Liquidity Financial flexibility www.fitchratings.com

  16. Capital Adequacy Requires Three Perspectives Prism • Independent, third-party review • Consistency – universal model / work with the data provided • Official “scorekeeper” • May be insufficient for today’s products / issues • Granular data / product analysis • Moral hazard of opportunistic assumptions Capital Adequacy Regulatory Requirements Insurer’s Internal Capital Models www.fitchratings.com

  17. Prism’s Targeted Approach Stochastic platform with interactive surveys using consistent assumptions Current regulatory models Insurer’s In-House Capital Model Optimal Spot for Fitch is Vertical Simple Complex Less than vertical is unresponsive • Arbitrary adjustments • Incomplete scope Past vertical is inefficient • Too much data • Too much time • Lack of comparability www.fitchratings.com

  18. Prism Features Adaptable to more closely reflect an insurer's unique financial profile A common platform from which to evaluate insurers globally Uses country-specific data for insurance risk parameterization Integrates and analyzes risk on a fully aggregated basis A sophisticated, stochastic methodology Powered by a realistic, economically based stochastic engine www.fitchratings.com

  19. Many papers available at www.fitchratings.com/prism www.fitchratings.com

  20. Premise #3: Enterprise “Reward” Management www.fitchratings.com

  21. ERM Pitfalls • Resource issues • Objectives • Benefits • Complexity • Modeling / measurement issues • Data / IT constraints • Credibility of results • Model over-reliance • Garbage In, Garbage Out • Over-optimization • Inappropriate diversification • Must have fundamental skills • Greatest asset: People • A few can bring firm down • SBU become risk-averse • Pass up opportunities since business line hurt but firm benefits www.fitchratings.com

  22. Business 101 • Adequate compensation for risks undertaken • Cannot mitigate all risks – leaves no profit opportunity • Firm’s appetite for risk • Past performance is not always a good future predictor • Equity markets • Catastrophe events • Knowing the unknown www.fitchratings.com

  23. ERM Sample Questions • List support agreements amongst entities • Stress-test upstream dividend capabilities • Assess current regulatory, legal and accounting risks • Describe ensuing competitive factors • What risk reports are monitored by your Board • Define your risk appetite • Show expected variability in future earnings • What is your risk exposure • What is economic capital threshold • What crisis management plans do you have • List top threats to franchise www.fitchratings.com

  24. Enterprise “Reward” - Sample Questions • What is your expected variability in future earnings projections - by business line and in aggregate? • What is your estimated redundancy or deficiency in your liabilities – by business lines and in aggregate? • How much capital is considered in place to support the current book of business on balance sheet versus expected new sales? • What do you determine your capital needs to be related to operational risk? • At what thresholds do you target for economic capital? • How does your risk mitigation efforts – reinsurance, securitization, hedging – lower your required capital needs? How do hedging strategies influence your earnings profile? • Do you consider potential liquidity charges in your various economic scenarios? If yes, what are they? www.fitchratings.com

  25. Recap • ERM: Next Logical Step in Risk Management • Measure What You Manage • Enterprise “Reward” Management www.fitchratings.com

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