Company Enterprise Risk Management & Stress Testing Case Study

1. Company EnterpriseRisk Management & Stress TestingCase Study

2. moderated byJoe Petrelli Sr.President, Demotech, Inc.presented byAnya KutsinaDirector, U.S. RE Analytics / Ultimate Risk Solutions

3. Implementing ERM and DFA Utilizing Risk Explorer

4. Agenda • The Importance of ERM for an Insurance Company • Why this topic is relevant • Evolution from RM to ERM • Industry Challenges • What is DFA? • Analyzing DFA results • Solvency Testing • Structure of a DFA model • URS DFA Application Suite

5. Agenda (cont’d) • Case Study: Lake George P&C Company • Lines of Business • Assets • Reinsurance Structure • Viewing Simulation Results • Comparison of Reinsurance Programs • Analysis of the Company’s Equity position under different scenarios.Cost / Benefit Analysis • Conclusion - Q&A

6. Why this topic is relevant Dynamic Financial Analysis • The source of origination for ERM, DFA concepts • Risk Management process is the foundation for Enterprise Risk Management • Static (deterministic) Financial Analysis is the foundation for Dynamic Financial Analysis • Evolution of both from original concepts

7. The definition of Risk Evolution of Risk Management • Any event that presents the possibility of loss or danger to organizations or people • Uncertainty – dealing with the unknown and uncertainty of outcomes

8. Risk Management: the original concept Evolution of Risk Management • Risk Management is a process for managing the uncertainty created from unexpected, unintended or accidental events • A process for making decisions that will minimize the impact of risk • The original focus was primarily on “Pure Risks”

9. Evolution from RM to ERM Evolution of Risk Management • Enron and other scandals prompted Congress to call for more financial controls • Calls for even greater corporate governance resulted in Sarbanes-Oxley Act of 2002 • Government and regulatory authorities responded by creating the Committee of Sponsoring Organizations (COSO) of the Treadway Committee • Rating organizations such as AM Best include it in their analysis

10. ERM – Holistic Managementof Risk Evolution of Enterprise Risk Management • Enterprise risk management is driven by the concept that one cannot effectively protect the whole organization without analyzing all factors that influence financial outcomes. • Risk is viewed across the entire enterprise

11. The Focus of ERM ERM — General Concepts • It considers the impact of “speculative, economic or business risks” on entity as well as “pure risks” • ERM incorporates each of management’s decisions with respect to risk • Who is in charge of risk at your company? How is it managed? • Who has the role of Chief Risk Officer?

12. Dynamic Financial Analysis DFA applications • Regulatory Inquiries • I.e. Stress Testing • Reinsurance Optimization • Strategic Asset Allocation • Capital Allocation • Performance Measurement • Business Mix • Pricing Decisions • Mergers and Acquisitions

13. Dynamic Financial Analysis ERM Tools • Scenario testing – projects business results under selected deterministic scenarios into the future. Results based on such scenario are valid only for this specific scenario. • Stochastic simulation (DFA) – thousands of different scenarios are generated stochastically allowing for the full probability distribution of important output variables, like surplus, written premium, loss ratios.

14. Setting the Time Horizon ERM Tools - Dynamic Financial Analysis • The first step used to compare different strategies is to apply a fixed time horizon • In the Insurance industry a projection period of five to ten years seems to be a reasonable choice • simulate to determine the long term effects of a chosen strategy • simulated values are less reliable over a longer projection period

15. Analyzing DFA Results Dynamic Financial Analysis • Return measure (e.g. expected surplus) • Risk measure (e.g. expected policyholder deficit) • Efficient strategy –if there is no one with lower risk at the same level of return, or higher return at the same level of risk

16. Solvency Testing Dynamic Financial Analysis • Financial position of company is evaluated from the perspective of regulators, agents and insureds • Quantify in probabilistic terms whether the company will be able to meet its commitments in the future • DFA provides a range of results regarding the anticipated Surplus of the company

17. What is Dynamic Financial Analysis ? • Portfolio risk management • Risk modeling • Reinsurance/retro-cession analysis • Risk-based capital calculation • Cash flow testing and financial planning (Statutory and GAAP)

18. Dynamic Financial Analysis FUNCTIONALITY

19. Evaluating Ceded Reinsurance/ Retrocession Programs Dynamic Financial Analysis • Handle any complexity • Easy to design alternative programs • Analyse the impact on: • Capital requirement • Profit • RAROC • Reinsurance cost allocation

20. RBC and Capital Allocation Dynamic Financial Analysis • Compare Capital alternatives: • Varying risk assumption • Varying reinsurance or investment strategies • Measure ROE for any portfolio segmentation

21. Case Study

22. Conclusion - Basic ERM Components Dynamic Financial Analysis