© 2008 Towers Perrin Embedding ERM — A Tough Nut to Crack Fifth Biennial Global ERM Survey Hélène Pouliot November 2008

© 2008 Towers Perrin

Embedding ERM — A Tough Nut to Crack

Fifth Biennial Global ERM Survey

Hélène PouliotNovember 2008

2© 2008 Towers PerrinProprietary and ConfidentialNot for use or disclosure outside Towers Perrin and its clients

Towers Perrin’s fifth biennial survey on Enterprise Risk Management in the insurance sector

During May and June of 2008, the Tillinghast business of Towers Perrin conducted a Web-based survey among senior executives in major insurance companies around the world

Chief Financial Officers, Chief Actuaries and Chief Risk Officers were asked to document the approaches to, and current status of, ERM activity within their companies

A total of 359 executives responded, making this the largest global survey of the insurance industry on its topic

Respondents include a wide range of insurance organizations from North America (49%), Europe (29%), Asia/Pacific (19%), Latin America (2%) and Africa/Middle East (1%)

Respondents come from all lines of business, including life insurance (34%), P/C insurance (33%), reinsurance (20%) and multiline insurers (13%)


Definitions

3© 2008 Towers Perrin 3© 2008 Towers PerrinProprietary and ConfidentialNot for use or disclosure outside Towers Perrin and its clients


Glossary of terms

Geographical terms North America — includes the U.S., Canada and Bermuda Europe — includes the U.K. and continental Europe Asia/Pacific — includes Asia and Australia Latin America — includes Mexico and South America Middle East/Africa — includes Middle East and Africa

Company size terms Large — Company with annual revenue in excess of U.S. $10 billion Medium — Company with annual revenue between U.S. $1 billion and U.S. $10

billion Small — Company with annual revenue less than U.S. $1 billion

DEFINITIONS


Participant Profile

5© 2008 Towers Perrin 5© 2008 Towers PerrinProprietary and ConfidentialNot for use or disclosure outside Towers Perrin and its clients


Respondents include a wide range of insurance organizations

Company Type

5%

0%

1%

2%

2%

4%

6%

13%

33%

34%

Other

Asset manager

Bank

Multiline (life andP/C) reinsurer

Life/annuity/pensionsreinsurer

Healthinsurer/reinsurer

Property/casualty(P/C) reinsurer

Multiline (life andP/C) insurer

Property/casualty(P/C) insurer

Life/annuity/pensionsinsurer

Primary Business

7%

2%

24%

29%

38%

Other

Fratenal

Mutual or mutualholding company

Private stock

Public stockPublic stock

Private stock

Mutual or mutual holding company

Fraternal

Other

Life/annuity/pensions insurer

Property/casualty (P/C) insurer

Multiline (life and P/C) insurer

Property/casualty (P/C) reinsurer

Health insurer/reinsurer

Life/annuity/pensions reinsurer

Multiline (life and P/C) reinsurer

Bank

Asset manager

Other


Our survey covered a wide geographic spread, with a significant contribution from North America, Europe and Asia/Pacific

Headquarters Country Respondent Country

50%

1%

1%

31%

17%

Asia/Pacific

Africa/Middle East

Europe

Latin America

NorthAmerica

49%

1%

2%

29%

19%

Asia/Pacific

Africa/Middle East

Europe

Latin America

NorthAmerica


Participants included many of the world’s largest insurers; 55% of respondents had revenues over $1 billion and nearly 16% over $10 billion

20%

48%

9%

7%

12%

4%

Less than $1billion

$1 billion to$24 billion




$500 billion ormore

Total Direct RevenuesMean: Approximately U.S. $3.8 billion

Total AssetsMean: Approximately U.S. $78 billion

7%

38%

27%

12%

16%

Less than$100 million

$100 millionto $999million

$1 billion to$4.9 billion

$5 billion to$9.9 billion

$10 billion ormore

$10 billion or more

$5 billion to $9.9 billion

$1 billion to $4.9 billion

$100 million to $999 million

Less than $100 million

$500 billion or more

$100 billion to $499 billion




Less than $1 billion


An incomplete list of the companies that agreed to be listed as survey participants

Assumption Mutual Life Insurance Co. AVIVA Canada Inc.

Blue Cross Life Insurance Company of Canada

Co-operators Life Insurance Company

Desjardins Financial Security

Empire Financial Group

Entraide Assurance-Vie

Equitable Life of Canada

FaithLife Financial

Groupe Promutuel Féd. Soc. Mutuelle d'Ass.Gén.

Manulife Financial

RGA Reinsurance Company

Sun Life Financial of Canada

Swiss Re Life & Health Canada

The Independent Order of Foresters

The Standard Life Assurance Company

Key Findings

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10

© 2008 Towers PerrinProprietary and ConfidentialNot for use or disclosure outside Towers Perrin and its clients


1. Embedding ERM is proving to be a significant challenge

2. Size matters

3. European insurers are better positioned

4. ERM is influencing decisions

5. Economic capital standards are emerging

6. Operational risk remains a weak spot

Our 2008 insurance ERM survey produced six key findings


Key Finding #1: Embedding ERM is proving to be a significant challenge

A significant percentage of insurers are still focusing on calculating EC (as opposed to using it) 37% of respondents indicate that calculating EC is an area where significant work is

needed, with just 10% of insurers believing they have an appropriate capability in place Improvements to EC calculations are focused on getting the basics right, with insurers

looking to enhance modeling methodology for individual risks (46%), improve data quality (45%) and extend the risks covered by their models (42%)

Factors which are integral to using EC in decision making — timeliness (25%) and granularity of results (16%), and allocation of diversification benefits (22%) — are not yet a high priority

Insurers admit significant work is required in the use of EC for performance management (60%) and decision making (55%), but neither is being treated as a top priority. This suggests these “difficult” issues are being deferred until the quality of core EC calculations improves

Among European insurers, only 11% consider their internal capital models are sufficiently embedded in how they manage the business to achieve Solvency II approval “Embedding the model within your company’s business” is considered the greatest

challenge to achieving internal model approval (mentioned by 63% of participants)

Only 30% of insurers incorporate risk measures into incentive compensation arrangements


Good business practice is a key driver of riskmanagement efforts in all regions and for all sizes of respondents

Good business practice aside, the key drivers of risk management efforts are: In Europe, Solvency II (86%), shareholder considerations (60%) and rating agency

considerations (54%) In North America, rating agency considerations (83%), competitive advantage (46%) and

shareholder considerations (42%) In Asia/Pacific, Solvency regulation and shareholder considerations (both 56%)

6%

32%

46%

47%

50%

68%

85%

Other

Sarbanes-Oxley or other corporate governance regulations

Solvency II or other insurer solvency regulations

Competitive advantage

Shareholder considerations

Rating agency considerations

Good business practice


The shift in responsibility for risk management from CFO/Chief Actuary to CRO/Risk Management Committee is slowing

The assignment of primary responsibility for ERM to Chief Risk Officer/Director or Head of Risk is more common in: Large companies (72%) compared to small companies (31%) European companies (57%) and Asia/Pacific companies (56%) compared to U.S. companies (32%)

82% of participants report that the person responsible for risk management has independent access to the Board or to a Board sub-committee

11%

1%

9%

23%

17%

39%

4%

1%

8%

18%

16%

43%

8%

3%

6%

17%

21%

45%

Other

Head of Internal Audit

Chief Actuary orCorporate Actuary

Chief Financial Officer orFinance Director

Risk ManagementCommittee

Chief Risk Officer or RiskManagement Director or

Head of Risk

18%

29%

53%Yes:To Board

sub-committee

Yes:To Board

No independent access

2008

2006

2004

Chief Risk Officer or Risk Management

Director or Head of Risk

Risk Management Committee

Chief Financial Officer or Finance Director

Chief Actuary or Corporate Actuary

Head of Internal Audit

Other


Key Finding #2: Size matters

Larger insurers are significantly more advanced in most aspects of ERM implementation and are increasingly looking to realize their competitive advantage Large companies demonstrate a superior level of commitment to EC, with 84% already

calculating EC, compared to 69% of medium-size companies and 37% of small organizations

Larger firms are also already leading the way in utilization of EC: 44% of larger companies use EC in strategic planning and capital allocation compared to 19% of small firms; 40% use EC in product design and pricing, vs. 17% of small firms

While 61% of large insurers are giving short term prioritization to using EC in decision-making processes, only 29% of smaller firms are doing so

Within two years, a high percentage (84%) of large companies plans to be using EC in performance measurement, but only 46% of small companies plan to do so

Competitive advantage features much more strongly as a driver of ERM activities among larger organizations (65%) compared to smaller ones (40%)


Within 12 months, 84% of respondents expect to have a documented risk appetite/tolerance statement in place

The development of risk appetite/tolerance statements is less advanced among smaller companies

In place

Planned within 12 months

Not planned

Small 34% 44% 22%

Medium and Large

57% 33% 10%

16%

37%

47%No, but

planned to be in place within next 12 months

Yes

No, and no plansto develop within

next 12 months


Key Finding #3:European insurers are better placed

North American (NA) insurers are trailing their European counterparts in key aspects, such as EC implementation and its use in decision making. Under Solvency II, these capabilities are expected to lead to lower capital requirements and therefore competitive advantage European insurers are generally more comfortable with their ERM capabilities. For example,

23% of NA firms feel significant work is needed in relation to managing market risk exposure, compared to only 7% of EU insurers. Similarly, for EC calculations (45% NA vs. 27% EU)

This is further evidenced in the documentation of risk policies, where European insurers and those in Asia/Pacific lead North American firms in most respects

Furthermore, a higher proportion of European companies have documented their risk appetite (52% of respondents vs. 40% in North America) and set risk limits for day-to-day management (e.g., for market risk, 88% of respondents in Europe vs. 61% in North America)

In addition, more European insurers calculate Economic Capital (78% in Europe, compared to 45% in North America and 59% in Asia/Pacific)

Perhaps as a consequence of this, European firms are giving greater short-term priority to using EC within their decision-making processes (56% of respondents), compared to North America (40%) and Asia/Pacific (38%)

Within 24 months, 80% to 90% of European insurers expect to be using EC in most major decision-making processes, compared to 60% to 75% of North American firms and 50% to 65% of insurers in Asia/Pacific

Moreover, 74% of European insurers expect to be using EC in performance measurement within two years, compared to 54% of North American insurers and 50% in Asia/Pacific


Key Finding #4:ERM is influencing decisions

In spite of the challenges of embedding ERM, significant numbers of respondents indicate that their ERM program has resulted in key business changes

Major aspects highlighted as having been influenced by ERM programs over the past two years include: Changes in risk strategy or appetite (36% of respondents) Changes in asset strategy (35%) Changes in reinsurance strategy (33%) Changes in product pricing (31%)

In addition, a reasonable percentage of insurers indicate that they are already using their EC results in decision-making processes — including capital adequacy/capital management (44%), asset strategy (36%) and product design and pricing (28%)

Looking ahead, 44% of respondents highlighted use of EC in decision making as a priority for 2008/9; this proportion increases to 82% for Bermuda respondents and 70% for U.K. respondents

Over the next 24 months, insurers anticipate significantly greater use of EC in decision making — for example, in product design and pricing (up from 28% to 67%) and in performance measurement (up from 17% to 59%)

However, only 30% of respondents indicate that they incorporate risk measures of any kind into incentive compensation arrangements and only 10% use EC for this purpose. Furthermore, 66% of insurers globally have no future plans to use EC in incentive compensation


Key Finding #5:Economic capital standards are emerging

EC methodology is moving toward a one-year VaR approach, with the majority (56%) using a market-consistent terminal balance sheet There has been a substantial global shift toward calculating EC base risk over a one-year

risk assessment period, from 32% of participants in 2004, to 56% in 2006 and 68% in 2008 Even in North America, where this approach is less common, the percentage has increased

from 43% in 2006 to 57% in 2008 While 85% of larger insurers apply a one-year risk assessment period, a significant

percentage of medium-size (35%) and smaller (39%) companies continue to use alternative methods, including a two- to five-year time horizon and the runoff of the portfolio

The use of VaR or Risk of Ruin as the primary measure of risk tolerance used to calculate EC has increased from 52% in 2004 to 67% in 2008. During the same period, the use of TVaR or CTE has fallen from 31% to 21%

The growing popularity of VaR is consistent across the industry with only marginal differences observed among smaller (61%), medium-size (69%) and larger (75%) firms

VaR is most often adopted as a risk measure among multilines (81% of respondents), whereas TVaR is most commonly used among reinsurers (33%) and life insurers (28%)

Although the use of a market-consistent terminal balance sheet is common among multilines (85%) and life (67%) companies, just 37% of P/C insurers adopt this approach


Utilization of EC in decision making is set to change dramatically over the next two years

10%

17%

15%

28%

30%

31%

33%

36%

44%

24%

42%

27%

39%

44%

47%

33%

32%

35%

66%

58%

33%

26%

22%

34%

32%

21%

41%

Incentive compensation

Performance measurement

M&A and divestiture

Product design and pricing

Annual business planning

Strategic planning and capital allocation

Reinsurance purchasing

Asset/investment strategy (including hedging)

Capital adequacy assessment/capital management

Continued…

Currently using Plan to use in next 24 months Do not use and have no future plans to use


Key Finding #6:Operational risk remains a weak spot

Just 7% of participants believe they have an appropriate operational risk management capability in place and 37% indicate that significant work is required. Operational risk also lags behind other risks in terms of setting risk limits and EC calculation methodology Operational risk is rated by 37% of global participants as requiring significant work, in

marked contrast to views expressed on insurance, credit and market risks (9%, 11% and 16%, respectively, requiring significant work)

However, operational risk management ranks only seventh among 2008/9 ERM priorities (mentioned by 41% of respondents globally)

Of those companies that have set limits to govern day-to-day risk taking, over 70% now have limits for market, credit and insurance risk, but just 26% have limits for operational risk

In calculating EC for operational risk, relatively simplistic factor-based methods remain the most commonly used approach (43%), with only 17% using stress testing and 16% stochastic methods

Among European insurers, the proportion expected to use an internal model for operational risk (51%) lags significantly behind insurance, market and credit risks (86%, 80% and 65%, respectively)

Documents

© 2008 Towers Perrin Embedding ERM — A Tough Nut to Crack Fifth Biennial Global ERM Survey Hélène Pouliot November 2008