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Enterprise Risk Management in the Insurance Industry
July 30, 2003 Value
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What is Enterprise Risk Management and why is it important to the insurance industry?
Agenda
Key findings of the ERM benchmarking survey
Results of related interviews and other intelligence
Strategic implications
ERM benchmarking study
Why We Did it
Many believe ERM holds great promise Approach to help companies
achieve financial and strategic objectives
But it is unclear whether: Senior managers see the value
of ERM Companies are realizing the
value
What We Hoped to Accomplish
Determine current state of ERM in insurance industry
Judge relevance of ERM to broader business issues
Identify current management practices
Assess satisfaction with current processes, tools and techniques
We surveyed and interviewed leading insurance executives around the world
Surveyed 66 insurance industry chief financial officers, chief actuaries and chief risk officers in major markets worldwide Geography: 60% North America, 40% rest of world Company structure: stock, mutual, other Type of operations: life insurance, property/casualty insurance,
mutual funds, banking Company size: $25 million to $10 billion in direct written premiums
Supplemented with in-depth interviews/company visits
Nearly all respondents share a basic understanding of ERM
Rigorous approach to assessing and addressing risks from all sources that: Threaten strategic and financial objectives, or Represent an opportunity for competitive
advantage
Definition Definition of ERMof ERM
Definition Definition of ERMof ERM
Enhance enterprise value by: Improving capital efficiency Supporting strategic decision-making Building investor confidence
ObjectiveObjectiveof ERMof ERM
ObjectiveObjectiveof ERMof ERM
Here are our key findings in a nutshell
Executives believe ERM is critical to helping them deal with their key business issues
They are not satisfied with current tools, techniques and processes to implement ERM — especially for dealing with operational risks
They want a more robust conceptual and methodological framework that: Encompasses all relevant risks — both financial and operational Integrates both financial and operational strategies to manage those
risks
“Top Ten Issues Facing Insurers Today”
1.Earnings growth
2.Revenue growth
3.Return on capital
4.Expense control
5.Competition
6.Capital management and allocation
7.Earnings consistency
8.Pricing adequacy
9.Asset/liability management
10. M&A activity
Respondents believe that ERM will help them address their top ten business issues
% of Respondents Selecting “Yes”
80%
81%
72%
100%
100%
62%
57%
97%
47%
80%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Earnings growth
Revenue growth
Return on capital
Expense control
Competition
Pricing adequacy
Earnings consistency
Capital management/allocation
Asset/liability management
M&A activity
Will ERM help address the top ten issues?
Companies are trying to manage their most important financial and operational risks
% of Respondents Actively Managing
44%
37%
71%
76%
66%
67%
77%
88%
75%
60%
89%
92%
82%
81%
85%
89%
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Technology
Are you actively managing important risks?
Interest rate
Distribution channel
Reputation/rating
Expenses
Products
People/intellectual capital
Asset market value
Liquidity
Credit
Reinvestment
Political/regulatory
Liability
Catastrophe
Capital markets
Currency
Respondents are generally satisfied with the tools they are using to manage financial risks...
87%
84%
82%
80%
77%
76%
69%
69%
75%
78%
63%
71%
71%
77%
74%
58%
69%
73%
67%
64%
71%
66%
74%
53%
Interest rate
How satisfied are you with your current tools to manage risk?
Credit
Reinvestment
Asset market value
Liability
Liquidity
Currency
Capital markets
Mitigation Retention/transferAssessment/measurement
…But they are less satisfied with the tools they are using to manage operational risks
69%
66%
66%
64%
63%
62%
61%
34%
60%
58%
61%
49%
50%
55%
53%
33%
57%
62%
56%
43%
48%
54%
49%
28%
Reputation/rating
Products
Political/regulatory
Expenses
Technology
Catastrophe
Distribution channel
People/intellectual capital
Mitigation Retention/transferAssessment/measurement
How satisfied are you with your current tools to manage risk?
Other key findings
Very few companies have a chief risk officer (CRO), although the position is much more prevalent outside of North America
Companies recognize the importance of integrating risk into their company’s strategic, operational and financial planning, but not all do so because of: Tools Organizational turf Processes Time
Most companies include operational risk in the internal audit plan, but far fewer include financial risk
Continued . . .
Other key findings
Less than half of respondents are factoring interactions among risk sources into their: Assessment/measurement Determination of diversification benefit Mitigation/financing strategies
There is a high level of dissatisfaction with respect to: Stochastically modeling the important risks Including operational risk in determining economic capital Prioritizing disparate risks using a common metric Optimizing financial and operational strategies in light of risk/reward
requirements Coordinating all these activities within a coherent framework
We see several strategic implications of the study results
Insurers face great uncertainty that challenges consistent high performance
Investors, regulators and rating agencies are demanding consistent performance, especially earnings
Insurers do not believe they have the tools to manage the risks that create the uncertainty — particularly operational risks
Insurers need an industry-specific ERM
The study suggests an insurance-specific ERM conceptual framework
ERM is a process to optimize the dynamic relationship between risk and value throughout the insurance enterprise
ERM is a process to optimize the dynamic relationship between risk and value throughout the insurance enterprise
ERM Comprises:
The development, implementation and monitoring of financial and operational strategies that treat the assessment, measurement, mitigation and financing of financial and operational risks for the purpose of increasing enterprise value
Enterprise Value is Driven By:
Providing appropriate level, structure and allocation of capital
Growing earnings and increasing return on capital
Improving consistency of earnings
This framework can also be illustrated graphically
Increase Value
Holisticallymanageall risks
Holisticallymanageall risks
Reinsurance
Capital Structur
e
Product Mix
Investment Strategy
Incentive Programs
Technology
Internal Controls
Distribution
M&A
Customer Service
Market Strategy
Hiring/Training
Investigate both financial
and operational strategies
Pricing
Dynamic Hedging
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Capital
Technology
Expansion/Diversification
People
Culture
Distribution
Processes
Risk Appetite
Understand both internal and external
environments
Investor Expectations
Economicconditions
Customer Behavior
Social/LegalTrends
Political/Regulatory Climate
Competition
Natural Catastrophes
Financial Risk
Operational Risk
Exploit natural hedges
and portfolio effects
Exploit natural hedges
and portfolio effects
The framework must recognize the unique nature of insurance operations
ERM for insurers and ERM for other financial services companies have some similarities — and some fundamental differences Single-period value-at-risk approaches are not sufficient for insurance
enterprises Statistical approaches do not capture causal relationships Structural simulation models are needed to anticipate the complex
interrelationships among risks in dynamic environments
The right framework can yield the results that insurers want but say they aren’t getting
The Right ERM Framework Can Help Insurers:
Determine necessary capital level and structure, efficient deployment of capital and improved return on capital
Properly allocate capital to business segments, supporting performance tracking
Ensure that owners receive proper compensation for risks they assume
Determine the optimal risk financing strategy
And It Can Provide:
Stability in earnings
Improved information
In summary...
Insurance executives believe ERM is critical to helping them deal with their top business issues
They are not satisfied with the current tools, techniques and processes they are using to implement ERM
They want a more robust conceptual framework and methodology that is unique to their industry
Analysis of survey results and interviews suggests what that framework would look like — and that it would deliver on the promise of ERM for insurers