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Enterprise Risk Management – Post 9/11A Benefit or a Fad?

Enterprise Risk Management – Post 9/11A Benefit or a Fad?

Jean-Pierre BerlietErnst & Young LLPCasualty Actuarial SocietyRisk and Capital Management SeminarJuly 8-9, 2002

Jean-Pierre BerlietErnst & Young LLPCasualty Actuarial SocietyRisk and Capital Management SeminarJuly 8-9, 2002

CASUALTY ACTUARIAL SOCIETYCASUALTY ACTUARIAL SOCIETY

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Risk Management Post 9/11 and Enron EventsRisk Management Post 9/11 and Enron Events

Do “unthinkable” events undermine the value of ERM initiatives?

Is ERM just another fad?

What should insurance company be doing in the present environment?

Do “unthinkable” events undermine the value of ERM initiatives?

Is ERM just another fad?

What should insurance company be doing in the present environment?

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ERM’s ObjectiveERM’s Objective

Protect and enhance company value by optimizing risk return tradeoffs across all major risks

– Insurance Risk

– Underwriting (including Cats)

– Market

– Credit

– Operational Risks

– Strategic Risks

Protect and enhance company value by optimizing risk return tradeoffs across all major risks

– Insurance Risk

– Underwriting (including Cats)

– Market

– Credit

– Operational Risks

– Strategic Risks

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The ERM ProcessThe ERM Process

The process links risk management and strategic planning

The process links risk management and strategic planning

IdentifyRisk

SimulateFinancialResults

DetermineEconomic

Capital

Evaluate Return

Develop Alternative Strategiesand Optimize

Develop Alternative Strategiesand Optimize

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Key ERM AssumptionsKey ERM Assumptions

1. All material risks can be identified and measured

2. All risk types generate an increase in economical capital

3. Combination of alternative business and risk management strategies can be compared with regard to their impact on

Economic capital

Expected return

Return volatility

1. All material risks can be identified and measured

2. All risk types generate an increase in economical capital

3. Combination of alternative business and risk management strategies can be compared with regard to their impact on

Economic capital

Expected return

Return volatility

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Enhanced ManagementProcesses

CounterpointCounterpoint

ERM analytical framework does not distinguish appropriately between risks that destroy the value by• Increasing economic capital• Increasing investors’ required rate of return

ERM process can overcomplicate the development of risk management strategies

ERM analytical framework does not distinguish appropriately between risks that destroy the value by• Increasing economic capital• Increasing investors’ required rate of return

ERM process can overcomplicate the development of risk management strategies

Risk TypeRisk Type Primary EffectPrimary Effect Risk ManagementApproach

Risk ManagementApproach

InsuranceInsurance Increase in CapitalIncrease in Capital

OperationalOperationalIncrease in

“Market RiskPremium”

Increase in“Market Risk

Premium”StrategicStrategic

Exposure Management &Risk Retention Strategy

Changes in CompanyInfrastructure &

Risk Transfer

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The Debate on the Benefits of ERMThe Debate on the Benefits of ERM

Enthusiasts

Return on ERM is very high

Huge opportunity cost of not implementing “ERM”

Enthusiasts

Return on ERM is very high

Huge opportunity cost of not implementing “ERM”

Pragmatists

Identifying significant incremental benefits from comprehensive approach is difficult

Developing approach to managing each risk type does not require costs and complexity of “ERM”

Pragmatists

Identifying significant incremental benefits from comprehensive approach is difficult

Developing approach to managing each risk type does not require costs and complexity of “ERM”

vs.vs.

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Insurance Companies are establishing risk management functions

Insurance Companies are establishing risk management functions Specialized underwriters may be closest to “ERM”

• Renaissance Re• Financial guarantee companies

Large companies addressing market conduct issue• MetLife• Prudential

Large European Multinationals• Multiline• Bancassurance

Domestic P/C companies appears to be focusing on narrow issues• Reinsurance• ALM• Development of Risk Adjusted Performance Measurement

Systems (“RAPM”)

Specialized underwriters may be closest to “ERM”• Renaissance Re• Financial guarantee companies

Large companies addressing market conduct issue• MetLife• Prudential

Large European Multinationals• Multiline• Bancassurance

Domestic P/C companies appears to be focusing on narrow issues• Reinsurance• ALM• Development of Risk Adjusted Performance Measurement

Systems (“RAPM”)

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9/11 and Enron Events9/11 and Enron Events

These surprises revealed that most insurers do not have adequate knowledge and control of their exposures, especially:• Aggregations/concentrations within lines• Aggregations across lines of coverage• Losses from assumed reinsurance (London market)

Insurers have an urgent need to gain control of their exposures• Market, rating agencies and reinsurers will require it• ERM initiatives will lack credibility if basic identification

and control on exposures are not in place

These surprises revealed that most insurers do not have adequate knowledge and control of their exposures, especially:• Aggregations/concentrations within lines• Aggregations across lines of coverage• Losses from assumed reinsurance (London market)

Insurers have an urgent need to gain control of their exposures• Market, rating agencies and reinsurers will require it• ERM initiatives will lack credibility if basic identification

and control on exposures are not in place

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Responses to 9/11 and EnronResponses to 9/11 and Enron

Terrorism Risk Analysis of exposures

by insurance line Underwriting

guidelines• Concentration limits

Loss modeling/analysis• Pricing

Reinsurance

Terrorism Risk Analysis of exposures

by insurance line Underwriting

guidelines• Concentration limits

Loss modeling/analysis• Pricing

Reinsurance

Credit-Triggered Risk Analysis of direct exposure in

investment portfolio Analysis of indirect exposure

through issuance of risk covers• Financial guarantees• D&O liability

Exposure management approach

Credit-Triggered Risk Analysis of direct exposure in

investment portfolio Analysis of indirect exposure

through issuance of risk covers• Financial guarantees• D&O liability

Exposure management approach

Companies are developing specific tools and approaches to deal with terrorism and credit triggered risks

Companies are developing specific tools and approaches to deal with terrorism and credit triggered risks

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Balance of ERM activities appear to be shiftingBalance of ERM activities appear to be shifting

Increasing focus on addressing new risks (terrorism, credit triggered)

Growing interest in establishment of RAPM systems

Increasing focus on applications with immediate pay-off• Reinsurance strategy

• Asset allocation

Increasing focus on addressing new risks (terrorism, credit triggered)

Growing interest in establishment of RAPM systems

Increasing focus on applications with immediate pay-off• Reinsurance strategy

• Asset allocation

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ConclusionConclusion

Risk management issues have become less tractable but more important

Focus needs to be on basic risk and capital implications of the core insurance process

Longer term, expect the ERM framework to be modified

Risk management issues have become less tractable but more important

Focus needs to be on basic risk and capital implications of the core insurance process

Longer term, expect the ERM framework to be modified