Upload
anis-lindsey
View
223
Download
0
Embed Size (px)
Citation preview
Risk Consultants - DFA Practice
Enterprise Risk ManagementA Case Study
CAS Seminar on Ratemaking
March 11-13, 2001
Risk Consultants - DFA Practice
Ratemaking?
• More of an account pricing issue than a technical insurance ratemaking issue.
• Of the 18 considerations listed in the CAS SOP Regarding Property & Casualty Ratemaking, ERM really directly impacts only 1 - RISKRISK
• ERM influences buyer behavior.
Risk Consultants - DFA Practice
“Risk” per the Actuarial Statement of Principles
• Random variation from expected cost.– Reflected in cost of capital assumption.– Influences the underwriting profit provision.
• Systematic variation of estimated costs from expected costs.– Reflected in the contingency provision.
Risk Consultants - DFA Practice
CoreBusiness
Strateg
ic
OperationalHazar
d
Financial
Capital
Cap
ital
Cap
ital
Capital
Risk from the CFO’s Perspective
Risk Consultants - DFA Practice
General Risk Categories
• Hazard/Legal Risks
• Financial Risks
• Operational Risks
• Strategic Risks
Risk Consultants - DFA Practice
Case Study - Imaginary Motors
• Based on composite and rescaled individual “Big 3” data, industry information, recent press releases and some pure “guestimates”
• Quantify risks individually and aggregate
• Measure “untreated” earnings impact
• Determine theoretical risk capital for selected level of earnings “protection”
Risk Consultants - DFA Practice
Imaginary Motors -Assumptions
• Market Cap = $42.8 Billion
• Net Income = $5.45 Billion (ttm)
• EPS = $4.72 (ttm); Share Price = $38.12
• Effective Tax Rate = 35%
• Protect against the “1 in 100 year event”
• Exposures can be transferred at pretax nominal cost (expenses offset PV factor)
Risk Consultants - DFA Practice
Imaginary Motors Risks - I
• Hazard/Legal Risks– Property
– Business Interruption
– Cargo/Marine
– Workers’ Compensation
– Automobile Liability
– General Liability
– Product Liability
– Employment Practices
– Crime
– Boiler & Machinery
– Directors & Officers
– Intellectual Property
– Product Recall
– Foreign Liability
– E&O/Professional Liability
Risk Consultants - DFA Practice
Imaginary Motors Risks - II
• Financial Risks– Credit
– Residual Value
– ERISA/Fiduciary
– Foreign Exchange
– Commodity Prices
– Energy Prices
– Interest Rates
• Operational Risks– Warranty
– Product Recall
– Contingent Business Interruption
– Political
– Intellectual Property
– E-Commerce
– Strike/Labor Relations
Risk Consultants - DFA Practice
Imaginary Motors Risks - III
• Strategic Risks– Model Selection
– Geographic Expansion
– Brand Image
– Product Pricing
– R&D Investments
– Acquisitions & Divestitures
Risk Consultants - DFA Practice
Imaginary Motors Hazard Risk
0
1,000
2,000
3,000
4,000
5,000
6,000
100% 99%
90%
80%
70%
60%
50%
40%
30%
20%
10% 1% 0%
Probability of Exceedence
$Mil
lio
ns
Avg. NI
NI (Agg)
$Loss (Sum)
NI (Sum)
$Loss (Agg)
Avg. Loss
Case Study - Hazard Risk
Risk Consultants - DFA Practice
Case Study - Hazard RiskRisk Area Min. Mean 100 Yr. 250 Yr. Max. St. Dev CV
Property Noncat -$ 8.54$ 28.19$ 32.20$ 53.23$ 6.08$ 0.71 Wind - 11.76 203.37 268.90 648.96 40.52 3.45 EQ - 15.35 520.95 903.91 2,570.03 108.63 7.08 Flood - 5.26 103.35 200.04 820.84 29.40 5.58 Automobile Liability 4.15 13.92 98.87 159.15 214.85 16.76 1.20 General Liability 3.90 11.49 38.97 50.50 284.32 8.15 0.71 Product Liability 349.87 572.73 1,232.59 1,284.46 3,301.76 157.74 0.28 Employment Practices 1.50 7.72 25.15 29.48 99.92 4.58 0.59 Crime - 0.06 0.52 4.41 58.29 1.02 16.23 Directors & Officers - 4.63 70.42 159.94 800.08 23.40 5.05 Foreign Liability 4.03 7.70 11.97 12.81 16.29 1.50 0.19 E&O/Professional - 0.02 0.10 0.37 28.22 0.52 32.76 Hazard Subtotal 363.45 659.18 2,334.46 3,106.15 8,896.79 398.30 0.60 Hazard Portfolio 395.83 659.18 1,454.98 1,784.28 3,840.32 201.88 0.31 Portfolio Effect 32.38 (0.00) (879.48) (1,321.88) (5,056.47) (196.42) (0.30)
Simulated Loss Amounts (in $Millions)
Risk Consultants - DFA Practice
Imaginary Motors Financial Risk
-2,000
0
2,000
4,000
6,000
8,00010
0% 99%
90%
80%
70%
60%
50%
40%
30%
20%
10% 1% 0%
Probability of Exceedence
$Mil
lio
ns
Avg. NI
NI (Agg)
$Loss (Sum)
NI (Sum)
$Loss (Agg)
Avg. Loss
Case Study - Financial Risk
Risk Consultants - DFA Practice
Risk Area Min. Mean 100 Yr. 250 Yr. Max. St. Dev CVResidual Value 86.11$ 1,341.16$ 2,794.97$ 2,901.04$ 3,316.00$ 603.18$ 0.45 Credit (1,907.99) 513.89 1,880.30 2,049.65 2,653.43 619.73 1.21 ERISA/Fiduciary - 0.36 3.17 4.45 14.58 0.69 1.91 Financial Subtotal (1,821.88) 1,855.42 4,678.44 4,955.14 5,984.02 1,223.61 0.66 Financial Portfolio (883.83) 1,855.42 3,886.43 4,139.83 5,366.54 872.49 0.47 Portfolio Effect 938.05 (0.00) (792.01) (815.31) (617.48) (351.12) (0.19)
Simulated Loss Amounts (in $Millions)
Case Study - Financial Risk
Risk Consultants - DFA Practice
Imaginary Motors Operational Risk
-5,000
0
5,000
10,000
15,000
20,00010
0% 99%
90%
80%
70%
60%
50%
40%
30%
20%
10% 1% 0%
Probability of Exceedence
$ M
illi
on
s
NI (Agg)
Avg. NI
$Loss (Sum)
NI (Sum)
$Loss (Agg)
Avg. Loss
Case Study - Operational Risk
Risk Consultants - DFA Practice
Risk Area Min. Mean 100 Yr. 250 Yr. Max. St. Dev CVWarranty 3,157.93$ 3,596.38$ 3,864.48$ 3,902.22$ 4,030.41$ 115.40$ 0.03 Strike - 288.22 2,609.33 3,230.20 5,551.49 599.07 2.08 Product Recall 5.62 248.84 1,280.31 1,733.32 3,397.26 261.43 1.05 Political - 51.89 1,968.22 3,114.63 9,924.05 373.77 7.20 Intellectual Property - 21.26 115.56 170.67 803.63 26.75 1.26 Operational Subtotal 3,163.54 4,206.59 9,837.89 12,151.05 23,706.84 1,376.42 0.33 Operational Portfolio 3,264.95 4,206.59 6,984.44 7,768.32 13,976.52 761.10 0.18 Portfolio Effect 101.41 (0.00) (2,853.45) (4,382.73) (9,730.32) (615.32) (0.15)
Simulated Loss Amounts (in $Millions)
Case Study - Operational Risk
Risk Consultants - DFA Practice
Imaginary Motors Strategic Risk
-2,000
0
2,000
4,000
6,000
8,00010
0% 99%
90%
80%
70%
60%
50%
40%
30%
20%
10% 1% 0%
Probability of Exceedence
$Mil
lio
ns
Lo
ss (
$Mil
lio
ns) Avg. NI
NI (Agg)
$Loss (Sum)
NI (Sum)
$Loss (Agg)
Avg. Loss
Case Study - Strategic Risk
Risk Consultants - DFA Practice
Case Study - Strategic Risk
Risk Area Min. Mean 100 Yr. 250 Yr. Max. St. Dev CVPhase Out Division X 603.92$ 893.66$ 1,121.21$ 1,158.46$ 1,287.24$ 893.41$ 1.00 Invest in Division Y 909.54 1,340.50 1,681.84 1,737.39 1,945.73 1,340.36 1.00 Division Y Sales Increase (3,626.97) (2,432.76) (1,919.97) (1,858.99) (1,610.99) 893.41 0.37 Strategic Subtotal (2,113.51) (198.59) 883.07 1,036.86 1,621.98 466.70 2.35 Strategic Portfolio (1,563.68) (198.59) 449.75 516.08 780.88 293.49 1.48 Portfolio Effect 549.83 - (433.32) (520.78) (841.10) (173.20) (0.87)
Simulated Loss Amounts (in $Millions)
Risk Consultants - DFA Practice
Imaginary Motors Composite Risk
-10,000
-5,000
0
5,000
10,000
15,000
20,000
25,000
30,00010
0% 99%
90%
80%
70%
60%
50%
40%
30%
20%
10% 1% 0%
Probability of Exceedence
$Mil
lio
ns
Avg. NI
NI (Agg)
$Loss (Sum)
NI (Sum)
$Loss (Agg)
Avg. Loss
Case Study - Composite Risk
Risk Consultants - DFA Practice
Risk Area Min. Mean 100 Yr. 250 Yr. Max. St. Dev CVHazard Subtotal 363.45 659.18 2,334.46 3,106.15 8,896.79 398.30 0.60 Financial Subtotal (1,821.88) 1,855.42 4,678.44 4,955.14 5,984.02 1,223.61 0.66 Operational Subtotal 3,163.54 4,206.59 9,837.89 12,151.05 23,706.84 1,376.42 0.33 Strategic Subtotal (2,113.51) (198.59) 883.07 1,036.86 1,621.98 466.70 2.35 All Risk Subtotal (408.39) 6,522.59 17,733.86 21,249.20 40,209.63 3,465.02 0.53 All Risk Portfolio 3,188.68 6,522.59 10,151.33 10,988.59 15,602.11 1,229.67 0.19 Portfolio Effect 3,597.07 - (7,582.53) (10,260.61) (24,607.52) (2,235.35) (0.34)
Simulated Loss Amounts (in $Millions)
Case Study - Composite Risk
Risk Consultants - DFA Practice
Imaginary Motors - Implications
• To protect against earnings volatility at the “1 in 100 year” level on a pretax basis:– finance $11.2 B if risks treated individually;– finance $3.6 B if risks treated as a portfolio.
• Risk finance cost difference of $76 Million.– $0.04 in after-tax EPS.– Almost $400 M in market capitalization at
current P/E multiple.
Risk Consultants - DFA Practice
Imaginary Motors - Caveats
• Not all risks to Net Income are included.– WC, cargo, etc. due to lack of data;– general economic risks - interest rates, etc.
• “Portfolio Effect” potentially overstated– not all correlations reflected (warranty, recall and
product liability, for example);– companies may look at some risks in portfolios
(integrated insurance programs, combined aggregate excess programs, etc.).