enterprise risk management rick gorvett, fcas, maaa, arm, frm, ph.d. director, actuarial science...
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“Who am I? Why am I here?” - Admiral James Stockdale, 1992 Currently –Director, Actuarial Science Program –Professor, Depts. of Mathematics and Finance –University of Illinois at Urbana-Champaign Prior –Senior Vice President –Director of Internal Audit & Risk Management Internal Audit Corporate Investigations Risk Management Enterprise Risk Management Business ContinuityTRANSCRIPT
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Enterprise Risk Management
Rick Gorvett, FCAS, MAAA, ARM, FRM, Ph.D.Director, Actuarial Science Program
Department of MathematicsUniversity of Illinois at Urbana-Champaign
Finance 590 – UIUCSpring 2005
March 29, 2005
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Agenda
• About me• A risky world• Broadening our perspective• Enterprise risk management (ERM)
– Evolution– Current state– Key considerations
• Conclusion
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“Who am I? Why am I here?” - Admiral James Stockdale, 1992
• Currently– Director, Actuarial Science Program– Professor, Depts. of Mathematics and Finance– University of Illinois at Urbana-Champaign
• Prior– Senior Vice President– Director of Internal Audit & Risk Management
• Internal Audit• Corporate Investigations• Risk Management• Enterprise Risk Management• Business Continuity
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Let X = current academic salaryLet Y = proposed corporate salary
Let Y = 4X
Y > X (or, Y >>> X)
Hmmm....
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Enron... Worldcom...Economy...Insurance industry...Gorvett’s Co. Announces$3.4B Loss
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An Initial ERM Comment
• You don’t become a famous writer by…– Reading a book– Reading about other authors– Watching someone else write
• Similarly, you don’t become an “Enterprise Risk Manager” by…– Reading a book– Taking a course– Listening to a presentation
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Rather, ERM is…
• A complex process…• … involving broad-based and in-depth
knowledge and understanding,…• … requiring an appropriate corporate culture,
…• … and creativity…• … born of a variety of experiences…• … and insatiable curiosity.
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A Risky WorldAnd it just seems to be getting riskier!
• What’s getting riskier about our world?• What isn’t ?
– Perhaps aspects of technology, medical care,…?• Evidence of riskiness
– Catastrophic events in a more crowded world with greater vulnerabilities
– Current events– Books – e.g., Safe Food: Eating Wisely in a Risky
World– Financial markets
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Steps in theRisk Management Process
• Determine the corporation’s objectives• Identify the risk exposures • Quantify the exposures • Assess the impact• Examine alternative risk management tools• Select appropriate risk management approach• Implement and monitor program
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The Bottom Line:It All Boils Down to Capital
• “Capital”– Assets less liabilities; owners’ equity; net worth– Support for (riskiness of) operations– Thus, supports profitability and solvency of firm
• “Capital Management”– Determine need for and adequacy of capital– Plans for increasing or releasing capital– Strategy for efficient use of capital
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Why Do We Care About Managing Capital?
• Leads to solvency and profitability• Benefits of solidity and profitability
– Higher company value– Happy claimholders– Better ratings– Less unfavorable regulatory treatment– Ability to price products competitively– Customer loyalty– Potentially lower costs
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The “Problem” With Capital
• A certain amount of capital is needed in order to promote solvency– Thus, we need to be able to raise capital
• But.... If there is too much capital, profitability
(as measured by return on equity) will suffer– Thus, we need to be able to efficiently deploy capital
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What Does Capital Management Entail?
CapitalManagement
ProductPricing Financial
Risk Mgt.
SettingObjectives
RaisingCapital
StrategicPlanning
LiabilityValuationAsset
Allocation
RiskManagement
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Enterprise Risk Management• Or “Enterprise Risk and Assurance
Management”• What is ERM?
– Concerned with a broad financial and operating perspective
– Recognizes interdependencies among corporate, financial, and environmental factors
– Strives to determine and implement an optimal strategy to achieve the primary objective: maximize the value of the firm
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Goals of ERM
• Ensure business continuity
• Enhance opportunities for the company to achieve its objectives
• Create and increase company value
• Make risk management more cost-efficient
• Stabilize earnings
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Evolution of ERM• Historically: “risk silo” mentality• Mid-1990s:
– First “Chief Risk Officer”– First use of ERM terminology
• Late-1990s:– Risk-related regulatory requirements (e.g., Turnbull)– Earnings protection insurance debuts
• 2001:– September 11– Corporate scandals– Beginning of efforts to improve corporate governance (e.g.,
Sarbanes-Oxley)
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Current State• Findings from various surveys
– An acknowledged need to improve risk management
– A recognition that a holistic approach is appropriate and preferable
– ERM can improve overall capital management and thus enhance corporate value and competitiveness
– A variety of approaches to improving risk management
– There are still problems to overcome
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A Paradigm ShiftTraditional
• Risks managed in silos• Concentrates on
physical hazards and financial risks
• Insurance orientation• Ad hoc / one-off
projects
Emerging• Centralized mgt., with
exec-level coordination• Integrated consideration
of all risks, firm-wide• Opportunities for
hedging, diversification• Continuous and
embedded
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Types of Risks• Operational
– Hazard– Physical
• Strategic– Capital / resource allocation– Industry / competitors
• Technological– Databases– Security– Confidential information
• Stakeholder
• Legal– Compliance– Regulatory
• Financial– Capital markets– Credit risks– Taxes
• Human capital– Retention– Training
• Reputational
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Issues in ERM Implementation
• Different corporate cultures require different ERM approaches
• Who is going to be the ERM champion within the company– Among senior executives– Among departments / functions
• How to embed a risk management culture and responsibilities throughout the firm
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Components of the ERM Process• Determine corporate objectives• Risk identification
– Goal: comprehensiveness– E.g., self-assessment
• Risk measurement– Volatility measures– Value at Risk (VaR)
Impact
Like
lihoo
d
Size of lossLi
kelih
ood
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Components of ERM (cont.)
• Assessing the impact– Stress or scenario testing– Stochastic simulation
• Examine and select alternative risk management tools and techniques– Traditional risk transfer– Natural hedging / diversification– Integration of risks
E.g.,“dynamicfinancialanalysis”
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Keys to Success in ERM• Senior management commitment and
sponsorship• Embed a “risk management culture” in the
corporation at the operational level• Provide for accountability, both specific and
widespread• Clearly defined responsibilities for
coordination and maintenance• Adequate communication
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Conclusion
“The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk”
- Peter Bernstein, Against the Gods