erm and the financial crisis: a failure of theory or practice?€¦ · erm and the financial...

ERM and the Financial Crisis: A Failure of Theory or Practice?

Sim Segal, FSA, CERA, MAAAPresidentPresidentSimErgy Consulting LLC

Federated Press 3rd Board Risk Management ConferenceE t bli hi d M i t i i Eff ti ERM P tiEstablishing and Maintaining Effective ERM PracticesApril 12, 2010

Defining ERM 3 waysDefining ERM 3 ways

ERM 10 key criteriaERM 10 key criteria ERM process cycle

V l b d ERM f k Value-based ERM framework

Copyright © SimErgy. All rights reserved.

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ERM 10 key criteriaERM 10 key criteria

1) Enterprise-wide – all areas in scope2) All risk categories – financial, operational & strategic3) Key risks only – not hundreds of risks) f4) Integrated – captures interactivity of 2+ risks

5) Aggregated – enterprise-level risk exposure/appetite6) Decision making not just risk reporting6) Decision-making – not just risk reporting7) Risk-return mgmt – mitigation plus risk exploitation8) Risk disclosures – integrates ERM information8) Risk disclosures integrates ERM information9) Value impacts – includes enterprise value metrics10) Primary stakeholder – not rating agency-driven


3

ERM 10 key criteria – banking scorecardERM 10 key criteria banking scorecard

1) Enterprise-wide – “golden boys” out of scopeX2) All risk categories – overly-focused on financial3) Key risks only) “ /

X

X4) Integrated – “silo” management / measurement5) Aggregated – no aggregate enterprise-level metrics6) Decision making

XX6) Decision-making

7) Risk-return mgmt – metrics only support mitigation8) Risk disclosures – inappropriate even post-event

XX8) Risk disclosures inappropriate even post event

9) Value impacts – only capital metrics10) Primary stakeholder – focus on ratings / regulators

XXX


4

ERM process cycleERM process cycleRisk

Identification

RiskQuantification

RiskMessaging

Ri kRiskDecision-Making


5

ERM process cycle – banking scorecardERM process cycle banking scorecardRisk

IdentificationLack of focus on non-financial risksX

Incentive compensation does not adjust for risk exposure

RiskQuantification

RiskMessaging

X

X

Ri k

Poor risk exposure metrics and poor

d l ti

X

RiskDecision-Making

model assumptions

Poor performance X


6

Risk Appetite

Value-Based ERM Framework

Qualitative

RiskMgmt

TacticsERM

Committee

Strategy

Value ImpactEnterprise Risk

Exposure5

15

1718

2221

26

24

29

32

33

ty

ScenarioDevelopment

Assessment

Exposure

Like

lihoo

d

Enterprise ValueX

1

2

3

4

6

79

8

10

11

12

13

14

16

19

20

23

25

27 28

3130

3435

Likelihood

Seve

rit

AllRisks

Key RiskScenariosMostly Objective

Correlation

Individual Risk

“Pain Point” Likelihood

ΔValue ≤ -10% 15%

ΔValue ≤ -20% 3%

ERMModelBaselineMostly SubjectiveStrategy

STRATEGIC

…

Credit

Market

FINANCIAL

Strategy

STRATEGIC

…

Credit

Market

FINANCIAL

KeyRisks

1+ events / sim

1 event / simIndividual Risk

ExposuresValue▪ ΔValue

Mostly Subjective

…

Process

HR

OPERATIONAL

…

Execution

…

Process

HR

OPERATIONAL

…

Execution

Loss of Key Supplier

International Risk 1

Execution Risk

M&A Risk

Loss of Critical EEs

Legislatiion Risk

IT Risk 1

Enterprise Value Impact

Quantification Decision-MakingIdentification

-25.0%-20.0%-15.0%-10.0%-5.0%0.0%

Consumer Relations Risk

Competitor Risk 1

Union Negotiations


IT Risk 2

Loss of Key Distributor

y pp


Risk Appetite

Value-Based ERM Framework – banking scorecard10

Qualitative

RiskMgmt

TacticsERM

Committee

Strategy10) No definition

of risk appetite

10

9) N l l ti f

Value ImpactEnterprise Risk

Exposure5

15

1718

2221

26

24

29

32

33

ty

ScenarioDevelopment

Assessment1) Risks not defined by source

15) Overly complex

correlations

9) No calculation of enterprise risk exposure

9Exposure

Like

lihoo

d

Enterprise ValueX

1

2

3

4

6

79

8

10

11

12

13

14

16

19

20

23

25

27 28

3130

3435

Likelihood

Seve

rit

AllRisks

Key RiskScenariosMostly Objective

Correlation1

3 6

correlations

5 8

Individual Risk

“Pain Point” Likelihood

ΔValue ≤ -10% 15%

ΔValue ≤ -20% 3%

ERMModelBaselineMostly SubjectiveStrategy

STRATEGIC

…

Credit

Market

FINANCIAL

Strategy

STRATEGIC

…

Credit

Market

FINANCIAL

KeyRisks

1+ events / sim

1 event / sim

3) Not analyzing multiple risks occurring together

3 68) VaR metric hides

exposure beyond tail

Individual RiskExposuresValue

▪ ΔValue

Mostly Subjective

…

Process

HR

OPERATIONAL

…

Execution

…

Process

HR

OPERATIONAL

…

Execution

Loss of Key Supplier


Execution Risk

M&A Risk

Loss of Critical EEs

Legislatiion Risk

IT Risk 1

Enterprise Value Impact

2) Not using discrete

2

4 7) Lack of enterprise value metrics

6) Poor model assumptions

7

Quantification Decision-MakingIdentification

-25.0%-20.0%-15.0%-10.0%-5.0%0.0%

Consumer Relations Risk

Competitor Risk 1

Union Negotiations


IT Risk 2

Loss of Key Distributor

y pp

scenarios for non-financial risks

4) Not measuring/reporting risk on pre-mitigation basis

4 value metrics 7


Some actions to prevent another crisisSome actions to prevent another crisis

Require companies to implement ERM, in a robust manner Require incentive compensation plans to reflect risk exposure (SEC rule) Require enhanced risk disclosures, including free cash flow projection

– Baseline scenario (strategic plan) / key risk scenarios (defined by management )/ t d d i k i (d fi d b l t )standard risk scenarios (defined by regulators)

– Investors apply their own discount rates, and compare scenarios cross-sector Replace capital requirements with pooled risk charges

Capital not there when needed anyway (must replace or be downgraded)– Capital not there when needed anyway (must replace or be downgraded) – Government guarantee protects rating during rehab period to rebuild capital

Employ ERM principles at the country level (e.g., concentration risks)– Firms “too large to fail” (e.g., banks, auto companies) / supplier concentrationFirms too large to fail (e.g., banks, auto companies) / supplier concentration

(e.g., energy) / oligopolies (e.g., rating agencies, monoline insurers) Employ ERM principles at the retail level (e.g., financial planning)

– Holistic view of risks and solutions for individuals/families


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Contact informationCo tact o at o

Sim Segal, FSA, CERA, MAAAPresident

SimErgy Consulting LLCSimErgy Consulting LLCChrysler Building405 Lexington Ave., 26th FlrNew York, NY 10174

(917) 699-3373 Mobile(646) 862-6134 Office(347) 342-0346 Fax( )

[email protected] www.simergy.com


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erm and the financial crisis: a failure of theory or practice?€¦ · erm and the financial...

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