International Insurance Society Conference

Management Strategies in Multi-Year Enterprise Risk Management

Remarks Prepared By

Joan Lamm-Tennant, PhDGlobal Chief Economist & Risk StrategistGuy Carpenter, LLC

Adjunct ProfessorWharton School, University of Pennsylvania

2

Overview

Alternative model design

Relevance of multi year assessment coupled with scenario testing

What problem are we trying to solve by allocating capital?

Management Strategies in Multi-Year Enterprise Risk Management

3

Strategy for “measuring” and “financing” riskModel design

Asset class proxies

Duration/maturity

credit

Correlated loss events

Frequency and severity distributions

Reinsurancedefault

Credit ratingsrecoveries

Reserve adjustments

Severity distributions

Catastrophe event tables

Aggregated losses

Operational risk event tables

Aggregated losses

EarningsEarnings

EconomicEconomiccapitalcapital

4

Mean Probability of Surplus over 5 YearsAll Scenarios

Scenario Probability 2010 2011 2012 2013 2014Base Mean $ 5.41 B $ 5.65 B $ 5.93 B $ 6.24 B $ 6.60 B

Rapid Growth Mean $ 5.37 B $ 5.31 B $ 5.02 B $ 4.62 B $ 4.24 BBase wLR Deterioration Mean $ 5.40 B $ 5.60 B $ 5.80 B $ 5.97 B $ 6.15 B

Rapid Growth wLR Deterioration Mean $ 5.36 B $ 5.26 B $ 4.82 B $ 4.08 B $ 3.15 BReduced Mkt Shr Mean $ 5.45 B $ 5.73 B $ 6.04 B $ 6.38 B $ 6.76 B

Severe Earthquake Mean $ 4.20 B $ 4.43 B $ 4.70 B $ 4.99 B $ 5.32 BLess $1.6B Surplus Mean $ 3.81 B $ 4.05 B $ 4.33 B $ 4.64 B $ 5.00 B

Less $1B Surplus Mean $ 4.33 B $ 4.48 B $ 4.68 B $ 4.90 B $ 5.16 B

Year-end

If planned results are achieved and no shocks are experienced, the company remains healthy in all scenarios

Growth is the more detrimental situation, magnified by deteriorating results

Subtracting Surplus has a proportional impact on results

5

99% (1 in 100) Probability of Surplus over 5 YearsAll Scenarios

Scenario Probability 2010 2011 2012 2013 2014Base 1 in 100 $ 2.08 B $ 1.06 B $ 0.92 B $ 0.42 B ($ 0.35 B)

Rapid Growth 1 in 100 $ 2.04 B $ 0.71 B ($ 0.06 B) ($ 1.42 B) ($ 3.33 B)Base wLR Deterioration 1 in 100 $ 2.07 B $ 1.01 B $ 0.78 B $ 0.15 B ($ 0.86 B)

Rapid Growth wLR Deterioration 1 in 100 $ 2.03 B $ 0.65 B ($ 0.29 B) ($ 2.10 B) ($ 4.88 B)Reduced Mkt Shr 1 in 100 $ 2.12 B $ 1.13 B $ 1.03 B $ 0.61 B ($ 0.13 B)

Severe Earthquake 1 in 100 $ 0.87 B ($ 0.16 B) ($ 0.31 B) ($ 0.82 B) ($ 1.63 B)Less $1.6B Surplus 1 in 100 $ 0.48 B ($ 0.54 B) ($ 0.68 B) ($ 1.18 B) ($ 1.95 B)

Less $1B Surplus 1 in 100 $ 1.00 B ($ 0.11 B) ($ 0.33 B) ($ 0.91 B) ($ 1.79 B)

The 2010 loss of Surplus is relatively high– Greater than 60% loss in even the Base Case

Rapid growth with deteriorating results is the worst-case for the timeframe

Removing $1B creates a 1 in 100 chance of insolvency in 2011

6

What Problem Are We Trying To Solve By Allocating Capital?

Financial markets

Cost of capital

Accept investments, but are we receiving enough return for the risk?

Reject investments, but the return compensates well for the risk and would lower the cost of capital

7

Benefits of aligning risk management with financial management Improves operational and financial decision making

Supports profitable growth– Identify each business segment’s contribution to enterprise risk– Riskier business units consume more economic capital (more

risk – more capital)– Benchmark performance relative to capital consumed

Risk-adjusted returns

Drives capital efficiencies– Optimizes the deployment of capital

Framework for hedging/reinsurance

8

2%Prob.Net

2%Prob.Gross

Aligning risk management with financial managementExample of hedging strategy

Gross Economic Capital

Gross Expectation

Income$0

Hedging reduces volatility By giving up some upsideand expected profit

(cost of hedging)In exchange for downside protection

Net Economic Capital

NetExpectation

Freeing up capital