jim rozsypal partner risk management practice - ernst & young erm symposium focus | support |...
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Jim RozsypalPartner Risk Management Practice -Ernst & Young
ERM Symposiumfocus | support | accelerate
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Agenda
Issues and trends in emerging risk management practices
Best practices and implementation challenges
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Competing Pressures on Management
Management must reconcile differences of views among key constituents
Differences in focus and perspective can lead to conflicting actions
Rating Agencies and Regulators
Investors
Risk Default on Obligations
Loss of Value
Capital Amount of Net
Assets Value of Investment
Performance Accounting Returns Return on Investment
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Sophistication
Sta
keh
old
er
Valu
e
Insurance Legal
Treasury
ERM
Most companies are positioned here with
leading edge companies moving up the
continuum.
Banks are leading the pack ; and will continue to
improve as they rush to meet Basel by 2005/6
Risk quantification, capital measurement, KPI and KRI Measurement Alignment with balanced scorecard and broader organization
measures.
Enterprise-Wide Risk Assessment
RiskSpecialization
RiskManagementIntegration
Value / RiskOptimization
Credit
Risk Management Continuum Market Trends
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What are Companies doing?
Building a bridge across risk silos:
—Realigning management responsibilities to facilitate integrated discussions of risk across the enterprise
—Aggregating risk through common issues and exposures
—Aggregating risk through capital measurement
Strengthening the management of non-financial risks:
—Putting accountability for these risks back in the business
—Implementing operational risk management frameworks
—Developing internal control assessment methods, tools and processes supporting compliance with Sarbanes-Oxley controls certification
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Steady Movement Toward Integrated Risk Management
Credit Risk Credit risk policy and limits Counterparty hierarchy definition Internal ratings methodology Exposure and default probability
measures Stand alone and portfolio credit
risk Operational/Business Risk Risk control policy and framework Business risk definition and risk
assessment Measurement methodology and
assumptions
Market Risk Market risk policy and limits Valuation and risk measurement
methods Market data and forward curve
modeling Stress and scenario testing FAS 133 issues and
considerations
Economic Capital Measurement
methodology Risk Integration Capital Allocation
Proactive Portfolio Management
Risk adjusted performance measurement
Risk based pricing Risk management
strategies
Risk Management Technology Infrastructure
Integrated Risk Policy Framework
Insurance Risk Underwriting and pricing policies Actuarial and financial modeling Loss/Reserve valuation methods Stat/Gaap/economic earnings
reconciliation
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Capital Management, Performance Measurement Alternatives
Determining capital adequacy Supporting risk-adjusted return
measurement Evaluating customer, product
and business risks, capital consumption and profitability
Supporting marginal pricing
Assessing adequacy of business returns
Business planning and financial forecasting
Evaluating strategic investments
Linking to reward framework
Best suited for:
Accounting BasedMetrics
External Risk Capital
Requirements
Bottom-up
Top-down
Internal Economic Capital Process
Measures of Risk and Capital Adequacy
Single Period Multi Period
Measures of Return Adequacy
Economic Driven Metrics
Financial Performance Metrics
ROEROIROA
RegulatoryRating Agency
Volatility ofAsset/Liability Values
Earnings Volatility
Economic ProfitEmbedded Value
Shareholder Value AddedAppraisal Value
Best suited for:
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Trends in Risk Measurement and Performance Reporting
Greater interest in more aggressively managing capital and returns due to stakeholder pressures
Availability of company-specific economic capital measures of growing importance in rating agency discussions
Move toward common performance measures, cutting across an enterprise and allowing all businesses and managers to be evaluated on a consistent basis
Numerous alternative performance measures are in use:
—Clear trend toward “economic” measures, away from accounting measures
—Consensus emerging around “Risk Adjusted Return on Capital”
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Emerging Best Practices in Methodology
Market value measurements increasingly viewed as the best conceptual framework, despite practical and management challenges
Recognition of limitations of regulatory/rating agency risk measures as drivers of business change
—Excess regulatory/rating agency capital viewed as a cost of doing business
Risk and capital measures more commonly based on earnings volatility, rather than insolvency considerations
Growing interest in separation of investment and business activities for capital allocation and performance measurement
Trend toward use of hurdle rates specific to each business unit’s earnings risk profile
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Emerging Best Practices in Management Processes
Banks have been doing it longer, offering both good and bad experiences
Many insurers are designing and implementing RAPM, but far fewer have been successful
Rapid integration into management processes is crucial, including:
—Quarterly performance reporting
—Business planning
—Incentive compensation programs
—Rating agency discussions
—Pricing methodologies
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Implementation Challenges
Data, Systems, Resources and Processes
— Relevant data for a rapidly growing business/enterprise
— Financial modeling expertise, adequacy of resources
— Dealing with dependencies on other management processes, e.g., planning, reporting
— Institutionalizing an efficient process
Change Management
— Getting real buy-in
— Integrating into decision making processes, incentive compensation programs
— Communicating with stakeholders, e.g. rating agencies and analysts
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Implementation Challenges
Methodology
— Selecting among measurement alternatives to compare heterogeneous businesses
— Reconciling to GAAP results
— Knowing when to stop drilling down
— Many complex technical issues